Would not a foreign bank want to get a higher IR return by lending to Australians rather than a lower IR return lending to Amercians?
Banks are in the business of risk adjusted return, a concept that can begin to be understood using the equation below.
Expected Profit = Probability of win * Size of win - Probability of Loss * Size of Loss.
If the outcome is >1, then the risk adjusted return is likely to be in profit.
Many things effect probabilities and size of wins and losses when lending money to people in foreign economies.
- foreign exchange risk (addressed above by Yield Matters)
- inflationary devaluation of currency
- economic growth
- political environment (effect of tax law, unions, environmentalism, and socialized services on business growth)
- national savings
- current account
- private and public foreign debt
Some of the main concerns foreign banks have about investing in Australia are:
- Australia's economy and dollar are viewed by the global community as highly sensitive to global demand for commodities such as coal, minerals, and agricultural products. If the price of these are going up, our economy will be seen as benefiting. Commodity prices are seen as comparatively volatile, so performance of investments in commodity economies can have high beta - volatility (or risk). Most investors seek low volatility. This volatility is expressed through the value of the AUD relative to the USD and other currencies.
- even though Australia has low public foreign debt, it has high private foreign debt (i.e. mining operations are 60% owned and financed by foreign interests, and property is now 31% dependent on foreign borrowing). The govt makes up for low public foreign debt by getting its income from a comparatively high taxation system. In fact, one of the disadvantages of a welfare state, is that the heavily taxed private sector is forced to more borrow funds from overseas (there's no free lunch). This adds to a high debt to gdp ratio, which is not healthy for the economy in the long term. You can understand it as a household having borrowed heavily for investment properties but having very little reserve income capacity to service the debt if rates move up.
- low national savings. This is a sign of country that consumes a high amount of goods and services compared to those it produces, either directly or by capital investment overseas. This adds risk to investing in our economy because our local banks have to borrow more from overseas to lend to us for whatever purpose. This makes us more at risk to whatever happens in global financial markets, such as the current credit crisis.
- when our interest rates are high, the govt is trying to restrain economic activity (to curb inflation) which restrains the current account from growing. If the bank constricts the economy too much, a recession is more likely, and that would add to the risk associated with a bank investing in Australian mortgages. We also have low national savings because we have driven our property prices up so high (and borrow significantly from overseas to do so) that much of our savings now flows overseas as interest. House prices are over 7 times the annual median wage. This is as boz says one of the highest rates in the world.
The take home message is that when an investment pays a high return, it is always because there is high risk. So high returns are not what savvy investors and banks look for.
All investors should seek high
risk adjusted returns.
Though Joe Public does not know how to consider all aspects of risk appropriately.
