From the AFR this morning:
Australia’s banks have received support from a major credit rating agency to withhold part of the Reserve Bank of Australia’s super-sized interest rate cut.
After Commonwealth Bank and the online arm of National Australia Bank yesterday became the latest lenders to pocket part of the cut from customers, Fitch Ratings said the moves were justified to protect profits and ensure access to global funding markets.
“Funding costs are likely to remain high in historical terms during 2012, which means the weighted-average cost of funding is likely to continue to rise, putting further downward pressure on NIMs [net interest margins] ,” Fitch financial institutions director Tim Roche said last night.
Reliance on volatile offshore funding markets was a key reason Australian banks had their credit ratings lowered by the three major rating agencies over the past six months.
The banks’ refusal to pass on all of the Reserve Bank’s half a percentage point reduction comes amid fresh evidence the domestic economy is suffering, an index of services companies slumping to its lowest point since the financial crisis.
They don’t spell it out, but this is the trap I’ve been describing for eighteen months. The banks cannot allow profits to fall by absorbing higher funding costs. To do so would lead inexorably to ratings downgrades as their capital positions deteriorated and and, ultimately, their capacity to lend.
Yet the economy can’t take the higher rates that the wider spreads to the cash rate leads to, leading inexorably to asset deterioration and a different path to the same capital constraint.
Throw in the same bind for the Budget, which guarantees the banks and must show a clear path to surplus, and the implications are obvious. A recessionary services economy (offset by mining in some measure) leading to a low growth economy and a lower cash rate than consensus is expecting.
Update
And it’s now official:
Fitch Ratings-Sydney/Singapore/
London-03 May 2012: Australian banks will continue to retain some of the interest-rate cuts by the Reserve Bank of Australia, or even increase lending rates independent of any RBA rate action, in order to reduce pressure on net interest margin caused by higher funding costs. Such an approach, combined with close management of operating expenses, will be important for the banks to maintain or even boost profit in an environment where loan growth is subdued and capital requirements are set to increase under the soon-to-be-implemented Basel III framework. National Australia Bank and Commonwealth Bank of Australia have announced that they will cut their standard variable mortgage rates by 32bp and 40bp, respectively, rather than the RBA’s full 50bp cut announced on Tuesday. We expect other banks to announce similar rate cuts.
Australian banks’ net interest margins have dropped steadily since the onset of the global financial crisis in 2008, particularly in their Australian retail operations, with the trend continuing in the last six months. For example, Commonwealth Bank of Australia’s NIM fell by 10bp to 2.15% in H112, while NAB’s NIM came down by 9bp to 2.19% in Q1FY12. These levels are still healthy, especially when compared with many of their international peers, but the downward trend means that we expect banks to take advantage of opportunities to increase asset pricing.
Funding costs are likely to remain high in historical terms during 2012, which means the weighted-average cost of funding is likely to continue to rise, putting further downward pressure on NIMs.
One reason that funding costs are rising is because banks are trying to reduce their reliance on wholesale funding, which accounts for about 35%-45%. In addition, the Australian Bankers Association estimates that around half of the wholesale funding derives from offshore investors, and just over a third have a duration of less than one year, and Fitch considers both of these factors unstable.
The introduction of covered bonds has helped extend duration, but there are still regulatory limits on the maximum amount of covered bonds a bank can issue.
Deposit costs are also a significant contributor to the rise in funding costs, as the banks seek to attract this more stable form of funding. Adding to the pressure, depositors are becoming more savvy about their investments, seeking out higher-interest-earning accounts.
