The deposit dilemma

The variability within the Australian economy seems to be a mystery to some and simple to others but I doubt many have considered the “deposit dilemma”. In the following paragraphs I am going to outline an hypothesis about how Mega Bank (the big four) has a sleeper hold on the Australian economy due to the inappropriate creation of deposits. Credit will be given in future posts if the hypothesis has been outlined by others.

The hypothesis is that Mega Bank has been allowed to create an excess of deposits to fund lifestyles and retirement for a select group and this is ultimately slowly squeezing most parts of Australia to sleep. I’ll outline the hypothesis in this note and follow up with supporting evidence.

When I’m referring to deposits I am referring to all domestic ie Australian, lending to banks and other ADIs.

As Mega Bank holds 85% of all Australian ADI assets and liabilities, we’ll assume for the explanation of the hypothesis that Mega Bank is the only ADI.  Admittedly though there is a continuing commercial war between Mega Bank and other ADIs especially over deposits.

How does Mega bank create deposits and where is the dilemma?

The Myths

In summary, saving income by households does not increase Mega Bank deposits, unless the funds would have been spent on imported goods.  Savings merely denote less economic activity and the hoarding of wealth within households.

Neither does selling any assets within the domestic economy create deposits, unless the buyer has borrowed funds.

 Capital Flows (ex Debt) into Australia

The trade account directly affects the level of deposits. Surpluses increase, deficits decrease Mega Bank deposits. Australia has a continual current account deficit. The CAD, however, has been funded by Mega Bank’s and the government’s offshore borrowing so trade surpluses create deposits and the deficit increases Australia’s debt. Nevertheless, when the net trade position annually over the last 15 years is analysed, its affect on deposits is not significant when compared to the level of increase in deposits. No doubt this is because the balance of trade has very little to do with the CAD. The real problem is the size of negative primary income in the capital account.

Net capital investment into Australian projects  (eg mining) by offshore investors increases deposits. Although due to our limited manufacturing sector, mining projects for instance which involve a majority of plant and equipment investment purchased from offshore, have limited net effect on Mega Bank deposits.

Selling the “farm” increases deposits. As does immigrants who bring in their own funds. But again as we also invest offshore and emigrate the net position has not been a significant increase in deposits.

The numbers show net capital inflows have increased deposits but not relatively significantly.

Government Borrowing Domestically (or Printing)

Although it’s possible to start anywhere in the cycle when explaining the deposit and lending cycle, I am going to start with a bank with the domestic deposit.

When a government borrows domestically (or prints) , and spends that money in the economy, it both creates a debt for itself but also it creates another deposit. In Australia’s case, the funds come from a Mega Bank deposit, and a loan asset to the government was created within the bank. The government spending was deposited in Mega Bank by taxpayers, doubling the deposit liabilities and the perceived wealth of the populace.

So what does Mega Bank do? It uses that extra deposit to create an asset by lending in order to earn income to pay interest on that deposit. In Australia the funds are lent mostly into residential mortgages. Australian government domestic borrowing both creates deposits and provides a large jolt into the residential mortgage markets.

Government domestic borrowing does have a natural unwind mechanism. By taxing the populace in the future, governments can broadly and on a targeted basis, receive funds to repay debt. But generating those excess revenue receipts through surpluses and repaying debt actually reduces the deposits originally created leaving a domestic deposit and a lending asset.

Its a manageable system if the beneficiaries and the ultimate payers are not too polarised by government policy. Since 2010, government borrowing has significantly increased bank deposits.

Productive Lending

A simple definition of a productive purpose would be providing goods or services or building an asset for sale.

When an Australian household with funds in Mega Bank withdraws funds in Mega Bank in order to purchase those goods or services or assets, then the seller takes the funds and deposits them into Mega Bank. These activities even when carried on a multitude of times per day do not increase the level of deposits although such a process continually increases the value of the money or productivity.

When, on the other hand, Mega Bank lends deposit funds to the provider of the goods and services in order for them to be provided, and those funds are used productively, deposits are created within Mega Bank in addition to the original deposit that started the process.

Naturally when the goods or services are finally purchased, the funds withdrawn revolve around the cycle to repay the debt and decrease the deposits. It’s an inbuilt unwind mechanism. Although the economy should operate so that more lending opportunities and therefore goods and services are created than is being unwound. A process that continually increases wealth by creating more and more deposits.

