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.