Australia's big banks are resorting to threats in the face of a possible new bailout policy. But how profitable are our banks? And, for that matter, how safe? On both counts, the reality falls short of the image, writes Ian Verrender.

Call it an omen.

When German stayer Protectionist shot to the fore last Tuesday and bolted home, it perfectly captured the mood pervading the boardrooms of our major financial institutions.

They've been mumbling threats and shooting dark glances for months. But on cue, as they unveiled yet another round of stellar earnings results, the chiefs of our major lenders fired another volley over the heads of regulators.

This month, former Commonwealth Bank boss David Murray will deliver his verdict on exactly how much responsibility our banks - and their owners, the shareholders - need to take for any future mistakes.

Right now, the Big Four are in the happy position of being able to reap all the benefits when times are good, safe in the knowledge that should things sour, taxpayers will ride to the rescue.

No other business is afforded such delightful terms and, not surprisingly, our bank chiefs would very much prefer it if the protectionist paradise they now inhabit remains exactly as is.

It wasn't always this way. Before 2008, when the global financial system came close to imploding, there was always an understanding that governments would try to maintain order in the financial system. Exactly what that meant had never been spelt out.

But the $120 billion taxpayer bailout of Australia's banks during the crisis - that's the amount they borrowed using the taxpayer guarantee - changed all that. It set the bailout provisions in stone. Depositors were protected at zero cost to the banks. More significantly, the guarantees on offshore debt shifted all the risk from bank shareholders to taxpayers.

The end result? Banking, the riskiest business on the planet, has become the safest place to take a stock market punt.

Contrary to popular belief, Australian banking did not sail through the financial crisis unscathed. And despite the incessant claims from our top financiers, Australian banks are not safer or stronger than those in the rest of the developed world.

Without the intervention of the Federal Government, they all would have encountered serious difficulties.

St George was gone. So was BankWest. They were snapped up by Westpac and CBA, while a purchase of the listing Bank of Queensland was thwarted only by the Federal Government bailout. And as I pointed out last month, Macquarie came perilously close to tanking as it desperately lobbied for government protection.

Of the Big Four, each and every one of them was faced with the near impossible task of refinancing huge offshore loans at a time when no-one was willing to lend a cent, at least not on ordinary commercial terms.

Our financial system faced a catastrophic meltdown.

In his interim report earlier this year, David Murray made it plain that he didn't believe the hype about the impregnability of Australia's banks and the argument that, given they were so strong, they should not be subjected to harsh new global rules.

From Murray's perspective, they ranked about middle of the table on the global banking scale.

Since then, he's consistently dropped hints that our banks need to put aside more cash to cover themselves in the event of another crisis.

And if his Financial System Inquiry follows the lead from Canada, it could be that bondholders and investors rather than taxpayers will be forced to cover the costs of any future bailouts.

As far as our financiers are concerned, this is the banking version of Apocalypse Now, replete with Colonel Kurtz muttering: "The horror, the horror."

In the past week, they've upped the pressure. With NAB the only bank not to report record earnings, and with the Commonwealth on the way to breaking the $10 billion barrier, they've resorted to threats. The cost of extra protection will be passed on to customers.

But how profitable are our banks? And, for that matter, how safe?

On both counts, the reality falls short of the image.

When it comes to earnings, the Big Four have enjoyed a stellar run for four years. But lending conditions have been the worst on record. Business customers have shied away from debt. And until a year and a half ago, home loan growth was stagnant.

So how could earnings soar? Cost cutting has played a part. The overwhelming factor, however, is that as interest rates have dropped, the banks have cut their provisions for bad and doubtful debts. They've used an accounting technique to transfer money set aside to cover bad debts, and applied it straight to profits.

This year, accounting firm KPMG estimates the major banks between them have scaled back their bad debt charges by $1.6 billion.

Last year, Ernst & Young calculated they hacked $1.1 billion out of bad debt charges which investment bank UBS suggested was a primary driver behind the earnings growth.

Total aggregate bad debt charges for the big four have been whittled down to just $3.4 billion, a skinny reserve on any measure.

The spin from the banks is that this reflects their magnificent management in improving loan quality.

The reality is that once interest rates or unemployment rises, more customers will default and bad debts will escalate. That will force the banks to set aside extra cash as provisions, causing earnings to plummet.

When it comes to safety, our banks are plugged into the global system which automatically makes them vulnerable.

But, as Michael Janda last week highlighted, the offshore borrowing binge they've embarked upon in the past 25 years and the decision to feed most of that into Australian real estate has been a major factor behind the extraordinary rise in Australian housing prices.

Around 66 per cent of all Australian bank loans are tied up in mortgages over Aussie houses, hardly what you'd describe as a diversified portfolio.

Deakin University's Philip Soos has spent years charting the increasing reliance of our banks on offshore funding and their obsession with channelling it into real estate.

He questions the wisdom of a decision by global banking regulators in 2006 to downgrade property loan risk - just as the American property market was fracturing - that has enabled Australian banks to now hold wafer thin buffers over property loans.

That has left them with virtually no margin for error and allowed them to leverage themselves to the hilt.

Most economists are obsessed with government borrowings but pay scant attention to private debt.

In Australia's case, foreign private debt - the bulk of it borrowed by our banks - now stands at about 85 per cent of national output while government debt is around 20 per cent.

Government debt across the eurozone and the US has risen enormously since the financial crisis. But that's because their banks ran into trouble and transferred the debts to governments.

As a nation, we've become a one-trick economy with one major customer, shipping unprocessed dirt to China.

It's allowed us to borrow vast sums from abroad and pour it into real estate, now among the world's most expensive. And we have a cabal of banks determined to keep it that way.

It's taxpayers who now need the protection.

Ian Verrender is the ABC's business editor. View his full profile here.