Unfortunately Mega Bank has actually significantly decreased productive or business lending since 2008 which has had a negative effect on deposits counterbalancing the increases in the decade before the financial crisis.

Of course, Mega Bank and producers get it wrong sometime with little or no demand for the goods or services at the required price. Losses are produced in this situation which correspondingly decrease deposits and wealth but over the history of banking systems these events have not been system destroying when productive lending is involved.

The process of productive lending creates not only a healthy Mega Bank but a healthy economy and more wealth across the general populace. Productive lending however, needs to do much more than simply provide those noble ends, it must generate sufficient wealth flow to repay non-productive debt when its due.

Non-Productive Lending

For the purpose of this hypothesis, non-productive borrowing is defined as borrowing for any purpose which a household does not need to live reasonably and cannot service and repay whilst living reasonably. As an example, a median household that is purchasing an existing dwelling and borrowing at 6 times gross income, I’d define around half the loan as non-productive lending as 3 times gross income is reasonable but 6 is not.

When, our theoretical family above purchases the said house with its Mega Bank mortgage, a deposit is created with the beneficiary being the vendor of the unreasonably priced house. In this circumstance, Mega Bank has a loan on its books that must be repaid from wealth created in the economy primarily from future productive lending. There is no other direct repayment mechanism, other than selling the house but that still does not extinguish the deposit.

On the other hand, the vendor has realised the perceived house wealth into a bank deposit with no deduction from tax. As the deposit is in Mega Bank, that deposit will be used to mostly fund more mortgages and non-productive lending. The lucky beneficiary can spend the deposit as they see fit into life style, non-productive purposes or actually for productive purposes. Mega Bank is now conflicted, it does not want the depositor to make any decisions, it wants to make the decisions and the deposit to support the mortgage loan that was created.

There is no systemic unwind mechanism for the situation I describe. If the borrower, or extrapolated, all the borrowers with non-productive debt, cannot not adequately service their loans, there is no way to both reduce the debt and to reduce the deposit. Even selling the houses to repay the debt does not bring back the status quo, as the lucky vendor wants the deposit serviced and there is no mechanism, to reduce the deposits value to reduce the burden.

By a country mile, Mega Bank deposits have increased due to non-productive lending more than any other classification. This is due to a number of factors that I have previously posted on, but for now the level of deposits is the issue.

Mega Bank is stuck, it cannot reduce its exposures to non-productive lending as it must service the deposits that not only must not migrate to the few lending alternatives but also must remain a reliable long term source of funds without discretion on use.

Offshore Borrowing (ex CAD)

We don’t need to be Einstein to understand that money borrowed from investors offshore by either the government or Mega Bank increases bank deposits. These funds are handed out to taxpayers or loaned to borrowers and ultimately find there way into Mega Bank. However, I believe that compared to domestic sources, offshore borrowings accelerates domestic deposit and loan creation.

Offshore borrowings add another creation leg into the deposit creation cycle. The loan itself does not need to rely on an existing domestic source and therefore my analysis starting at the point of domestic deposit adds one extra deposit creation point to the cycle. This would seem to me to be a great advantage if deposits are created through productive lending, but a system threatening issue when its been through primarily non-productive lending.

Without Australia having both a trade and current account surplus, there is no unwind or repayment mechanism to repay offshore borrowings. But whilst that is an eventual system destroying risk, the deposits created through the process have far more social and risk distribution ramifications than just analysing the issue from a national point of view.

Over the last few years, whilst Mega Bank offshore borrowings have stablised, the Commonwealth has stepped up to the mark to fill the gap maintaining the increase in deposits. Offshore borrowings have contributed greatly to increasing Mega Bank deposits. Unfortunately, however, it’s mainly through the increase of non-productive lending and that has added to the sleeper hold.

Hypothesis Summary

Mega bank has significantly increased its deposit base through non-productive lending accelerated by offshore borrowings, distorting the distribution of wealth. The level of non-productive lending is so large that it’s not possible to service and repay this debt through productive means. The beneficiaries of the non-productively generated deposits are not about to give up their value and the mortgagors will not reasonably be able repay their loans or sell the assets at unreasonable values.

