S&P thanks you for supporting the banks

On a number of occasions in recent months, I’ve pointed to the elevated cost to investors of insuring their Australian bank debt via CDS. There is a pretty clear relationship between that rising cost and European troubles. The chart above shows you what I’m talking about (the price today is 181).

CDS prices signalling something about our banking system. It’s the same vulnerability took all four big banks to the brink of insolvency in 2008 before they were bailed out by the tax payer with funding guarantees: dependence on wholesale debt.

Now, the AFR reports today that:

…the banks are less vulnerable to losing their coveted AA credit ratings after the release by Standard and Poor’s of global credit criteria that identified the domestic banking system as the world’s third-safest behind Switzerland and Canada.

Even so, the big four may still be hit with a one-notch downgrade, to AA- from AA, after it lowered its Banking Industry Country Assessment (BICRA) score to 2 from 1. A more severe downgrade of two notches, to A, remains possible but is perceived to be less likely now that Australia’s BICRA score standing has been resolved.

Commonwealth Bank of Australia chief financial officer David Craig told the AFR the most likely scenario was for the big four to be downgraded to AA-, which would not have a material impact on the price they paid for fund internationally.

Whilst I am thrilled for the bank that this is the case, I will just point out that at least one of the reasons it’s not material is that the bank remains locked out international markets for long term debt (ie it’s too expensive) so it doesn’t make a lot of difference if it doesn’t gets more expensive at this stage.

Back to the story and Mr Craig is not finished:

Significantly, S&P appeared to lift the perceived level of Australian government support for banks from “supportive” to “highly supportive”.

Mr Craig attributed this to governments and financial regulators playing key roles in protecting depositors when a bank has been in financial trouble.

Former Treasurer Paul Keating helped facilitate CBA’s rescue of State Bank Victoria in 1991. ANZ Banking Group bailed out the Bank of Adelaide in 1979, while more recently regulators helped facilitate the takeover of Bankwest by CBA during the GFC.

“There has never been a banking collapse in Australia, because deals have been done behind the scenes and depositors have never lost any money from a bank collapse,” Mr Craig said.

It is reliance on offshore borrowing that S&P remains concerned about.

“In our view, weaknesses are partly offset by domestic debt capital markets that can support the banking sector and the government and central bank, which we view as responsive and flexible to the banks funding needs”.

The AFR journalists seem to be having some fun at Mr Craig’s expense. S&P could not be much more explicit in its description of why the banks are considered both vulnerable and safe. In fact, in the actual release, they state it straight out:

In our view, weaknesses for the Australian banking sector are its material dependence on net external borrowings, which fund about 24% of domestic customer loans; and limited support from core customer deposits, which fund only about 38% of domestic customer loans. We consider that these weaknesses are partly offset by a domestic debt capital market that can support the banking sector and the government and central bank, whom we view as responsive and flexible to banks’ funding needs.

We classify the Australian government as being “highly supportive” of the banking system, reflecting our expectation of timely financial support to ensure the stability of the financial system, if needed. This assessment factors in a well-developed administrative and institutional framework that should facilitate a timely and coordinated response, and a track record of proactive and prompt support for the banking system through measures such as guarantees for retail and wholesale funding during the global financial crisis. We believe that the existing legislation, policy, and relationships with supranational agencies do not hinder the Australian government from assisting the banking system.

Why the AFR can’t also say it straight out is an interesting question in itself (though at least they reported it).

So there it is people. In black and white. Your ongoing but idle guarantee of the banks is all that stands between them and some nasty downgrade action that could take them (and us) into some kind of deflationary loop. Moody’s has already said much the same.

This is why I maintain that it is unwise to drive the Federal budget deeper into deficit.

BICRA Australia MR

David Llewellyn-Smith
Latest posts by David Llewellyn-Smith (see all)


  1. Why the massive recent spike followed by return to trend H&H? Is this another case of Europe’s gone, no it’s not, yes it is…….?

    I notice it’s shooting back upwards again and we’re in the midst of GFC MkI territory again.

      • Do we have any idea of the size of the counterparty risk associated with the hedging of the banks’ foreign borrowings?

        I’m under the impression that the Big Four have foreign denominated liabilities equivalent to about 40% of GDP, and of course this is all hedged, so no problem. But that implies that if the Aussie Dollar drops back to 60 cents then someone out there is supposed to pony up US$200 billion to cover the banks losses. Who can take that kind of hit without going bust?

        Have you looked into the nature of the Aussie Bank’s exposure and who is supposedly protecting them from the enormous potential currencies risk implied by their depedence on overseas funding?

        • “…..of course this is all hedged, so no problem…..”

          How is it hedged? Is it insured with the captain of the Titanic?

