The World Bank’s warning that the global economy is on the verge of another financial crisis, with the prospect of a much broader freezing of capital markets than occurred in the wake of the collapse of Lehman Brothers in 2008, would be resonating loudly with bank treasurers.
The major Australia banks entered 2012 knowing that they would have to raise close to $100 billion of funding this year, with a significant proportion of it coming from wholesale markets, mainly offshore.
While all the banks have been stocking up on liquidity – not just because of the looming new prudential requirements but in case the eurozone crisis does worsen and affect their access to funding markets – at some point they will either have to tap those markets or dramatically shrink their balance sheets.
The World Bank’s gloomier prognostications depict a crisis that, because of the vastly-reduced capacity of governments and central banks to respond, could be deeper and more lasting than that which occurred in 2008 and 2009.
That means the banks have to be prepared for something other than a temporary closure of their funding markets and that the prospect that the federal government might need to reinstate its wholesale funding guarantees is alive. The Reserve Bank last year did put in place repo arrangements under which the banks can get access to emergency liquidity, at a price.
The 'apocalypse now' scenario of a complete shutting down of funding markets also means the banks will try (and are already trying) to raise as much term funding as they can, while they still can.
Today there are reports that National Australia Bank is about to launch another covered bond issue offshore, this time in sterling. Earlier this week Commonwealth Bank raised $3.5 billion of five-year money with the first Australian dollar issue of covered bonds.
CBA issue said quite a lot about both the domestic bond market and the urgency with which the banks are now moving to lock up as much funding as they can.
The decision to issue domestically followed CBA’s aborted attempt to issue covered bonds in Europe last year. It pulled that issue not because it couldn’t raise the funds but because, having seen the spreads on similar issues by ANZ and Westpac blow out in secondary trading, it wasn’t prepared to pay the price it would have taken to get its issue away.
This week’s issue was successful in securing a sizeable lump of five-year funding, but CBA had to pay the investors 175 basis points over swap rates, the biggest yield premium for a domestic big bank issue ever recorded. It is instructive that the bank said that relative to other markets for five-year money, the deal was attractive – essentially it was saying it would have had to pay even more had it issued offshore.
It is worth noting that when the federal government gave the banks the ability to issue covered bonds for the first time last year the majors did make it clear that the primary appeal of the bonds, which are secured by the cash flows from dedicated packages of bank assets, wasn’t the prospect of lower-cost funding, but rather than it would diversify their funding sources.
Because of the worsening eurozone crisis, the covered bond issues that have been made haven’t been cheap, but they have provided access to term funding when markets for unsecured bank debts have been effectively closed.
The domestic bond market is relatively shallow, so CBA’s ability to raise as much as it did was a major achievement. In the process, however, the issue forced a re-pricing of existing unsecured issues of bank debt. Conventional issues, assuming the market could absorb them, could be very pricey.
More particularly, because the domestic market is so shallow, it doesn’t offer the majors a safe haven from a closure of offshore markets.
When ANZ conducted the first of its new monthly interest rate reviews last week, it referred to the mounting pressure on its funding costs created by the eurozone-induced spike in wholesale borrowing costs and the continued competition for customer deposits, which it expects to be sustained.
The CBA experience and the fact that the majors are still scrambling to issue their covered bonds despite the rising cost would suggest that the funding pressures are still increasing.
That has implications for monetary policy. It increases the possibility that the majors will not fully pass on any future Reserve Bank reductions in official interest rates, or even impose out-of-cycle rate rises to both protect their margins and credit ratings and/or create some headroom to try to attract more deposit funding with higher term deposit rates.
Even if the World Bank’s worst-case scenario doesn’t eventuate, the fact that the banks have been trying to lock in as much of their 2012 funding requirement as they can in advance, and paying the price to secure longer-term funding rather than accept the refinancing risk of opting for cheaper short-term money, means that the legacy of the eurozone crisis will be built into their overall cost of funds for some years.