Fear factor builds banks' cash flow

Potentially there are enormous sums that can be diverted to equity securities – shares or property – if there was more confidence.

That liquidity is both local and global. Nothing illustrates the local funding potential more than a remarkable revelation hidden in the impressive profit reports from our top four banks.

All four of them have reported strong growth in customer deposits. In other words, many Australians have ridden the ride of lower interest rates down and not removed their money from the banks. We have also seen the power of the international liquidity on the US market, and that power is spreading around the world.

But first to what is happening in Australia?

The Commonwealth Bank’s customer deposit funding of its book has risen from 62% in June 2012 to 64% in September 2013; NAB’s customer deposits are up 6.9%; ANZ’s customer deposits have risen a remarkable 12%; while Westpac is up 10%.

What that tells us is that, for the most part, a large number of Australians have not participated in the sharemarket increase and have suffered badly from lower deposit interest rates. Talking to retailers, they tell me that their older customers have been cutting back on their discretionary spending and that any retail growth has been confined to those in younger age brackets.

That simply wasn’t the case two or three years ago, and so the lower interest rates are very much a part of an intergenerational wealth transfer. Those in the younger age brackets are benefitting from lower mortgage payments and more equity in their homes. I must confess, on the question of bank deposits, I have been wrong. I thought that once term deposit interest rates fell below 5% it would affect the volumes, yet it didn’t. Indeed, term deposit interest rates are now below 4%, and this is still not affecting deposits.

Fear factor

When I am clearly wrong I like to understand what is happening, and during the week a veteran general practitioner put me right. He said that among his elderly patients there was a deep fear of another global crash – many had seen their savings hit in 2008 and did not want to experience that again. They found that when they had shares they worried about markets all the time, and it shortened lives. Many found that small share portfolios are expensive to administer because the accountancy charges  are high as a percentage of income .

And, as the sharemarket rises, people become more nervous that they have missed out and fear that the next move is down.

Accordingly, for many of those with retirement savings, lower interest rates have actually made them more nervous about risking capital in high-yielding equities for fear of further damage. So, in a strange way, the lower interest rates almost lock in the bank term depositors. It is a most unusual process.

Nevertheless, there are a lot of very unhappy bank depositors and I think that portion of the money will start to chase yield. (see below)

I don’t think there are many Eureka readers in this situation, but I think we are looking at a phenomena that may extend way beyond Australia. In the US, there has been massive public support for bonds.

Awash with money

The massive stimulation of the global economies in the US, China and Europe has caused the world to be awash with money, and that excess liquidity from the world system is starting to affect stock markets in different ways.

And so, this week we saw the US market actually rise in line with better figures in the economy, when three or four months ago better figures meant that quantitative easing would end sooner and tapering was closer, so the market fell. I think there is a view developing around the world that a gradual tapering process, while it would reduce the amount of funding in the system and will no doubt cause a correction on Wall Street, will not represent a catastrophic change in the American direction. The upward momentum that is beginning to develop in the US is bigger than a gradual tapering of quantitative easing.

In Australia, we are currently seeing $5-6 billion raised in initial public offers. Merchant bankers are working long hours because their clients want the public floats to get off the ground before Christmas, fearing some catastrophic event might take place and they might miss their chance. And yet the market is going to handle that $5-6 billion without problems because of the current global liquidity.

And as far as Australia is concerned, I had expected that the next interest rate move would be up, and I guess that is still my view, but we are starting to see a wall of unemployment developing in the next two or three years as the mining investment programs are wound down, the motor industry is possibly abandoned and retail begins to be affected by the switch to the internet and higher wages.

This will cause a lot of labour surplus and make it very difficult to increase interest rates. So retirees are not about to get relief in the short term, unless there is a considerable rise in overall global interest rates.

During last week I found myself in the company of non-food retail CEOs . They are pessimistic about the outlook for shopping centres outside the very top ones like Chadstone and Bondi Junction. Check your portfolio, and if it includes a substantial content of retail shopping centres, you should lighten the retail load.

Term deposit deals

At the end of last week, I received the first indication that term depositors are just starting to react to low rates.

I ran into one of the local bank managers and he was a bit downcast. He explained that the NAB via UBank had just lifted their six months rate to close to 4%. And the Commonwealth has a special offer via BankWest, which gives a six-month return that is even higher.

“I am only offering 3.35% for six months”, he explained. He can’t compete and his bank is beginning to lose deposits. If that loss rate starts to accelerate his bank will have to respond.

In preparation for the new capitalisation rules, banks are starting to divide depositors into baskets. Because of the looming new capital/liquidity requirements, institutions who simply plonk a large sum with a bank on deposit will require the banks to set aside liquidity on the basis that in a crisis that institutional deposit money would not stick.

Conversely if you deposit less than $250,000 and are subject to the government guarantee, and/or you have your transaction account with the bank, little or no liquidity has be set aside.

Your transaction account is therefore very valuable to your bank. Make sure you use that value to get the best possible deposit deal.