In light of the savage downgrading by ratings agency Standard & Poor’s, are Australian banks really safe for depositors? While my answer to that question is an absolutely unqualified yes, I raise the question because just before the downgrading, I had a deep conversation with a top Australian banker about just how his bank would handle a global banking crisis.

The combination of that conversation and the Standard & Poor’s ratings downgrade made me realise that S&P is delivering to Australian banks a much needed wake-up call which bank CEOs ignore at their peril and to the peril of Australia.

And just to underline that this is a serious matter, the German-based global giant Siemens is establishing its own bank because it does not trust the solvency of the major European banks. The major Australian banks now have the same rating as some suspect European banks. While that says more about the fear inside the US-based ratings agency about the impact of bank downgrades, it again underlines our longer-term vulnerability.

Another long-term warning comes from the sharemarket, where the high yields on Australian bank shares show that international investors are worried about our banks’ ability to maintain profits in the new world of global banking.

Australian banks have been money-making machines because they have paid low rates to bank depositors and supplemented their consequent low Australian deposit base by borrowing between 40-50% of their funding requirements from the global wholesale market. (It’s currently around 40%). The banks have then used their fund avalanche not so much to support businesses, but to fund houses. Australian dwellings have become among the most expensive in the world because of the widespread availability of bank credit.

What Standard & Poor’s is telling the bank CEOs, Treasurer Wayne Swan and the Australian public is that it is highly likely that longer-term this game can’t continue. Because of the deep problems in the European and US banking communities, plus the demand for funds in Asia, massive wholesale bank borrowing to fund housing markets will not be available unless you are prepared to pay much higher rates of interest.

Right now, the wholesale banking market is shut down so we can’t fund our banks, but we clearly expect it to open again. I asked my top banker what happens if it stays shut for an extended period — say a year or two. He points out that most of the large Australian banks have borrowed over three years so they will be impacted gradually. When wholesale funds become due for rollover next year, the impact will be minimised because demand for funding from businesses is low and housing is not buoyant.

Moreover, the strong rise in local deposits has kept the banks very liquid. And the banks know that in the superannuation movement there are substantial funds which could be tapped with higher rates if necessary. And if all that proves to be insufficient, there is the Reserve Bank as a back-up.

While that is a good plan for the short term, it is not a good plan for longer-term funding. First of all, scrambling for superannuation funds in a crisis would be very expensive. Most of the big public superannuation funds do not have a “bank deposits” classification because the funds can’t get commission on them. As interest rates fall we are beginning to see the self-managed funds — which control 30% of the superannuation market — switch to equity-style securities that offer higher yields. A few more deposit rate reductions will accelerate that trend and that money will not be easy to get back.

The wake-up call to Australian banks requires them to become less dependent on wholesale bank deposits and begin to fund much more of their loan book at home. Secondly, banks will need to be much more active in funding businesses that create jobs to generate the capital city employment needed to enable homeowners to service their loans.

And finally, the banks better hope that the mainland Chinese cutback in apartment buying is not a signal for a wholesale mainland Chinese withdrawal from our apartment markets in Sydney and Melbourne. Then we really would have trouble.

*This article was originally published at Business Spectator