There is no unwind mechanism to share the problem equitably between Australian depositors and mortgagors and no incentive to boost productive lending. This is the deposit dilemma and the Australian prosperity delusion.

To ZIRP and beyond!


  1. Exactly! What a great post. For me the line “The lucky beneficiary can spend the deposit as they see fit into life style, non-productive purposes or actually for productive purposes” says it all. Aging beneficiaries are more and more going to ‘hoard’ their non productive capital and spend it on retirement etc. There is no solution to aging ….even ramped up immigration, substitution of ‘our young’ with ‘their’ young ,will not alleviate the aging process for those of us who ‘hold the wealth’ It’s Japan for us….

  2. Great post and excellent hypothesis. If someone else has already suggested this, you have still offered a convincing and well supported argument. Pity it’s a bad situation. There is something obscene about such levels of unproductive lending.

  3. reusachtigeMEMBER

    Good stuff and great hypothesis (not necessarily a theory). Well done on heading off the attacks from a particular poster who gets all worked up about such terminology and claims.

  4. There is a different risk profile for business lending, which is why banks gravitate towards residential home lending. I have mentioned before that a portion of lending that is classified as residential lending is actually for small business.
    However even allowing for that there is a shortfall in funding for business. The interest rate differential isn’t enough to tempt the banks to alter their lending policy, and I suspect that they only remain in that space to keep up appearances so to speak.
    We can’t change the risk profile, we can’t slug business much more than the current interest rate differential, so could we offer an extra tax break for business lending, would that be enough to overcome the greater risk profile for lenders?

    • The government can’t give tax concession’s to business’s as they need the money to give out to “ordinary” Australian’s in the form of handouts to buy into property.

      Maybe the government should introduce something like a First Business’s Owners Grant?

      Start a business and employ 5+ Australian’s and you get X amount of money or only pay 15% tax for first two years???

      Imagine doing this rather than funnelling more funds into unproductive assets that rely on debt to grow.

        • Im sorry my mistake, I like the idea but I really think its an issue of residential rates being far too cheap for its risk profile and so the sector sucks up otherwise productive investment that would have gone into business’s.

        • Stormy Waters

          Isn’t the “risk profile of business lending” primarily determined by APRA/Basel III treatment of reserve capital requirements for different assets classes?

          Change the relativity between resi mortgages and business lending and you totally change the incentives of the banks as resi mortgages would become less profitable as more capital had to be held against them.

          • Precisely! Peter may be correct when he states that ‘you can’t change the risk profile (of mortgage lending, although I would suggest that ‘it’ changes itself, the more that various ratios change to reflect, say, a higher income-needed/price-paid ratio , etc)” but you can change the reserving requirements to anything that is necessary!

          • That’s a good thought, but even with a lower margin home loans would probably be more profitable than business lending due to the loan maintenance costs. Although I don’t have figures on that, just past experience.
            Banks want profit, that is their objective, so a tax break to encourage business lending might just do it – carrot and stick approach.

  5. Jumping jack flash

    Good hypothesis.

    I’ve reckoned for some time now that “savings” is simply unspent debt.

    As the dis/deleveraging occurs, this savings must be reabsorbed.

    The mechanism to do this is cost of living. Un unregulated market will set prices to what the market can bear.

    Consider retiring boomers who have each offloaded 2/3 IPs for borrowed money that is someone else’s problem at around 450K each.

    These boomers can easily pay a 20% increase in food and utilities.

    The common man, and indebted will not be able to, and must either draw into equitymate, or spend down savings in order to keep up. Or they could downsize to absolute poverty.

    There is a mixture of all 3 scenarios occurring as the large debt (wealth) transfer continues to occur.

    It would be interesting to see consumption per demographic segment to see which demographic is actually setting the prices for these essential items. I have my suspicions.

  6. Fabulous post and the best description I have seen of the full nelson the big 4 banks have on the Australian domestic economy. A small important detail:

    “non-productive lending as 3 times gross income is reasonable but 6 is not.”

    I don’t think Megabank writes many x6 mortgages, small business and liar loans aside. (Peter?) Instead, we have a significant proportion of the population with up-to-pussy’s-bow mortgages at over x3 AND all their equity trapped in their home. They are able to service but not significantly reduce the principal owing. They are ‘All In’ on residential RE.

