Figure 1: Net Interest Margins.


Figure 2: Profitability of Australian banks: The trolley squeaks with the weight of price increases.

Inflation occurs when there is a general rise in prices: people spend more on the same amount of goods and services than they did, say one year ago. Inflation, left unchecked, can harm the economy. It drags down households’ standard of living which can in turn drive up wages, leading to more inflation.

No body benefits from inflation and therefore Reserve Bank of Australia’s (RBA) intervention is essential: price stability is a precondition for sustainable economic growth. RBA has ratcheted up interest rates to 4.10%. to contain inflation to within 2-3%. Further increases cannot be ruled out causing further pain to borrowers, including mortgage holders.

The large profits reported by major banks brings their conduct into sharper focus as many households struggle with cost-of-living pressures.

An important question is: Does the hiking of the interest rate by RBA enrich the banks?

Two indicators can be relied on to answer this question. First is the net interest margin (NIM). It measures total interest received (i.e. by people paying interest on loans) minus total interest paid (i.e. by banks paying interest on deposits). The net margins have spiked recently, after a long period of decline (Figure 1).

Second, is the return on equity (ROE). Figure 2 shows a pickup in ROE, but the longterm trend is one of declining profitability. ROE of Australian banks was lower when compared to the average of a group of countries (UK, USA, Canada and New Zealand).

For example, ROE of the former in 2021 was was 13.48% compared to the international banks’ average of 20.24%. The conclusion is that Australian banks enhanced their profits in the post pandemic period to reverse long term decline in profitability; despite this, their returns were below the average of the referenced countries.

High profits posted by banks are not necessarily bad if some of these are ploughed back into business to expand capacity, raise productivity and improve services. Anecdotal evidence suggests this has occurred. High profits may be unfair, but everyone gets more from a bigger pie!

Imposing taxes to claw “excessive/unfair” returns of banks and the corporate sector is fraught. Taxing profits may impair Australia’s ability to import foreign capital to supplement its meagre domestic savings.

Market forces and competition can be relied upon to normalise profit levels, except in case of monopolies. Also, fairness can be enhanced if the give-aways to the well-off are wound back, such as franking credits, negative gearing and asset/income thresholds for age pension entitlements.

Subduing inflation by compulsory savings is not feasible especially when household budgets are under immense pressure due to inflation. The operating costs of businesses are likely to go up if they are forced to contribute towards the super increase for their employees. They will either pass on the costs (thus negating the anti-inflation intent of the policy) or simply close shop and lay off workers.

Profit maximisation is central to capitalism. However, there is a growing interest in developing a holistic metric to assess contributions of business to society through quadruple bottom line reporting.

But this is within the conventional economic paradigm and does not meet the high bar set by Islam in matters such as morality and fairness.