      • Ok I have asked this several times on here. HnH, DE, ED, Deep T etc MB. could the elephant in the room be the guarantees the govt made to bailout the banks. Even though Australia looks great in MSM on paper with these garantees if they come to light the national debt is actually not 43billion but 3 or 4 trillion….. just trying to understand this. I hope one or all of you will respond

  2. There is an excellent case for the imposition of a “Finance Industry Guarantee Levy”…possibly to be known by the acronym FIG… and applied to some of the profits of the banks.

    Such a levy would not need to be large, but would be a way of returning an income to taxpayers in exchange for the assumption of risk. It would also ultimately relieve taxpayers of this burden while still providing the means to guarantee the banking industry. In this sense, it would function like an expanded Deposit Insurance Scheme, and have the capacity to not only support deposits but other bank liabilities.

    The proceeds could be used to create a financial loss indemnity fund, administered like a Sovereign Wealth Fund, possibly by the Future Fund.

      • There would be very strong public support for this. Banks are experts at taking from their customers. There would be widespread acclaim for anyone that was prepared to take something back, especially if the revenue was going to be used to add stability to the system.

        We have to put up with a banking oligopoly that is able to extract “excess” customer revenues all the way down the line. The public should capture that revenue and ensure it is used to add security.

        Anyone on good terms with Wayne Swan?

      • I would expect any bailout to be a long-term loan/equity along the lines of the US/UK bailouts?not a bad business to be in, all in all…

  3. Very cool post H&H.

    “In our view, weaknesses for the Australian banking sector are its material dependence on net external borrowings, which fund about 24% of domestic customer loans; and limited support from core customer deposits, which fund only about 38% of domestic customer loans.”

    I thought these percentages were higher from what I read this year?

    The didn’t mention anything about the $1.4 Trillion of private debt, and approx $560 Billion of national debt that is heavily dependent on China …. no risk there? I assume they would look at the total debt picture, but maybe not??

    Looking at the bond auctions in the US and EU long term debt is harder to get, and more costly. Does that mean more RMBS and other bonds being used by the banks??

  4. I don’t remember a taxpayer funded bailout, or the banks becoming insolvent – I do remember the government doing what it is supposed to do by ensuring supply of money via guarantees.

    I guess it is a matter of semantics, but they can be used both ways, and excessive use does weaken arguments IMHO.

    There is a weakness in the system, we all know that, but there are weaknesses in every system, and we have to live with those risks. To me that is a matter of living, and not an instrument of revenge.

    It is of course interesting and worth looking at, but cooler analysis would yield a more incisive point of view.

    OK there is 300 million owing to European investors – given that the banks have borrowed long and not short as they did before the GFC – when do those rollovers come into play? and given that european investors will be very happy that they put their money into Australian banks instead of European banks, is there not a risk of them becoming more overweight in Australia in future.

    Would you pull you money out of a performing asset to rescue a fast falling asset?

    • You can make excuses like many others but it is true that the banks told the PM that if they did not get their debt guaranteed then there would be a whopping credit crunch and they would be insolvent sooner rather than later.

      The guarantee was of course the sensible response. But don’t kid yourself, it was an act of support that was completely outside of all of the regulatory architecture and frameworks and could not have been provided by the private sector. That is a bailout and the taxpayer has been funding it ever since in the drive for surpluses.

      I have no problem with the banks getting ongoing support. But support that is implicit, not explicit and the kind of excuses that you use, is private profit/public risk. I have a big problem with that, as should any self-respecting capitalist.

      • What money,Peter? If Euroland goes belly up, they won’t have any money to rollover…they’ll need it all there to recapitalise what’s not on fire. And given the interest rates that they will have to pay, anyone elses money will head there, and not here,well…unless we pay up, in competition, of course.

        • Hi Janet – do you think that investors in europe only have 300 billion in total? Collectively they would not lose everything – would they invest what they managed to save into european banks? what are their alternatives?

          I rather suspect that some EU members will have to abandon the euro, and that means rewriting the membership rules, but that only takes the political will, a pen, and some paper. Rules get rewritten everyday.

          Member countries could then float their own currency and accept whatever the market dictates.

          • Not only would they actually need to write the rules for exiting in the first place, the scenario you’re talking about is unlikely, if solely for the fact that any reduced Euro-zone exacerbates problems for the remaining non-German members. Unless they’re running a CAS, the Euro is going to just tip more and more to being a quasi-German currency.

            As for former members floating their own currency, as soon as the word gets out that this is happening there will be a massive out-flow of deposits to Euro-based accounts, amplifying the problem for the banks in the newly non-Euro country.

            There’s a reason no-one wrote the rules for exiting: there’s no nice way to do it.