    Falling house prices erase that precious personal equity and leave the painful mortgage intact.

    Consumers have switched to net saving ~10% of earnings, which is the long hard way to eliminate mortgage debt.

    Now the government is urging banks to reduce their overseas borrowing, unwinding the deposit Ponzi Deep T describes and creating a domestic capital drought.

    Brace yourself, this is going to hurt.

    • Australia’s profound mal-investment – wherein we trade tulips with each other – has a very serious opportunity cost. We had the money to buy up majority foreign owned BHP. And Rio. And Vale. And Glencore. And… And… To the value of trillions. Trillions!

      But our stupid tax system channels savings to unproductive land speculation and we seized the incentives with both hands.

      If ever there was an argument for a decent Land Value Tax to deflect saver appetite to productive investment, here it is. Our entire financial architecture is complicit
      and has diminished us all.

      Our failure to reform and refine Australia’s taxation arrangements condemns us to an era of gross underperformance – mainly because politicians are unwilling to risk ‘political capital’ taking on the rentier mentality that seeks to impoverish fellow citizens.

      Bah! Humbug!

  7. It doesn’t stop amazing me how the Western economics slowly but very consistently walk towards Marx’s economic analysis. People now “discover” the productive and unproductive side of the economy and banking, the fictionalization of the economy, the fictitious capital and wealth etc. This is not a new hypothesis, but an old theory, for those who had the gut to read what was politically inconvenient. It had been already proven a century and a half ago that without debt the capital can’t grow, it had been already proven that there will be a stage of capitalism development when everything will be perceived as capital and will be indebted, which will be destructive for the economy, because the consumption (including the house we live in) is not a capital per se for the consumers. It creates capital only for the producers and the lenders. But this simple and obvious truth was ignored for half a century in the name of the great illusion that everyone can be a capitalist and investing capital. It is not a surprise what is going now in the Western world, it is only a concrete prove of once fearsome theory. Nothing new under the sun, only the growing awareness and realization of what is going on is maybe the new trend.

    Having that in mind, your article is a hope and light for the blinded and is very educative for the populace. Good luck with this great task of helping the populace with disillusionment.

  8. Yes the Banks are addicted to non productive lending it’s all they know these days. I suspect the divisions within Mega Bank which specialise in productive lending are small in comparison to the legions of mortgage lenders.
    If you wanted to borrow against plant and equipment to start a business the first question would be ” what is your real estate worth?”
    So the point DT makes about the essential need for real production to service long term non producing housing debt is critical to continued prosperity.
    Not only do we have diminishing real production we have another dillema, the tax payer funds a swollen public service which in real terms accounts for the most significant employer in Australia.
    As our Banks are obsessed with non productive lending the tax base will need to rely more heavily on property taxation.
    My rates just increased by 5% my land tax doubled wait for negative gearing to be abolished.

  9. Thanks Deep T. I just watched Glen Stevens at the Economic Forum in Canberra and he urged productivity to cure our ills; he seemed to be directing it to the government.

    I’m sure the Aussie Mega Banks had reps at this IIF conference.

    “Banks need a radical overhaul to boost profitability against the backdrop of tougher new rules and a grim economy – and they expect their customers to share some of the pain”

  10. Let’s say I work at a financial business in a non financial area. Someone calls me to help because there’s an issue with their voice recorder and they can’t type up meeting notes.

    No worries, you go grab a coffee and I’ll fix this. So I fix the issue and continue typing up the voice notes
    until they come back from the tea room.

    What I heard in the notes was the story of the “assets” held by Joe Debt and the little lady. They’d come in because they felt their finances weren’t structured right.

    There were 3 investment properties, two for him, one for her and the family home. Between his two IP’s there was like 70k in equity (based on his valuations) of course he’d tried offloading one at his assumed valuation – no bites, but of course his valuation would still be valid.

    Her, well her IP was purchased at $XXXX, valued at the same (bought 12 months ago) and the amount owing was about 10% higher than the purchase price. I guess LMI and closing costs were chucked onto the loan.

    Family home, same situation. Bought sometime last year for $XXXX and the amount owing was about 5% higher than the purchase price.

    I was astounded. Unfortunately there was no talk about who lent these people money.

