A deposit war to trump the euro battle

Banks around the world are preparing for what they see as the likely split of the euro, but here in Australia it's the ongoing war for deposits that will play a more critical long-term role.

While German Chancellor Angela Merkel is optimistic that German aid to the Spanish banks will gain approval, around the world banks are now starting to prepare for the real possibility of a euro split in the next 12 to 18 months, which is adding to funding pressures and intensifying the European credit squeeze. People no longer trust many European banks which is why bond yields in countries like Germany are so low.

In Australia the action is also in the deposit market.

A month or two ago banks tended to put the euro split possibility aside because the losses were too great. Stock markets, currently enjoying a flush of liquidity, are ignoring the euro split risk and look set for a period of higher prices as the American dollar eases. But the risk is now real and no banker can afford to ignore it. Many European banks are moving to match their lending and deposits in individual countries.

Given the warning, Australian banks should not suffer the big losses that the European banks face on the euro split. Any Australian bank CEOs who get caught in a major way will lose their job given the warning.

The Australian risk is that the overseas wholesale deposit market, which funds about 40 per cent of Australian bank loans will dry up over the next three years, and will need to be replaced by local deposits and/or reductions in lending.

We are currently seeing the big rural Dutch bank Rabo roll out Australian television advertisements offering 5.8 per cent for five years and a string of shorter-term deposit rates that are all over 5 per cent. Rabobank is one of the few well-capitalised European banks and in Australia lends to farms and agriculture. Given its European exposure, the parent will need to be preparing for a euro split, but Australian deposits with Rabobank below $250,000 are Australian government guaranteed. You wonder how long the local Australian banks can afford to allow Rabobank to cream the market.

We are starting to see some term deposit aggression from NAB via its UBank arm with a 5.3 per cent rate being offered, and Westpac is offering 5.2 per cent for 5-year deposits. But there is a big gap. What is happening in the deposit market is becoming more crucial to long term banking than events in the mortgage market which get all the publicity.

All this happening while bankers are undergoing a rethink of their business models. Too often global bankers think one dimensionally and so they do deals without any thought of down stream consequences. That applies to US sub-prime; lending to bankrupt European governments, Libor rigging, or the enormous risks still being undertaken in trading.

In Australia the deposit war is going to play an enormous part in what happens to our banks.