Prime Minister Kevin Rudd clearly has no idea of the dangers facing the Australian banking system and their potential to create a severe recession.

This week he threatened to treat Australian banks like oil companies if they increased their interest rates beyond the quarter of a percent Reserve Bank rise.

Yet half the Australian bank deposits come from overseas and the cost of these deposits has risen by an amount greater than the rise in Australian official interest rates.

Prime Minister Rudd claimed that the banks have large profits so can absorb any extra cost. Bank bashing has always been good for popularity, so on the surface Rudd was only doing what Peter Costello enjoyed doing.

But the game has changed. If the Prime Minster was to carry out his threat to treat banks like oil companies, then there is a risk that the 17 per cent mortgage interest rates seen during the Keating government could return with only one person to blame – Kevin Rudd.

Because the big lenders to Australian banks have lost so much money in the US, they are very nervous about who they lend to. At the moment they don’t see a great risk in Australia, but if Australian banks are unable to pass on higher costs then world lenders will sniff that the credit rating of our banks must be lowered.

In a world where every bank eyes every other bank with deep suspicion, we will be downgraded and have to pay even greater costs for our overseas borrowing – which would have to be passed on or our banks would be bankrupted.

Kevin Rudd says that bank profits are high so they should have no problem absorbing the current extra charges by shaving profits. Now is not the time to reduce bank profits by lowering margins because of the effect it will have on their ability to borrow offshore. In any event – without the intervention of Kevin Rudd – bank profits are going to be under pressure from higher loan failures. Hopefully the level of bad loans will not boost our borrowing costs.

If Kevin Rudd had been made Prime Minster a year ago and decided to attack bank profits then the fallout would have been limited to bank shareholders. In two years time, if he decides to attack bank profits again, the fall out is likely to be again limited to bank shareholders.

But right now, and until world turmoil subsides, we need bank profits to be as high as possible (consistent with proper accounting treatment) because that way we will obtain the overseas capital we need at the lowest cost.

As Alan Kohler pointed out yesterday, a CEO of one of the big four Australian banks has predicted that the US banking system’s losses will top $US1 trillion, four or five times the current level of write-offs. If he is right then the contraction of available capital in the world will be even more severe and we may face the combination of higher overseas interest rates and a credit crunch on 40 to 50 per cent of our bank funding. We don’t need Kevin Rudd to make it worse.

Of course, the Reserve bank might offset any escalation in overseas rates with lower official rates. It was reassuring to see that Treasurer Wayne Swan did not follow the Prime Minister in demanding harsh bank treatment – he does not want the “Keating” tag.

Kevin Rudd should stick to talking about things where he has knowledge. Given the critical time ahead we do not need an inexperienced Prime Minister becoming a bull in a china shop.