    • keep it coming, manfin… 🙂
      preferably with some numbers for Joe’s and little lady’s income, their lifestyle, and the house valuations.. 🙂

      • lol I just couldn’t believe someone is still dishing out loans with a higher value than the asset.

  11. are starting to get the very first steps in MMT.

    Firstly, I think you seem to accept Loans create deposits and deposits never really leave the system. If that is the case, this is huge first step, and of course you are correct.

    But you fall down a bit after that

    External Accounts
    No money ever comes into Australia – or leaves. A CAD simply reflects a swapping of deposits – not a net change in deposits. When a local buys a car from Japan he / she swaps the AUD deposit for the car – the new owner of the deposit is a foreigner – but the deposit never leaves the system.

    You have fallen for the MSM and description of Government spending. Yes governments spends money into existence (you got me excited for a moment) – but it does not get the money from anywhere. It simply credits the relevant bank accounts of its citizens. THE FUNDS CERTAINLY DO NOT COME FROM MEGABANK AS YOU SUGGEST.

    The new deposits (liabilities for megabank) are offset by reserves with the CB (assets of megabank). These reserves are eventually managed (drained) by the issuance of government paper – initially repo’s, but eventually bonds. So the spending comes first – bond issuance and taxation come later.

    This is a round about way of describing horizontal money as defined by the MMTers (or as the MMR’s define it S = I + (S-I)). So this part of your “theory” seems quite right on my first read. IMO, the title of this section really does not tie in with what you are saying though.

    “We don’t need to be Einstein to understand that money borrowed from investors offshore by either the government or Mega Bank increases bank deposits”
    Ok – you are now way off base here.

    There is no Chinaman in Beijing sitting on a bag of AUD waiting to deposit funds into mega bank – that is simply ludicrous. Aussie Banks borrow offshore for TERM only. They do not borrow offshore to gain deposits.

    The process is very simple when you think through the steps.

    Step 1.
    Megabank issues (say) US$1bn in term notes to US investors.

    Megabank now has a US liability of US$1.0b, and a US assets US$1.0bn as cash sitting in an authorized US agent (let’s assume its Wells Fargo)

    Step 3
    Megabank swaps the US$1.0bn cash into AUD$1.0bn cash (assume currency parity)

    Where did the A$1.0bn cash come from?

    The FX market from ALREADY EXISTING DEPOSITS in the accounts of Megabank. Those depositors have now acquired USD inexchange for AUD and can now buy real US goods and services.

    Step 4
    So all that has really occurred it Megabank has swapped a USD bond liability for existing customer deposits liability. The net deposits in the system have not changed – just the owners of the deposits has changed (formally customers of mega bank, now US bond holders). The entire exercise is about TERM, not funding.

    Step 5
    Where did Megabank put its newly acquired AUD? Where it always does – at the CB as part of its ESA. The ESA balance had remained unchanged during this process, because megabank’s newly acquired AUD offset the loss of customer accounts equal to the same amount.

    Step 6
    To manage risk, Megabank entered into a hedge contract on the USD liability (probably with Well Fargo)

    *NB: You commentary on non-productive lending is so subjective it is almost impossible to comment on factually (why is 3x lending productive and not 6x ???? – surely there are better ways to value the underlying collateral). Your then seem to back-track a bit and move back to the loanable funds model of money (which is flawed). My reply is already too long so I will address these other issues another day.

    • You know, you’d get a lot further in trying to encourage debate or acceptance of MMT – if that’s your goal – by not taking on such a preachy and dare I say it, condescending tone.

      It detracts from the points and constructive criticism you raise.

      • Thanks Prince.

        I was not trying to be condescending, and your point is noted.

        I apologise to Deep T if he feels in anyway insulted by the tone of my post.

      • Then what about a guest post Prince, then b_b could take the questions and criticism.

        • Actually I think it’s pretty clear he has no idea what he’s talking about. For instance:

          “External Accounts
          No money ever comes into Australia – or leaves. A CAD simply reflects a swapping of deposits – not a net change in deposits. When a local buys a car from Japan he / she swaps the AUD deposit for the car – the new owner of the deposit is a foreigner – but the deposit never leaves the system.”

          He is totally confused about the difference between reserves and deposits. This is macro 101 stuff… BB is discrediting MMT as he speaks, not because it isn’t useful but because he doesn’t understand it.

          DE has covered this at length already in his Macro 101 series. I suggest you all read them.

