Scrutiny on banks as lower 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…
When the article says Australian bank funding costs are at their lowest since the global financial crisis (GFC), it means the price banks pay to raise money in wholesale markets — especially for longer-dated borrowing — has dropped significantly. Lower funding costs can boost bank profit margins and increase pressure on lenders to pass any future official interest-rate cuts on to borrowers.
Short-term funding costs have fallen to lows, and long-term funding costs have recently dropped as well. This shift matters because cheaper long-term funding reduces banks' interest expenses over time, improving profitability. The article notes long-term costs were previously elevated due to economic problems in Europe, but relief is coming as three- and five-year expensive funding from the GFC era rolls off.
ANZ sold $1.75 billion of five-year bonds at 85 basis points over benchmark swap and bank bill rates. Analysts called it the cheapest five-year issue by a major bank since the GFC. That sale is a clear market signal that long-term wholesale funding is now cheaper, which can help bank margins and influence investor expectations for bank profits.
Lower wholesale funding costs increase the case for banks to pass on interest-rate cuts, and the article says lenders are under pressure to pass any future cuts in full. However, banks and the Reserve Bank note that competition for deposits remains a key influence on lending rates, so changes to customer rates depend on both wholesale market moves and deposit dynamics.
The government decided to stop new investments in residential-mortgage-backed securities because market conditions improved. The move reflects better wholesale funding and market conditions, reducing the need for further government investment in those securities.
Yes. While wholesale funding costs have fallen, banks say a main ongoing pressure is competition for deposits among lenders. As more spare funds flow into shares and other assets, banks may have to offer higher deposit rates to attract customers, which can offset some of the benefit from cheaper wholesale borrowing.
The article cites several historical examples: ANZ and Westpac issued five-year paper in September 2007 at a 42 basis-point spread over swaps and bank bills, with additions in May 2008 at 94 basis points. It also notes Commonwealth Bank sold $3.5 billion of secured three-year bonds at a record 175 basis points above benchmark rates at the start of 2012. These examples show how spreads widened during stress and have since narrowed.
The Reserve Bank has played down the direct significance of the sharp fall in wholesale funding costs for lending rates, emphasizing that competition for deposits remains the key influence on banks' overall funding costs and therefore on the rates banks offer borrowers.
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