APRA spills the beans

Adding to recent RBA speeches, John Laker of APRA gave a speech late last week that parted the curtain on Invisopower! more directly than I have seen before. In his opening address to the Senate Standing Committe on Economics, Mr Laker said:

Our assessment is that the Australian banking system is well placed to deal with the current market turbulence. Its financial condition is very sound. Authorised deposit-taking institutions (ADIs) in Australia are recording relatively strong levels of profitability, aided by a continuing gradual decline in bad debt expenses. ADIs arealso holding historically high levels of capital. At end June 2011, the Tier 1 capitalratio of Australian banks reached a record 10 per cent, having operated betweenseven and eight per cent for the decade prior to the crisis; the comparable ratio forcredit unions and building societies is higher again. The Australian banking system has only a limited direct exposure to the Europeancountries currently under the most severe financial pressure – Greece, Portugal, Ireland, Italy and Spain (the so-called PIIGS countries). Exposure to the broader euro area is larger, although still less than two per cent of banking system assets. The relatively small size of these European exposures suggests that any direct impactfrom pressures on one of the troubled European countries would be minimal. However, ADIs will not be completely insulated from broader market turbulence, particularly if it persists for some time. The larger Australian banks are well awareof the potential for indirect impacts via the disruption or closure of global fundingmarkets caused by a widespread investor retreat from risk. They have been there before. As it stands, global short-term funding markets remain open and accessible to Australian banks, which seem to be beneficiaries of ‘safe haven’ status, though pricing is higher than earlier in the year. However, global markets for unsecured longer-term debt are regarded as effectively closed. Spreads are sufficiently wide that no bank wishes to issue unsecured debt for fear of being perceived as desperate for funds.

This is not causing the larger Australian banks any immediate stress. Low lending growth, coupled with ongoing solid deposit growth and wholesale funding activities that are ahead of targets, mean that the larger banks have built up liquidity and can operate without access to global term funding markets in the immediate period ahead. Compared to their position in 2008, Australian banks have a substantially more robust funding profile because they have significantly reduced their reliance onshort-term wholesale funding, which has fallen over this period from around one-third of total funding to one-fifth

The strengthened liquidity positions, coupled with unused self-securitisations that can be used in repurchase transactions with the Reserve Bank of Australia, provide comfort that ADIs could survive a period of months without access to global term debt markets, provided short-term and domestic markets continued to operate relatively normally. That said, should the disruption to markets extend well into 2012, it will start to coincide with wholesale debt maturities. ADIs will then be seeking to raise funds in markets likely to be crowded by sovereigns and offshore banks. The larger Australian banks are therefore preparing to tap covered bondmarkets now that the legislation has been enacted, and to pursue funding securitisations (another form of secured funding) to assist in alleviating any future pressures.

So, in contrast to RBA rhetoric, we have an offical admission that the banks’ long term offshore funding sources are already shut. Bravo for coming clean. Now we can make some sense of the banks’ CDS pricing, which has been indicating stress of some sort for months.

As for the solutions, I support covered bonds for the very reason that they are described here. They help the banks to fund in private markets, especially (hopefully) in periods of stress (though the recent European experience has shown covered bonds are not immune).

But self-securitisations are another matter. This is the opaque repo market set up by the RBA during the 2008 crisis that allowed the banks to repo, as one analyst put it, ‘coconuts’ with the RBA. Without tranparency in that market, we remain somewhere too close to public risk and private profit in my view. After all, is “ADIs will then be seeking to raise funds in markets likely to be crowded by sovereigns and offshore banks” really a reason for opaque emergency facilities?

We need rules for this stuff.

Open Statement SE 20 October 2011

Comments

  1. Bravo APRA, though the motivation seems to be CYA.

    However, global markets for unsecured longer-term debt are regarded as effectively closed.

    That said, should the disruption to markets extend well into 2012, it will start to coincide with wholesale debt maturities.

    What is left unsaid is that a lot of Swanny guaranteed debt will mature in 2012.

    So covered bonds ($150 billion) are basically a premium-free replacement to roll over maturing taxpayer insured GFC I era debt.

  2. Your interpretation is quite incorrect. The offshore funding is not shut, it just isn’t as necessary as before due to the growth on domestic savings.It is still being used though.

    What is difficult to understand about that?

    I do agree that the state should not be the purchaser of securities long term, but as a short term solution, it was an intelligent move that allowed us to keep functioning as an economy.

    On maturity, the paper will be picked up by the market. If some rollovers are needed, well I don’t expect any difficulty there either.

    Peter Fraser

    • You mean APRA’s interpretation is wrong…

      Sure it was a sensible measure, which I’ve written many times. My point is that we need some tranparency now.

      Good on you for expecting no roll over problems. Are the Australian poeple supposed to rely on your judgement?

