Banking Profitability, Bank Capital and Competition


In this Australian Centre for Financial Studies Financial Regulation Discussion Paper, Professor Kevin Davis looks at Australian bank capital and bank profitability. The evidence regarding whether banks are making excessive profits is mixed, although high market to book ratios for the major banks (stock market value of equity relative to its accounting book value) are indicative of some inadequacies in competition. In order to generate the returns that shareholders require on the value of their investments, high market to book ratios (averaging around 1.5) mean that the major banks need to target accounting returns in the order of 15 per cent p.a. or more. The majors compete with each other within that constraint.

But that leaves unanswered the question of why other competitors who should be able to operate with lower target accounting returns are not exerting a restraining influence on bank pricing and profitability. It also leaves unanswered the question of how market to book ratios for the major banks evolved to such levels with inadequate competition over many years being a prime suspect. This FRDP provides an overview of the issues, but more detailed research is needed to evaluate whether calls for greater regulation or special taxation have merit.

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This paper was prepared by Professor Kevin Davis, Research Director of the Australian Centre for Financial Studies.

The ACFS Financial Regulation Discussion Paper series provides independent analysis and commentary on current issues in financial regulation with the objective of promoting constructive dialogue among academics, industry practitioners, policymakers and regulators and contributing to excellence in Australian financial system regulation.

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