Economy

Oct 25, 2011

Bartholomeusz: banks battening down for funding freeze

According to Australian Prudential Regulation Authority chairman John Laker, bank funding markets are already demonstrating some crisis-like features.

Stephen Bartholomeusz

Business Spectator commentator

Over the next week, three of the major banks will file their full-year earnings reports. Throw in Commonwealth Bank, which has already reported, and it is a reasonable assumption that headline earnings numbers approaching $25 billion will dominate popular discussion. Of greater near-term consequence, however, will be what the banks’ chief financial officers have to say about their funding positions as the global financial sector lurches through a new bout of European-inspired instability that could easily turn into another full-blown global financial crisis. In fact, according to statements made by Australian Prudential Regulation Authority chairman John Laker to the Senate economics committee last week, bank funding markets are already demonstrating some crisis-like features. Apart from some discussion in the economics blog macrobusiness, the significance of his comments about the Australian banks’ preparedness for another crisis appear to have been largely overlooked. Laker wasn’t being alarmist. Indeed he went out of his way to be reassuring about the state of the majors, saying the financial condition of the system was sound, tier-one capital was at record levels, the system’s exposure to short-term funding markets had been significantly reduced and liquidity levels significantly increased. All that is true. By global standards, the major Australian banks are very conservatively positioned. They are strongly profitable (a good thing in the event of a crisis), they have reduced their reliance on wholesale funding by increasing their holdings of deposit and they have "termed out" their funding structures. A period of weak credit growth has also helped. Household savings are up at historically high levels and borrowing by households has been growing at its lowest rate for probably 20 years. Business lending has actually shrunk, which probably reflects a mix of risk-aversion among businesses and a tougher approach to business credit by the banks. In any event, the modest credit growth means stronger balance sheets and smaller funding requirements that would otherwise have been the case. The direct exposure of the Australian banks to the European economies and sovereign debts under pressure is also quite modest. Laker said their exposure to the broader euro area was less than 2% of banking system assets. If there is to be a banking crisis as a result of events in Europe, the obviously vulnerable banking system is Europe’s, although there are some concerns, perhaps overstated, about the exposures of the big US banks. Australian deposit-taking institutions aren’t, however, completely insulated from the kind of broader market turbulence Europe could trigger, and indeed has already triggered. Laker said the majors were well aware of the potential for indirect impacts via any disruption to or closure of global funding markets along the lines of those experienced in 2008. While short-term funding markets remained open and accessible to the Australian banks, pricing is higher than it was earlier this year. More disconcerting, according to Laker, global markets for unsecured longer term debt were regarded as "effectively closed". They aren’t actually closed -- banks can raise longer-term wholesale funds -- but the spreads have blown out to such an extent that to issue into them would be interpreted as an indication of stress. In Laker’s view, the stronger funding and liquidity structures the Australian banks have built since the last crisis means they could survive another closure of wholesale debt markets, but he qualified that statement by saying they "could survive a period of months". If a disruption to markets extended into next year it would start to coincide with wholesale debt maturities, he said, and the banks would be forced to raise funds in a market likely to be crowded by sovereign borrowers and offshore banks. Earlier this month, federal Parliament legislated to allow Australian banks to issue covered bonds -- bonds where the investor ultimately has access to the underlying cash flows of the assets supporting the bonds. That approval was mildly contentious, given that it means Australian depositors will no longer have a priority claim on all a bank’s assets. Because of the security supporting them, however, covered bonds are regarded as safer than ordinary issues of bank bonds and therefore are likely to be cheaper than conventional bank debt to issue and to find investors even in nervy markets. Already, within weeks of the legislation being passed, the majors are scrambling to make issues. Laker linked that to the debt maturing next year and said the banks were also pursuing funding securitisations to head off any future funding pressures. There would be other measures that APRA, the Reserve Bank and the federal government could reinstate if today’s volatility in bank funding markets developed into another full-blown financial crisis, but the smartest thing the highly rated Australian banks can do to protect themselves at this point is to do what they have done since wholesale markets reopened after the worst of the crisis and ensure they raise the required funds well before they are needed. The next week will provide an insight into the extent to which they have done so and the degree to which the Australian system remains vulnerable to another full-blown financial crisis sparked by the sovereign debt crisis within Europe. *This article was first publish at Business Spectator

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