A rates recipe to hinder housing

As Australian banks shift funding ratios towards local deposits interest rates will remain higher than many expect, limiting property growth and toughening retail and manufacturing borrowing.

Get ready for an acceleration in the significant change we are starting to see in the way banks conduct their business in Australia.

It’s a change that will have a long-term effect on our housing values and business borrowing.

It is also an important part of the Australian productivity story.

The first clue to the extent of change actually came in the Pimco's KGB Interrogation, when Pimco’s Australian chief said that the overseas wholesale lenders to Australian banks were concerned about the long-term solvency of our banking system given the high cost of Australian housing. It was an important revelation (Rating Australia's housing risk, March 28).

Australian banks found that the overseas wholesale market let them down in the global financial crisis and then against the end of 2011 and early 2012.

For decades our banking system has been based on the major banks concentrating on gaining loans for houses and businesses. The deposits would look after themselves because if there were not enough Australian depositors then the sources of funding overseas would fill the gap. This formula has served Australia well for decades and led to big rises in asset values – particularly houses.

But Australian banks have now seen how fickle the overseas wholesale market is and now are being told that they are being regarded with suspicion.

The big Australian banks at one point were borrowing 50 per cent of their book from overseas and other wholesale sources. Now it is around 40 per cent and some of the big banks have their local deposit rating up around the 65 per cent mark. But increasingly banks are looking at lifting the share of funding from local depositors from around the 60 per cent mark to 70 and even 80 per cent.

And so we are going to see a much greater emphasis on attracting local deposits. Ultimately that will lift the cost relative to the Reserve Bank official interest rates.

And Australian banks have dedicated themselves to passing on any increases. That means interest rates on borrowings are going to remain higher than many expect and the amount of lending available will be limited to the growth in deposits.

That’s not a recipe for a major collapse in house prices but it will limit future increases.

Add to that the power price rises coming thanks to the carbon tax, plus other forces (Gillard's perfect power storm, March 28), and we will see more pressure on the consumer.

In this environment banks will be casting a tougher eye over retail, manufacturing and residential development proposals. Proposals involving health, professional services or resources are likely to be better received. Only those enterprises that have really worked on their productivity need apply.

This is the Australian version of the global deleveraging that is taking place. It is why we are going to re-engineer vast numbers of Australian enterprises and why we have started Productivity Spectator. It is profound.

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