ABA revelations (updated)

What a morning!

Your blogger spent it wading through the Australian Business Association's submission to the Senate Inquiry into bank competition and the corresponding ABS data.

The focus of this post is on the section of the ABA document dedicated to liabilities, which forms the key to the banks' claim that their rising cost of funds is the reason behind the need for increased interest margins.

This blogger has no interest in pursuing the claims. It is self-evident that banks are increasing margins. It is more interested in how the banks have represented their liabilities because that's where the national risk lies.

In the section the ABA states:

At the end of June 2010, bank funding was at $1.47 trillion, an increase of $100 billion or 7.3% over the previous year. Usually, banks source their funds from deposits (50%) and through short-term wholesale funding (25%)9 and long-term wholesale funding (25%) 10 (statistics may vary from quarter to quarter).

...In June 2010, short-term funding (excluding bills of exchange) comprised 62% domestic issuance and 38% offshore issuance11. (These proportions vary from bank to bank.) From August 2007 to March 2009, short-term funding costs were extremely volatile. On several occasions during this period the 90-day Bank Bill Swap rate (BBSW) spiked sharply (August 2007, September 2007, December 2007, February 2008, March 2008, June 2008, September 2008, October 2008, January 2009, February 2009 and March 2009). While spreads have decreased on short-term funding, these are still around 2-3 times higher than the levels prior to the GFC and remain elevated.

In June 2010, long-term funding comprised 26% domestic issuance and 74% offshore issuance. (These proportions vary from bank to bank.) Since August 2007, long-term funding costs have remained elevated, with no evidence of significant easing. Spreads on long-term funding are around 8 times higher than the levels prior to the GFC.

...The changes in funding mix – that is, towards more stable, but expensive types of funding – means that banks’ overall funding costs remain significantly higher relative to the official cash rate than they were in mid 2007. The proportions of banks’ funding are now 53.5% deposits, 16.6% short-term wholesale funding and 29.9% long-term wholesale funding (Graph 7).[provided above]

This blogger has one observation.

The ABA has chosen to use an uber-conservative measure of ADI deposits. The number used in its calculations is $787 billion. That is close to $400 billion lower than the official figure available in the ABS 5232 Financial Accounts. For instance, the ABA has ignored $150 billion or so in local pension fund deposits. $100 billion of which is in the more conservative category that is made up mostly of term deposits.

Whilst the ABA should be praised for using conservative definitions of bank deposits, this blogger can't help wondering if the terms of the Senate Inquiry - which are limited to investigating bank competition - aren't having a perverse effect. The banks have every incentive to make their wholesale borrowings look as large as they possibly can in rationalising their argument for wider interest margins. One way to do that is to downplay the proportion of deposits.

Instead of the nation having a debate about the wisdom of wholesale funding we have the Kafkaesque spectacle of the ABA up-selling the banks' reliance on this vulnerability.

Despite this, two points are still obvious from the graph. The first is how reliant Australian banks became on wholesale funding during the post-2004 boom. Second, when the boom hit the skids in the July quarter of 2007, after BNP Paribas declared the US ABS market insane, Australian banks were busy making a $57 billion plunge on short term debt.

Because the data is quarterly, we can't tell whether the surge was in response to the crisis but if so it makes a certain amount of sense. If the banks thought the crisis was temporary they may have chosen to shorten maturities to keep debt cheap until the crisis passed. But even if the borrowings were simply part of the blowoff cycle, they don't make the banks look too prudent.

Either way there is a clear lesson for regulators.

Update

It was remiss of this blogger to not also note the good work of regulators post-crisis which is obvious in the reduction of that same short-term debt reliance. According to ABS 5232 and noted in the ABA document, short term debt has fallen $140 billion since the GFC. No small achievement. However, the reductions have mostly been in domestic short term debt, and any shrinkage in foreign short term debt has been more than compensated in the dramatic increase in longer term foreign debt. A point this blogger will return to after next week's release of September quarter 5232 figures.