The big four's risky rates play

Australian banks will be tempted to cut deposit rates in order to recover lost margin from mortgages, but it's a dangerous game to play as wholesale funding markets seize up.

The next round of the European crisis will involve banks. In Australia, suddenly what banks pay for deposits will become a major issue. Having been forced to cut their mortgage interests rates, the Australian banks will be tempted to recover that money via lower term deposits and other deposit rates – in other words, to take the money from retirees.

But there is a danger in this. Australian term deposits are cheaper than borrowing on the overseas wholesale market. Moreover, there are clear dangers that the wholesale market could be greatly diminished by the European manoeuvres. The ratings agencies have already downgraded the big Australian banks for their dependence on wholesale borrowing. Losing market share in deposits carries risk.

And to underline this global banking risk, foreign investors are rushing into Australian government bonds at yields below 4 per cent. They are snubbing Australian banks, which are paying in the vicinity of 50 per cent more for their money than government bonds. The government will have to consider reinstating its deposit guarantee.

At the moment, there is a minimum of trust among European banks because everyone knows everyone is hiding losses – it’s a question of who is broke and who is not. As trust breaks down, so does confidence in European banks. Of course, if the politicians can convince markets to pay more for Italian and Spanish paper, then those paper bank losses will decline.

Nevertheless, any further deterioration in Italian and Spanish bonds (and perhaps French) during 2012 would severely damage the wholesale banking market, possibly at a time when Australian banks have maturing overseas wholesale loans.

Australian banks have already slashed deposit interest rates, and if they cut them again you could see an exodus of self-managed funds and other money, which will seek better rates from corporate securities, bank hybrids or even bank shares.

At the weekend, the most aggressive bank in leading deposit rates down was ANZ – the bank that broke ranks in cutting mortgage rates. This morning it has narrowed the gap, although its term deposit rates in most periods are still a little below the other big banks, except in five-year paper where ANZ offers 5.8 per cent – the same as NAB.

However, in this five-year sector Westpac has suddenly taken the lead and has lifted its offering from 5.8 per cent about two weeks ago to 6 per cent, compared to ANZ's 5.8 per cent, CBA’s 5.9 per cent (over $50,00) and NAB's 5.8 per cent.

It is fascinating that while the Westpac economics department has been the most vocal in forecasting lower rates, when it comes to term deposits the bank's special rate for products up to five years' duration either matches or beats its opponents.

CBA and NAB match Westpac in most (but not all) rates but if customers with larger sums seek a better rate, they can usually negotiate it. This is a game that will unfold as the day and week moves on.

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