Term deposits shift the banking battleground

The battle for deposits, and the success the major Australian banks have had in attracting them, has been an increasing feature of the discussion around bank funding and its cost. There are, however, deposits – and then there are term deposits.

The Reserve Bank's minutes of the monetary policy meeting of its board today made that distinction. The RBA minutes said board members had noted that a major near-term determinant of funding cost pressures for Australian banks would be the pricing of term deposits.

Deposits, they said, now accounted for more than half of banks' overall funding, with the share having increased from 40 per cent in 2007, and within that term deposits had risen from 30 per cent to 45 per cent of the total.

As a consequence of the aggressive competition for term deposits, their cost had risen materially to the cash rate and the relatively short average maturity of term deposits meant that any changes in deposit pricing would flow through relatively quickly to the whole of the banks' deposit books, the board members concluded.

The focus on deposits is a direct consequence of the fright the banks received during the first phase of the global financial crisis, when their reliance on wholesale funding, and offshore wholesale funding in particular, was exposed as a systemic vulnerability when those markets suddenly froze and funding was at times simply not available.

Ever since then, aided by the flood of money out of non-bank institutions and the shock the crisis created for equity market investors, the banks have been aggressively shifting their funding profiles away from wholesale funding towards deposits. Senior bankers make it clear that this is a trend with some distance to run – there are bankers who'd like to see deposits funding as much as 80 per cent of their balance sheets, if not more.

At face value that is illogical, despite the spotlight ratings agencies have shone on the Australian banks' exposures to wholesale funding markets as a continuing source of vulnerability.

In their residual wholesale funding books, the banks have significantly reduced the proportion of short-term funding to focus on longer maturities. One would have thought that five-year wholesale funds would, for instance, pose less of a risk to banks than deposits.

The distinction the RBA made between deposits and term deposits is an important one. Within the overall deposit bases of the banks there are term deposits, largely from individuals, and then the short term, sometimes over-night, funds deposited by corporates which could be withdrawn in an instant.

So the core deposit funding is therefore the term deposit. Those, however, have an average maturity of somewhere between six and nine months, which begs the question of why they are considered safer than longer term wholesale funding.

In practice, apparently, most of those retail deposits are rolled over and the average term they are held by the bank is more like two-and-a-half years. The Australian Prudential Regulation Authority apparently takes the ‘'stickiness'' of the different forms of deposits into account and has been encouraging the banks to chase retail deposits.

It is also requiring the banks to hold varying levels of liquidity against the various types of deposits – near 100 per cent liquidity against overnight call deposits – which could have implications for banks' operating online savings accounts with the money at call as well as for the cost of holding overnight money.

The GFC did tend to indicate that in a crisis the deposits held by the major banks won't rush out the door – in fact quite the opposite – and the explicit guarantees on deposits up to $250,000 will to shore up the view of the major banks as safe havens.

Nevertheless, the reality that term depositors could withdraw their funds within relatively short time frames – which might be a particular issue if one of the majors got itself into some form of difficulty – means that APRA has been talking to the banks about finessing their term deposit offerings.

It is probable that, to minimise the amount of liquidity they have to hold against their term deposit funding, the banks will have to introduce meaningful penalties against early redemption to ensure the funds are there for the full term. There may also be automatic rollovers of the deposits when they mature unless the depositor explicitly instructs otherwise. There is an active discussion occurring between APRA and the banks about how to make those deposits ‘'stickier.''

If they are to retain and increase their holdings of term deposits materially further from what is today a limited pool of available deposits the banks are going to have to find ways to attract money that is currently invested in other asset classes, whether in DIY super funds or, indeed, institutional funds.

That implies further and probably material increases in the cost of deposits relative to the cash rate which, as the RBA said, will flow through far more quickly to the banks' overall cost of funds than would changes to the cost of the mix of wholesale funding and deposit funding the banks maintained in the past.

That's the argument ANZ's Phil Chronican was making earlier this month when he said that in the new banking environment only depositors would be better off, with borrowers and shareholders the losers. (Bank battles drive a depositors' dream, April 4).

It is the banks' growth and market shares in term deposits, not growth and shares in the market for home loans, that is the new banking battle ground for the sector and that is something that the banks, their regulators and their customers are still trying to get their minds around.