Banks negotiate their balancing act with aplomb
But then the GFC hit and in the aftermath the European Union hit the skids and the Australian banks had to look elsewhere for funding, in particular the US.
The theory goes that the Australian housing market boom was funded by bank access to lots of cheap offshore debt. With that cheap debt gone, the Australian housing market was supposed to go into terminal decline.
But a funny thing has happened.
The big Aussie banks were able to resume their borrowing in European markets, particularly in the second half of last year and at steadily improving rates to boot.
According to data supplied by ADCM Services, euromarket borrowings by the Aussie banks amounted to the equivalent of $59.4 billion last year - a new record. All this against a backdrop of the eurozone unemployment rate hitting 11.8 per cent and real GDP contracting 0.4 per cent.
The major banks' AA- credit rating and Australia's strong economy meant that the big Aussie banks were able to keep borrowing - their paper was seen as a safe investment.
More recently all-up funding costs of wholesale debt have fallen below 100 basis points compared with 150 basis points for most of last year.
The market is now expecting the big Aussie banks to hold their net interest margins flat in the first half of 2013 - a remarkable achievement against a backdrop of a decline of about 10 basis points a year and the turmoil of recent years.
In other words, the banks have been able to use their market power in the domestic market to pass on some of the pain. They have held back rate cuts, toned down mortgage discounting and upped margins for the perennial whipping boy - the SME (small and medium-sized businesses) sector.
All the funding indicators are going the right way for the big banks. None of this is to suggest that banking stocks are cheap - only to justify the 30 per cent rise in banking stocks over the past eight months. It's still important because as long as the big banks can keep raising money offshore, there is a chance Australia's economic dream run can continue.
The easing of offshore credit markets has come just in time.
Equities managers are reporting the first discretionary flows from retail customers. With equity markets back in bull-run mentality, mums and dads are pulling cash out of low-return term deposits to jump back into the stockmarket.
Domestic deposits now make up about 55 per cent of total bank funding, compared with less than 40 per cent before the GFC, but don't expect it to keep rising.
All that sticky deposit funding the banks had built up in the aftermath of the GFC might turn out to be anything but.
Banks are inherently unstable entities if only because they borrow money for shorter durations than they lend.
Despite a higher reliance on deposit funding, Australian banks still have the highest proportion of wholesale funding of comparable foreign countries. This makes them more susceptible than most to a repeat of any global funding crisis.
But for the time being all the signs are good for the once-neglected liability side of Australian bank's balance sheets. And that is good news for the entire Australian economy, including our stockmarket.
Frequently Asked Questions about this Article…
Before the GFC, Australian banks relied heavily on the euromarket for shortfall funding. After the GFC they shifted to other markets (particularly the US) but more recently were able to resume and even increase euromarket borrowing — recording the equivalent of $59.4 billion in euromarket borrowings last year. So while domestic deposits have grown, offshore funding remains an important part of their mix.
Investors continued to view the major Australian banks' paper as a safe investment because of the banks' strong AA- credit ratings and Australia's relatively strong economy. That perception helped banks tap European markets despite eurozone unemployment at about 11.8% and real GDP contracting by 0.4%.
Wholesale funding costs have fallen to below 100 basis points from around 150 basis points for much of last year. That easing helps banks' funding expenses, and the market is expecting the big banks to hold net interest margins roughly flat in the first half of 2013 — a notable result given a historical trend of about a 10 basis point annual decline.
Banks have used their domestic market power to limit rate cuts, reduce mortgage discounting and increase margins on lending to small and medium-sized enterprises (SMEs). In short, they’ve passed on less of the funding-cost relief to mortgage customers and lifted margins for SMEs.
Domestic deposits have risen and now make up about 55% of total bank funding, compared with less than 40% before the GFC. However, the article cautions not to expect that share to keep rising indefinitely.
Despite stronger deposit funding, Australian banks still have a higher proportion of wholesale funding than comparable foreign peers, making them more exposed to any repeat of a global funding crisis. Banks are inherently vulnerable because they borrow for shorter durations than they lend, meaning a funding squeeze could still cause instability.
Equity fund managers have reported the first discretionary flows from retail customers as mums and dads pull cash out of low‑return term deposits and reinvest in equities. This shift is part of why deposit levels and funding mixes are changing, and it also supports equity markets' rebound.
The article argues that as long as the big Aussie banks can keep raising money offshore, there's a better chance Australia's economic 'dream run' can continue. The recent easing of offshore credit markets has come at a timely moment to support the liability side of bank balance sheets and, by extension, the wider economy and stockmarket.
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