      • But the taxpayer has profited from that. Had the government not acted, the taxpayers could have been wiped out, and it is the governments job to protect taxpayers.

        I accept that the situation was grave, but if governments around the world want a banking system, and they encourage the banks to take on extra risk to drive an economy upward, and if they then expect banks to invest in those same governments, then wouldn’t you say that the relationship was co dependant. One side falls, both sides fall, and that would just leave anarchy.

        So is it the players, or the rules?

        I’m not saying that we don’t have a concern, we do, but working through the issues and better controls will help, although risk can never be eliminated. If you accept deposits and then lend that money out, you have systemic risk.

        If you don’t have a banking system you have Zimbabwe levels of living standards. It’s in everyones interests to protect our system. The complete crash that some call for may stimulate our blood flow, but it would be so counter productive to even contemplate.

        I don’t want my life dictated by thugs and pirates, so I shall support sensible measures, even if I understand that the system is heavily flawed.

        As an example (not an extreme example) think Argentina in the not so distant past. I can’t wish that on the Australian populace – I happen to like most of them. At least the ones that I have met.

        • Who said anything about not having a banking system. I just want a private one with explicit rules. I mean look at the AFR coverage. All that sneaking around and sniggering. Let’s bring it out into the open and give the banks back their risk through a fee.

          • Fair enough – the risk should be priced in and past on to the consumers – I’m ok with that.

            Many want to see the system crash – I’m not ok with that, I suspect they don’t understand the consequences of their demands.


        • So i guarentee the banks and my reward for that is that they don’t lose all my money … not sure im into that one.

          The Lloyds names have made a fortune from playing guarrentor of last resort. Why can’t we ? How about we take a billion a year of each of them ? that will leave them with only 5 billion profit each.

  5. System crashes are not necessarily a bad thing in the long term (think Schumpeter). What is not benenficial in the long term is preserving a status quo that the taxpayer is ultimately rsponsible for, particularly when the banks are privately owned. The same taxpayer is also saddled with the negative externalities (property bubble) of the current banking system.

    • And half the poor b—-y taxpayers who are paying through the nose for the next 30 years for the nationalised bank debt, have been wiped out themselves in the property crash. Really, really bad.

  6. External Indebtedness – Australia in Bad Company

    Australia has one of the worst Net International Investment Positions in the developed world at -61% of GDP in 2009 according to the Bank of Japan. (1)

    Could we face action by “bond vigilantes” in the same way as Italy?

    Our position (2) is worse than:

    Country Year % of GDP
    United Kingdom 2009 -13.1
    United States 2009 -17
    South Korea 2009 -17.8
    Sweden 2010 -22.2
    Italy 2010 -24.3
    Slovenia 2010 -35.1
    Mexico 2010 -36.5
    Brazil 2009 -37.5
    Kazakhstan 2009 -38.1
    Turkey 2009 -44.9

    However we are in a better position than:

    Poland 2010 -63
    Slovakia 2010 -66.4
    Estonia 2010 -71.8
    Greece 2009 -83.1
    New Zealand 2009 -90.1
    Spain 2009 -93.6
    Ireland 2009 -97.8
    Portugal 2009 -108.5

    Is a position better than Poland and Slovakia but not as good as Kazakhstan and Turkey sustainable?

    Is a position of 4 times as much net international investment as a percentage of GDP as the US and UK sustainable? And for how long? And can we allow our current position to deteriorate further?

    In a world of “bond vigilantes” perhaps we need to examine our vulnerability. We have seen a number of myths exploded over the last few years:
    1. House prices don’t fall
    2. Banks don’t get bailed out,
    3. Bank debt to foreigners doesn’t matter of itself.
    3. Western developed countries are immune to sovereign debt concerns.

    While we have the benefit of being an issuer of our own currency (and can print and “quantitatively ease”) to our heart’s content, that doesn’t help where our debt is denominated in foreign currencies, or we want to borrow more money from foreigners (remember the “Belgian dentist?).

    We also have the benefit of low sovereign debt, but our states, while generally well rated, have large pension obligations under old defined benefits schemes many of which are indexed for inflation. The states can’t issue currency and therefore need to fund these pensions over time as our demographics (dependency ratio) deteriorate.

    The Federal Government has already had to guarantee some of our major banks borrowings from overseas which are needed because of the historically poor savings rate over the period from about 1995 to 2007.

    Remember that European and US banks are likely to have to raise hundreds of billions of dollars in additional capital over the next say 5 years, or sell assets to reduce balance sheets. In those circumstances, will those banks increase lending to Australian Banks or to Australian governments wishing to fund welfare such as health, education, unemployment and retirement benefits?

