How much profit is enough

How much profit is enough?

20 August 2010

A disturbingly large number of Australians, almost 20 per cent, apparently believe that the larger a bank’s profits, the safer the institution. At least that’s according to a recent research paper from the Australia Institute.

Even though solid bank profits reflect the Australian banking industry’s success in weathering the affects of the GFC, isn’t it time to ask: how much profit is enough?

Yesterday the ANZ announced that its nine month profit had risen 26% to $3.6bn. Last week, the CBA announced yet another annual record profit and dividend: $5.66bn.

By any measure these are huge numbers. But are they too big?

To answer this question we need to consider the size of the profit relative to the size of the bank. When we do, the result is startling.

CBA’s $5.66bn profit actually equates to a return on shareholders’ equity (ROE) of 18.7%. Put another way, for every $100 invested in CBA shares, the bank generated profit for its shareholders of $18.70.

That’s an excellent return for shareholders. But are profits of this level really needed to sustain the safety of the big banks?

Compare this with the position of credit unions and building societies.

These mutual organisations are regulated on exactly the same basis as the big banks and come with the same government guarantees on retail deposits. In many respects they are more ‘risk adverse’ than big banks, because they don’t get exposed to risky international and corporate banking ventures.

The big difference relates to profits: credit unions and building societies don’t have external shareholders to pay. So instead of maximising profits to pay out inflated dividends, they deliberately return profits to members through better interest rates, lower fees and better service.

That’s the big difference.

The recent experience of US banks is proof that high profits are no guarantee of safety in finance. Big profits don’t necessarily mean more safety. But they do mean inferior interest rates and higher fees. Just look at the cost of your bank credit card.

Not everybody appreciates this. So the Australia Institute has called for Australians to be better educated about the financial system and the options available to them.

If you’d like to know more about what we do and how we work, please ask. We’d love to talk to you.

Credit unions and building societies have an obligation to ensure the safety of members’ money and provide trusted financial advice.

After all that’s what we’re for.