  12. Diogenes the CynicMEMBER

    If I have borrowed 6x my after tax income to buy a Mc Mansion and suddenly am saving 10% of my after tax income to pay down the principal – how long will it take to pay off?

    Answer: longer than the house will last.

    We could put these maths questions in highschool matriculation examinations to at least try and combat the insanity.

    • You have left out a few important points which makes your analysis impossible to calculate.

      1. depreciation rate of the house (quality of the build, and the ratio of build to land)
      2. Growth rate income
      3. Long term mortgage rate
      4. Size of the deposit
      5. The rate of inflation of replacement buildings.

      Now assuming
      20% down
      4.5% household income growth
      5.5% mortgage rate (2.5% spread over ten year Bonds)
      Building product inflation 4%
      Depreciation (of building only) 4% per annum
      building / Land Ratio 50%

      I reckon after 25 years you will be
      – Debt free
      – Have a house where the improvements are worthless (assuming no maintenece capex) but land
      – Assuming land grows in line with nominal gdp (land values move in line with the economy), your land value would be 3.5x the original land value in nominal terms (1.9x total purchase price), or 1.5-2.0x original land value in real terms.
      – Assuming this land value is correct, then to accumulate the same value but not owning, you will need to save your growing 10% of income, and earn an after tax return equal to nominal GDP per annum (after tax return of 5.5%, or pre tax return of 8%).

      A few points to debate here I’m sure, but I do not think the maths is a simple as you make it.

      • So in a life where you expect to work 45 – 50 years, let’s dedicate 50 years of that productive output for shelter?

  13. I think it is a worldwide problem. We have illusory “wealth” that is no more than unrepayable debt. Insistence on the repayment of such debts will cause the economy to go into depression. Wiping the debts will cause catastrophe to the financial system. Stagnation is inevitable, but we still need zirp and a dose of inflation to get out of this. I suspect the inflation part will only come after prolonged pain of stagnation.

    • The sad part is that this is a government sponsored scheme.

      I’d question inflation premise at the rates we see however. We will get ZIRP, and be driven into the markets like our UK/US experience shows. Trade the volatility….

      • Just Dismal 2

        contrary to spruikers of fixed interest securities, under zirp, wealth is more likely to be cteated by productive assets. Risk investors will earn a decent risk premium.

  14. “Selling the “farm” increases deposits. As does immigrants who bring in their own funds.”
    Just add to what b_b has written, neither foreign buyers or immigrants add to deposits. If a UK immigrant with 1m pounds comes to Australia, someone else becomes the owner of his 1m pounds in the UK and he becomes the new owner of already existing, on deposit, AUD. Nothing moves. No funds are brought in.
    Similarly, if a foreigner buys a farm in Australia he will have to obtain AUD which already exist in the Australian banking system.
    If the new owner of the AUD holds those AUD in a different type of bank account their may be some effect on the bank’s opportunity for lending and creating deposits. But we have no reason to believe there will be any overall change.

    • Just Dismal 2

      The monetary system based on fractional reserve banking is recursive. Money can be created out of thin air, subject to reserve ratio, or these days capital adequacy ratios.

    • “If a UK immigrant with 1m pounds comes to Australia, someone else becomes the owner of his 1m pounds in the UK and he becomes the new owner of already existing, on deposit, AUD. Nothing moves. No funds are brought in.
Similarly, if a foreigner buys a farm in Australia he will have to obtain AUD which already exist in the Australian banking system.”

      Don’t you need to consider effect on value of AUD?
      E.g. when UK immigrant swaps £1 million for AUD doesn’t the GBP/AUD exchange rate alter (temporarily); thus fewer AUD needed to purchase a product/service denominated in GBP (temporarily)?
      Isn’t this why the AUD has been above parity with USD (because mining industry requires o/s folks to purchase AUD)?
      The higher AUD reduces AUD-denominated cost of o/s-sourced products & services, thus more AUD remain on deposit in Megabank (unless of course, the unspent AUD are immoderately frittered away on extra purchases).
      Leaving aside the propensity (on the large scale) for Australian consumers to fritter away any savings, on a smaller scale, doesn’t the UK resident’s purchase of AUD (temporarily) provide savings for Australian consumers (who purchase goods/services denominated in GBP at that time)?