      • I think that we have transparency.

        Do you expect the banks to have trouble finding investors to buy the rollovers, I don’t. However if they couldn’t refi every RMBS rollover on the due date, would you expect the Government to foreclose on the very banks that they strive to protect?

    • “The offshore funding is not shut, it just isn’t as necessary as before due to the growth on domestic savings”

      This statement is incorrect. Australia has a CAD so the only way that domestic deposits have increased is if there has been a transfer of debt to the public sector but the country is still reliant on offshore borrowings which will not be taken up domestically. The rate of increase may have slowed but not the reliance.

      • Are you serious?

        http://www.rba.gov.au/speeches/2011/images/sp-ag-170211-graph08.gif

        I’ll look to find a later graph if you’re unconvinced.

        One regional bank who I talk with is funding all lending from depositors balances, with no RMBS issues. They just are not necessary. I would expect the majors to still rely on offshore funding, but not as much as in the past.

        If you choose to walk to work and not drive, it does not mean that your car has been taken from you.

        • Nobody said the deposits aren’t flowing. This is a discussion about the big banks offshore funding needs.

          Obviously your belief that it’ll all be ok is not a tool of public policy.

          John Laker has just stood up and told the nation that the RBA’s repo facilities – that were never designed as a part of the system architecture – may be in use again next year.

          The question is HOW APPROPRIATE is that?

          • I was replying to your claim that “we have an offical admission that the banks’ long term offshore funding sources are already shut” which in my experience is simply incorrect. If banks are able to fund onshore, I have no problem with that, although I don’t think that public institutions should be long term funders.

            Offshore funding is still a very much available option for the banks, what is your evidence that it is not, other than a statement by APRA saying that the banks are not taking that option at this very moment?

        • >If you choose to walk to work and not drive, it does not mean that your car has been taken from you.

          Actually this scenario is not a positive as it sounds. The increase in the savings ratio, or non-consumption ratio as it should be named, has led to a slowing of credit issuance which, as RPData latched onto last week (http://www.macrobusiness.com.au/2011/10/rpdata-seeks-green-shoots-in-the-desert/) , is leading to falling asset values.

          So even though the banks are reporting that they are able to “fund” their loan books by deposits, what this actually means is the velocity of money has slowed significantly which is starting to flow through as a fall in wealth of households.

          I can’t comment on the funding side of the banks, but this is not a good outcome for the asset quality side of their balance sheets, as BoQ has shown over the last few weeks.

          • I don’t have sufficient time to debate every point, but in essence I don’t disagree. In particular it hurts retail. Retail can slow without affecting lending to the same degree, but it would not be common, they usually run more or less parallel.

    • Your interpretation is quite incorrect.

      How else would you interpret the following statement of the John F Laker, Chairman of APRA.

      However, global markets for unsecured longer-term debt are regarded as effectively closed. Spreads are sufficiently wide that no bank wishes to issue unsecured debt for fear of being perceived as desperate for funds.

        • Well I agree, bonds would be difficult and they offer very little security/confidence for investors at the moment, but bonds are not the only funding means, and as far as I’m aware Laker did not restrict the point to bonds.

    • “However, global markets for unsecured longer-term debt are regarded as effectively closed.”

      How would you interpret that?

  3. Diogenes the CynicMEMBER

    Bravo. We need the bright light of transparency over here to uncover all of the defections.

    The issue is still not being directly addressed, the language refers to disruptions not crisis. A crisis in Europe with banks falling over and raging contagion, bank runs etc would definitely mean the closure of long and probably short term debt markets for an extended period of time. Some blog articles are saying that sovereigns will be unable to raise debt or even rollover existing debt in this environment. How do our banks survive that? Fed government guarantee, banks cut domestic lending, cut off/restrict access to deposits to protect against bank runs…time to start looking at the financial history books again.

  4. HMMM – what happened to my last post?

    Laker also said “This is not causing the larger Australian banks any immediate stress. Low lending growth, coupled with ongoing solid deposit growth and wholesale funding activities that are ahead of targets, mean that the larger banks have built up liquidity and can operate without access to global term funding markets in the immediate period ahead.” and that was kind of my point.

    • This is not causing the larger Australian banks any immediate stress

      By immediate, he meant the next 3-6 months. He goes on to say..

      That said, should the disruption to markets extend well into 2012, it will start to coincide with wholesale debt maturities.

      So basically, going into 2012, banks will have to replace the longer-term debt that are maturing with covered bonds (hard limit of ~ $150 billion on that) and the rest with short-term debt at a higher price.

  5. I guess if the moderators here don’t allow a right of reply, then winning a debate is quite easy for the bloggers here.

