Over the past year there has an ongoing debate about Australia’s little financial crisis. It was the dramatic widening of bank-to-bank funding costs. Coats starting falling as the Hayne Royal Commission wound up. Westpac explained the spread compression then by observing an abundance of cash:
Is the lack of a March “turn” a sign of things to come? In outright terms, 3m BBSW has fallen to the lowest outright level since early 2018, effectively delivering a rate cut to BBSW-based borrowers since the turn of the year. At just above 1.8%, they are on the cusp of moving back into the OIS+15-30bp range that prevailed throughout 2016 and 2017. So how likely is that? The lack of a of March “turn” has surprised many and positions entered to take advantage of higher rates have been exited over the past week. BOB spreads are at, or near, the bottom of their ranges 3 and 12 month ranges (top chart), suggesting that the market sees lower levels as more sustainable. It is probably to be expected that hedging and funding strategies would have adjusted over the past year, smoothing quarterly effects, however we think there is also an usual amount of “cash” available at present. Investment managers have been keen to take advantage of the inverted front end of the bond curve, targeting the higher yields at the short tenors. And beyond that, this week and this quarter have seen a recorded amount of cash paid out as dividends (bottom charts).
But that suggests the problem was one of liquidity which is highly questionable, previously from Damien Boey at Credit Suisse:
We can debate why spreads have been this wide, and why they should matter for mortgage rate settings. But the reality is that elevated levels of money market spread historically correlate with ongoing expansion in the mortgage-to-cash rate spread. Our going theory is that wide spreads, despite the best of RBA liquidity injections, implies counterparty credit risk, which in turn must be related to a deteriorating economic outlook. It makes sense in these circumstances that banks try to build a (margin) buffer ahead of a slowdown. On the flipside, we do not adhere to the view that the issue is funding cost per se, because the interbank market is merely a transfer system between banks. One bank’s gain is another one’s loss, and this should all net out from a system perspective (especially given competitive pressures).
Exactly. The BBSW spread really blew out when the Hayne Royal Commission was called, so it makes sense that an outcome more benign than expected for bank earnings from the RC would mitigate solvency fears commensurately. That took the spread from 60bps to 20bps.
Then when the deeply corrupt ScoMo Government was re-elected, the BBSW spread compressed another 10bps in a day and is now virtually gone, right along with counterparty risk and official scrutiny.
It’s clear now that what kills Australian banks is sunlight.