Banks under scrutiny as low funding costs lift profits
The sharp drop in long-term funding costs coincides with a government decision last week to stop new investments in residential-mortgage-backed securities in response to better market conditions. During the week ANZ sold $1.75 billion worth of five-year bonds at 85 basis points over benchmark swap and bank bill rates. During recent years, banks have paid well over 150 basis points to secure the long-term funding.
The ANZ issue marked "the record for the cheapest five-year issue by a major bank since the GFC", said Philip Bayley, an ADCM Services credit market analyst.
Bank executives have argued that while short-term funding costs had fallen to lows, the price of securing longer-term funding remained persistently high. Economic problems in Europe and pressures on the region's troubled banking system had been the main cost drivers.
Further relief for bank profit margins is expected to come as the three and five-year funding locked in during the depths of the global financial crisis is starting to roll off.
Even so, banks argue that the main pressure is not global money markets, but rather competition for deposits among lenders. This is expected to intensify as more spare funds are ploughed into shares.
At the start of 2012, Commonwealth Bank sold $3.5 billion of secured three-year bonds at a record 175 basis points more than benchmark rates. Before the financial crisis took hold of credit markets in 2008, bank funding costs were running at record lows. ANZ and Westpac issued five-year paper in September 2007 at a spread of 42 basis points over swap and bank bills. Additions were made to these lines in May 2008 at 94 basis points over the benchmark rates.
The Reserve Bank recently played down the significance of a sharp drop in wholesale funding costs for lending rates, saying competition for deposits remained the key influence on banks' costs.
Frequently Asked Questions about this Article…
It means the price banks pay to raise money — especially long-term wholesale funding — has dropped to levels not seen since the global financial crisis. Lower funding costs can boost bank profit margins and increase pressure on lenders to pass any future interest-rate cuts on to customers.
ANZ sold $1.75 billion of five-year bonds at 85 basis points over benchmark swap and bank bill rates, which analysts described as the cheapest five-year issue by a major bank since the GFC — a clear sign long-term funding is cheaper than in recent years.
Bank executives pointed to economic problems in Europe and strains in that region's banking system as major drivers keeping long-term funding spreads elevated even when short-term funding had eased.
As three- and five-year funding that banks locked in during the worst of the GFC matures and rolls off, banks should see relief on funding bills, which can help lift profit margins relative to when those expensive facilities were on their books.
Banks say competition for customer deposits is a key influence on their overall funding costs and lending rates. The Reserve Bank has also downplayed the direct impact of wholesale funding falls on lending, noting deposit competition remains crucial.
A recent government decision halted new investments in residential mortgage-backed securities because market conditions had improved, removing a policy support that had been in place when markets were strained.
Before the GFC, five-year paper was issued at very tight spreads (ANZ and Westpac issued at about 42 basis points in Sept 2007). During and after the crisis spreads widened substantially — for example, Commonwealth Bank sold secured three-year bonds at 175 basis points in early 2012 — but recent deals indicate spreads have narrowed again.
The article says lower wholesale funding costs increase pressure on banks to pass on cuts, but regulators and banks point out that deposit competition and other cost factors also strongly influence lending rates — so passing on cuts in full is not guaranteed.
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