The real Ruddbank

Amid all the hype about RuddBank one thing seems to have been conveniently ignored – it is not really a bank at all.

It is a conduit for distributing loan funds, and a very small amount of loan funds at that.

At a time when equity is king, it is notable that the Big Four banks will not be tipping any equity funds into the venture. They will simply be directing $500 million each in loan funds to be distributed by RuddBank.

The federal government's contribution of $2 billion is believed to be of a similar nature. That is loans, not equity.

The $2 billion in loans from the Big Four should be put in the context of the total credit in the economy at December 2008 of $1.9 trillion. About $770 billion of that is lending to business by financial intermediaries.

RuddBank, which is still being finalised and won't be available for use until March, is a contingency fund designed to cover a withdrawal of funds by foreign banks.

The key details of its lending criteria are as follows: it will lend to viable, existing commercial property projects that already involve lending by one or more of the Big Four; it is not permitted to refinance exposures of the Big Four; it will not fund new developments and lending will be on commercial terms, and at no worse terms than those given to the Big Four.

RuddBank grew out of discussions between the government and National Australia Bank. Westpac was an enthusiastic supporter while Commonwealth Bank and ANZ later agreed to get on board.

It is being created to provide a safety net in case the foreign banks pull out of Australia.

The anecdotal evidence is that some foreign banks are pulling out of Australia because of deleveraging of their balance sheets and a general repatriation of funds to their home markets.

Foreign-owned registered banks and financial corporations currently account for around 22 per cent of business loans and 15 per cent of the mortgage market, according to Macquarie Equities Research. Putting those percentages against the latest credit aggregates suggests foreign lending to business of $169 billion and foreign lending to home owners and residential property investors of $148.5 billion.

Foreigners are major participants in the syndicated loan market. Using data from the Bank of International Settlements (BIS) and Thomson Reuters, Macquarie estimates that foreign banks accounted for a little over half the syndicate loans of $75 billion in 2007 and about 40 per cent of the $63 billion in 2008.

Another statistic that puts the $4 billion RuddBank in perspective is the total foreign lending to Australia by offshore banks compiled by the BIS in its consolidated banking statistics. The BIS gives a breakdown of consolidated foreign claims vis-a-vis individual countries on an ultimate risk basis by nationality of reporting banks. This covers 24 reporting countries.

At the end of September 2008, the total was $US562 billion with the eight largest exposures being the European banks at $US421 billion, the UK banks ($US158 billion), the Netherlands banks ($US89 billion), German banks ($US60.5 billion), US banks ($US58 billion), Japanese banks ($US56 billion), French banks ($US49.8 billion) and Swiss banks ($US30 billion).

These figures, which include lending to banks, non-banks and government, are dominated by interbank lending. Naturally the bulk of the lending is to the Big Four.

The BIS data and the Macquarie estimates highlight how vulnerable Australia would be to a sudden large scale withdrawal of funding by foreign banks.

But bankers told Business Spectator that although there were indications that banks from Europe, the UK and the US had been withdrawing from the market, there was still reasonable demand for loan funds from the French, Japanese, Chinese and Swiss banks. Also, there is said to be growing interest in the Australian market from sovereign wealth funds.

RuddBank is an emergency response to a problem that has yet to manifest itself in the credit data published by the Reserve Bank and the Australian Prudential Regulation Authority, which tracks movements in loans and advances by locally incorporated foreign banks.

The banks have good reason to be cautious about providing equity to RuddBank, apart from the fact that an equity injection would involve a bigger hit to their capital than a straight loan.

A properly capitalised, government-owned bank with decent management could become a small but formidable competitor for the Big Four in the institutional lending market. A bank with $4 billion in capital could lend up to $40 billion.

It is not that long ago that the federal government was the sole provider of risky loans for infrastructure investment. The government created Australian Industry Development Corp, better known as AIDC, which had a patchy profit record but its staff were industry leaders in infrastructure funding and they financed some solid projects.

When AIDC was sold, its assets formed the basis of what eventually became Babcock & Brown, which is this week expected to be rescued by its lenders in a $2 billion debt-for-equity swap.