      • No – that would be completely out of character for me. I don’t play games, I just post. I noe that I can’t log in as Peter Fraser anymore. I did ask for assistance on that, but I created as new login as PF assuming that it was a glitch.

        And now every answer that I post on subject is deleted, but off subject remarks are accepted?

        What gives, is there a limit on the characters, or a problem with inverted commas – I did use them?

        It’s got me bushed, I’ve never been banned or stopped from posting on any site.

    • HMMM – what happened to my last post?

      Laker also said “This is not causing the larger Australian banks any immediate stress. Low lending growth, coupled with ongoing solid deposit growth and wholesale funding activities that are ahead of targets, mean that the larger banks have built up liquidity and can operate without access to global term funding markets in the immediate period ahead.” and that was kinda my point.

      He was talking about “accessing” the market, not “access” to it. There is a
      difference, and I thought that you took the wrong interpretation of that remark.

      • >”This is not causing the larger Australian banks any immediate stress. Low lending growth, coupled with ongoing solid deposit growth and wholesale funding activities that are ahead of targets, mean that the larger banks have built up liquidity and can operate without access to global term funding markets in the immediate period ahead.”

        I find these statements very interesting ( and smart ). The use of the term “immediate” and the suggestion in the language that slowing lending and increased deposits are somehow separate events is quite clever, but ultimately dangerous.

        Anyone who understands how the economy actually functions knows full well that slow lending growth and solid deposit growth are linked. These are not independent events, they are in fact intrinsically linked and are only advantages to the banks in the short term.

        As people are moving their wealth out of non-financial assets then the value of bank deposits grows, but at the same time the opposite occurs to the “value” of those non-financial assets. In the short-term this seems positive for the banks but, as I stated above, this is actually not good past the short term because it leads to a fall in the asset quality for the banking sector as the value of the assets that back their loan books begins to fall.

  6. bingo – there goes another post. Whenever I post on subject you delete it – surely that is not an open debate.

  7. Thanks for the report H&H.
    DTC forsees scary stuff! Hopefully it won’t come to that.
    It is somewhat comforting that the banks and the RBA have been sailing the difficult waters well so far.
    The difficult part is that Australia has had the same private debt binge as everyone else and that was not contained in time – like they never are. Everyone loves a good party and it’s hard to put a gentle end to it.

  8. If the Aussie banking system is so strong how come the govt had to bail out the banks during the GFC. How come short selling was banned?

    • It is banks generally. the system is flawed, and that flaw applies to all banks everywhere.

      If the government sets the benchmark for the banks, they are encouraging the banks to take a level of risk which in the governments view is acceptable, and it will give a level of support to the community through lending. Banks who don’t take the risk become uncompetitive and run the risk of being taken over.

      When everything falls apart, strong banks become affected by counterparty risk – that is just unavoidable.

      It depends on your philosphical view, but it is almost impossible to separate banking from the government for every moment of every day forever. They come together in times of dire need, even though all think the banks are private enterprise, they are not so private that they can exist entirely without government support forever.

      To make them much stronger, banks would have to work with a much greater capital base with much higher spreads. The higher spreads means higher rates for you and I when we borrow, so you will appreciate the political impasse. People complain about banks when they charge a high rate of interest, and it makes our commerce less efficient by comparison globally.

      The weaknesses exposed by the GFC can be countered, but at a cost to the public, which they won’t wear, so here we are.

      • How much are we (taxpayers) charging the banks for this ‘support’?

        Is this a good deal for taxpayers?

        How much actually at risk if (when) our support is needed?

        • Currently we don’t pay anything, but the risk is real nevertheless.

          On the flipside, you wouldn’t want to live in a country without a banking system, they are dirt poor and have very low living standards. Even if the thought of banking offends you, they are what has made the Western nations stronger, but a strength in a system is also a weakness that can be exploited under the right conditions.

          I hope that isn’t confusing.

          • I have nothing against banking per se, and I don’t think I came across that way in my comment. I have an issue with poor governance and public backing of poorly run businesses.

            Correct, I wouldn’t want to live in a country without a ‘banking system’. Just the same as I don’t want my government giving explicit guarantees for private businesses for unspecified amounts of money.

  9. I don’t claim to know, but further evidence of wholesale funding squeeze are the big four selling RMBS paper in the US recently. There might be a lot of liquidity around, but who is willing to lend these days? Also, on the savings … what’s the point of having a percentage without knowing the amount. Also, the banks can’t fund all the projects we have at the moment so more evidence. If you’re a SME try to get funding is another piece of the puzzle.

    Thanks for the post H&H.

  10. In defence of Peter Fraser, he always eminently sensible and rational and his posts are very worthwhile.
    However my guess is Peter doesn’t think in DeepT’s macro scale so he misses DeepT’s point…JMO Peter because DeepT is correct.