Data Diary

Australian banks reliance on international capital markets

Posted on 14 May 2010

I started this post some months ago with the intention of digging deeper into our Australian banks reliance on the international capital markets.  In particular wanted to get an understanding of what the impact of the government guarantee funding facility would be.  I’ve been dragging my feet, so in an effort to get it out of the in-tray, herewith the thinking to date:

Australian banks trade at a premium to their international peers

Our banks are trading expensive relative to their global peers (like this simple analysis from Citibank – via Alphaville here).  There are many valid arguments put forward to support this – such as “Australia has…”:

• A stable (and consolidating) banking oligopoly
• A mortgage market structure that has historically lead to low default rates
• Recent population growth at ~2.5% per annum
• An economy leveraged to the industrialisation of China and India

On the other hand, an oft cited risk to our privileged position is that as a capital importer we are reliant on the good graces of our creditors – something that becomes more fragile with national borders getting firmer by the day.  How are our banks exposed to the rising cost of risk?

A snapshot of the Australian majors balance sheets

It’s a big question, and not one that can be answered in a short(ish) note.  Just want to focus on the most obvious aspect of bank funding in this respect – the wholesale debt market.  Following is a quick summary of the four majors balance sheets:

In short, ANZ has 20% of its loan book funded in the wholesale markets (“Bonds”), CBA 22%, NAB 35% and WBC 33%.  That’s not insignificant in itself.  Whether ‘deposits’ are directly exposed to international capital flows is something for further investigation – at the very least, rising risk premiums will flow through to deposit rates eventually.  But let’s leave deposits for another day.

How much of this wholesale funding comes from international capital flows?

According to the RBA, Australian financial institutions have ~$320bn in offshore funding – something approaching 70% of their wholesale long term funding requirements.  We can get a glimpse of the make-up of this across the market via the government guaranteed funding scheme.  At it’s closure in March this year, there was approximately ~$140bn in long-term funding guaranteed.  A breakdown of this guaranteed debt by borrower is:

And then looking at the maturity profile of the guaranteed debt:

So what does this tell us about our bank’s international funding requirements?  Not a whole lot other than it looks like going into the end of calender year 2011, the banking sector will be hoping for a favourable pricing environment for the refinancing of a reasonable lump of debt (~$60bn) across 2012.

Wholesale funding requirements of a major trading bank

Absent the bandwidth to analyse each of the majors individually, here is a summary of CBA’s wholesale funding requirements:

CBA has a reasonable slab of debt that needs to be refinanced over the next two years – $26bn represents ~25% of its total wholesale funding requirement.  Note too that amount is five times the volume of guaranteed debt.  If we were to extrapolate that to the rest of the sector, the total wholesale funding requirement looks more like $300bn (of course, given the sample size it’s a highly dubious extrapolation – but point taken on it being significantly bigger than $60bn).

But does this mean the banking sector is unduly exposed to international capital markets?

Well using CBA as an example, the simple answer would be no.  At just over 5% of the aggregate of its loans outstanding – the wholesale refinancing requirement of CBA for the next 2 years is manageable.  The impact of higher funding costs would certainly impact margins – but it is not a game-changing event in isolation.  (Note what applies to CBA may not apply for others…in the interests of expediency I’m using CBA as a litmus test.)

But cost of funds will rise

The point is that rising risk premiums in the international capital markets will flow through domestically.  If international capital costs are higher, local deposit rates will ultimately follow.  Bank margins will be squeezed.

Conclusion

Does this all mean Australian banks are unduly exposed to international capital markets?  Based on the toe in the water, the answer is no (unless ‘deposits’ are hiding some international capital flows).  The wholesale funding requirement looks like it is manageable even under stressed conditions.

However, the global cost of risk is on the rise.  Not necessarily due to inflation pushing rates up (the deflation/inflation debate is one that is yet to be won) but simply because risk is being repriced.  No amount of money printing will solve this – it, in fact, reinforces the trend.  This is the reason why Australian banks have been forced to ratchet up loan rates ahead of official rate rises.  It is a trend that has yet to run its course.  And it alone is sufficient to step warily around bank earning forecasts for some time to come.

Epilogue – Expect the government guarantee scheme to be reintroduced

The scheme commenced on 28 November 2008 and closed to new liabilities on 31st March – existing commitments will remain guaranteed until they mature (subject to the requisite fee being paid).

Under the scheme, Australian ADI’s (and qualifying others) got deposits and funding guaranteed by the Commonwealth Government for up to 5 years. A fee of between 70, 100, or 150 bps per annum is payable on the guaranteed amounts subject to the rating of the entity receiving the guarantee (respectively AAA to AA-, A+ to A-, BBB+ or below and unrated).

This has been a good little earner for the government – it booked $103m in February ($111m in January) and $1.3bn to date under the scheme. The fee structure is sensitive to the exchange rate on foreign currency denominated borrowings – that is, the fee is paid on the face value of the foreign currency amount borrowed (AUD down, fees up).

Given the perceived cost of guaranteeing bank debt is low, while the revenue is large enough to be meaningful, I think we can expect the government will be credit wrapping bank debt again in the future – regardless of whether it distorts Australia’s capital markets.