    Will international banks wishing to accept additional Australian exposure simply lend only to those major resource projects with undoubted export markets such as energy projects and not into general pools of funds in banks unless they are guaranteed by the Federal Government? Might foreign banks only fund their own major companies and their projects in Australia?

    Could we face a foreign debt capital strike? Or increased yield requirements?

    How can our policy makers address this position without causing a recession, higher unemployment, falling house prices and possibly a bank failure or two?

    1. See Table 5 on page 10 of http://www.boj.or.jp/en/research/brp/ron_2010/data/ron1009a.pdf
    2. See Wikipedia: Net international investment position

    • I don’t think we are in for any of this so long as the Budget is kept healthy.

      However, I don’t not think we can QE, either. We’re simply not big enough. That would cause a capital strike and the dollar would be 10 cents as soon as you blink. It would be inviting an inflationary bust (instead of a deflationary one).

  7. Good one Explorer!
    That’s pretty much a condensed logical treatise of all my ranting and raving! 🙂

    As to your last question the answer (sorry to be repetitive) the answer lies 50 years back in time.
    The screw squeezing us between the rock and the hard place will get considerably tighter.

  8. Explorer, you’re right about this except in one crucial respect. Our foreign obligations are denominated in AUD, not in other currencies. Effectively, our lenders have gone long on this country. Who here would counsel against that?

    The US, of course, has to create surplus dollars (run a net external income deficit) in order to supply dollars to meet the reserve requirements of the global economy. So their external liabilities are positive for both the US and the global order. If this seems counter-intuitive then consider: if the US always ran a current account surplus, the system would always be short of dollars and the US currency, from the standpoint of other economies, would start to replicate gold. The result would be dollar-hoarding and global contraction. It follows that to enable growth in the global system, the US needs to create a dollar surplus over time – that is, run up external liabilities.

    To a very limited extent, Australia does the same thing. AUD-denominated assets form part of the asset base of the global banking system, which is good for both the issuers and the holders as long as we maintain a firm-money stance over time.

    As long as growth in the global economy manifests as demand for our exports, we will not have a problem servicing our (privately held/publicly guaranteed) debts. Rebounding net external income has allowed us to reduce our net foreign debt:GDP ratio while simultaneously reducing the fiscal deficit, expanding household savings and sustaining near-full employment. At the same time, we have been able to finance the resource investment “pipeline”.

    We have been showered with cash and happily enough, for once, have not wasted it.

  9. This is why I maintain that it is unwise to drive the Federal budget deeper into deficit.
    That is why I maintain the reverse – spend the money on the poor, disabled and unemployed, either now or during a financial crisis… instead of allowing the budget to support the banksters who keep getting their million $ bonuses and continue with the status-quo.

      • You can never make them pay for it!! They will think of new ways to exploit the explicit guarantee
        Look at the recent BofA for example – they moved the dodgy derievatives from Merrill Lynch BU to the FDIC insured BAC holding company. So, now the taxpayers are also responsible for making the derivative counterparties whole. Will the premium charged by the FDIC ever enough for this level of support?

        • In fact, during GFC I, Maq Bank reported to have started a whole new division to exploit the arbitrage from taking government guaranteed funding and then re-lending at a higher interest rates to the riskiest, nastiest parties they could lay their hands on.

  10. A major cause of the whole Wall Street meltdown, was the underpricing of mortgage backed security RISK via CDS’s.

    Now we have a taxpayer guarantee propping up Australia’s property Ponzi indefinitely?

    Poor b—y taxpayers, is what I say.

    What has it cost the Irish to nationalise their debt? Is it a bit over or a bit under $100,000 per person – I forget? I recall a calculation that Ireland will need 10% higher tax rates or 10% lower government spending for thirty years because of this.

    Pity about all the usual electoral pressures meanwhile. And the fact that half the population has been wiped out in their own balance sheets in their property bust.

    There has never been such naive belief in government omnipotence, as the idea that the State can sustain standing behind a nationwide property Ponzi. Do the sums – they are mind boggling.

    If international CDS prices are high and rising for Aussie Bank debt, it means the international investors are waking up. There is an increasing chance that the people of a nation like Australia will rebel when they are told what they are on the hook for.

  11. As a saver I prefer to be rewarded for lending my cash to a bank. If rates reduce, other options come into view. If covered bonds are issued and deposits rank lower, then the guarantee becomes more important, even though it means I have to have more accounts.

    If there is a proper stuff up by gov’t and the financial side and we see our dollar reducing in value I will move to gold and banks can find another way of attracting deposits. If banks borrow overseas and they end up going broke, the execs should be sacked and the banks nationalised. If they lend overseas and rely on exotic forms of insurance which don’t pay out, they have to suffer greatly in the same way Eurozone banks will soon.