The big four banks have suddenly found that money is getting more expensive and their customers – that’s you – will pay the price.
The cost of wholesale funding, or selling debt – which banks use to supplement deposits to help finance their operations and manage risk – is at a two-year high and showing no signs of decreasing as world markets, including the credit markets, switch to gloom mode.
Typically, the banks get one-third of their money by selling commercial paper – bonds – by promising to repay the money at a margin over a benchmark market rate. Commonwealth Bank went to market in January at 115 basis points over the benchmark, up from 108 basis points for a similar offering three months before and up from 90 basis points at the same time a year ago.
When borrowing gets more expensive, the banks have to look for cheaper funding elsewhere to protect their stratospheric earnings and keep their shareholders happy. (The Commonwealth Bank, Westpac, National Australia Bank and ANZ Bank made record combined profits of $28.6 billion last year, with average earnings growth of 5.7%).
The oddity is that because interest rates on deposits are low and savings are increasing, the banks’ cost of funding actually improved as the funding mix changed. That situation is unlikely to last if the banks increase their rates, as money will be diverted from savings to meet the higher cost.
The banks also sold sizeable chunks of shares in 2015 to meet upcoming changes to prudential regulation, according to Reserve Bank of Australia (RBA) data. The additional capital increases the cost base of banks as equity is a more expensive form of funding than debt.
The industry watchdog, Australian Prudential Regulation Authority (APRA), wants to force the banks to fund themselves with more long-term debt. The aim will be to get banks to maintain a stable funding profile – called the net stable funding ratio – to limit the over-reliance on short-term, wholesale funding that can vanish quickly in a crisis, and APRA wants the rules in place by 2018.
“Some further lengthening of Australian bank maturity profiles is likely to be needed over time to truly strengthen their funding resilience,” APRA chairman Wayne Byres told an actuaries event in Sydney in January.
However, that also will push up banks’ funding costs, which, naturally, they will pass on to customers.
“There will be an extra cost to consumers if we have a lot more long-term debt,” Paolo Tonucci, group treasurer at Commonwealth Bank of Australia, told The Sydney Morning Herald.
This comes on top of some already big moves by APRA to ensure the safety of the financial system.
APRA last year directed banks to restrict the growth of lending to property investors to 10% a year and requested lenders increase the amount of capital they hold against their residential mortgage exposures to between 25% and 30%, up from about 16%.
Commonwealth Bank of Australia Chief Executive Ian Narev said at the time the obvious effect of the higher capital requirements would be lower shareholder returns.
“As you carry more capital and wear more costs, you are going to get a moderate decline in profitability,” he said at the bank’s announcement of a record $9.14 billion full-year profit.
Increasing the cost of money will in turn push up household debt in Australia, which has grown at an annual rate of 10.3% over the past 20 years and now stands at more than $2 trillion, according to a Bankwest Curtin Economics Centre study entitled Beyond Our Means? Interest payments now absorb about 9% of average household income, up from only 6% in the mid-1990s.
The good news for consumers is that the RBA may ease the decision for the banks by cutting official interest rates again, which will encourage the most indebted households in the world (that may include you again, sorry) to keep borrowing. But if official rates remain unchanged, it may be a good time for investors to consider their options.