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David and Goliath banking

Stephen Bartholomeusz

Published 1:02 PM, 8 Feb 2010


Anyone who believes that the removal of the federal government’s guarantee of wholesale funding that was announced at the weekend will somehow level the playing field between the major banks and their smaller bank and non-bank counterparts is going to be severely disappointed.

There are a lot of myths and misconceptions about the impact of the guarantees on wholesale funding and deposits the government provided the banking system during the global financial systems dark hours in the aftermath of Lehman Bros collapse.

They have been characterised as bail-outs of the major banks and a competitive distortion that has heavily tilted the banking system towards the majors.

The reality of the wholesale funding guarantee is that until Ireland, with its banking system teetering, introduced its guarantee of deposits, the Australian majors were, as among the best-rated and stable banks in the globe, able to access the barely functioning wholesale debt markets.

Once Ireland moved, the flood of deposits across UK High Streets from the branches of UK banks to their Irish counterparts forced the UK government’s hand. It not only guaranteed its banks’ deposits but their future wholesale funding needs.

That forced the rest of the world to follow suite and, almost overnight, the majors’ premium AA ratings had been relegated to a second tier by the renting out of the sovereign debt ratings to banks with significantly inferior balance sheets.

When introduced, therefore, the guarantee wasn’t about the cost of bank funding but simply about access. It was the actions of governments elsewhere that forced the Rudd government to act. It is often over-looked that the government also guaranteed state-government borrowings – a move that underscored how dire conditions were in the markets at the time and how unrelated to their individual condition was the capacity of institutions to borrow without a guarantee.

Similarly, there seems to be a misunderstanding of the impact of the deposit guarantees. They weren’t introduced to save or shore up the majors but slow the massive outflows of retail deposits that were occurring from second tier banks and non-bank authorised deposit-taking institutions that was underway.

There were runs occurring on the smaller institutions as depositors rushed for the safety of the majors, deemed by depositors as too big to be allowed to fail. The guarantee was introduced just in time for banks like Suncorp and Macquarie, among others.

The wholesale funding guarantee did contain differential pricing for the majors and lesser-rated institutions and it is true that the majors have dominated guaranteed funding, with about $130 billion of the $160 billion of borrowings raised with the guarantee made by the majors.

However, that differential pricing reflected the underlying reality – the second tier institutions were lesser-rated because they were inherently riskier. With or without the funding guarantee the lesser institutions would have had limited, if any, access to wholesale funding and to the extent that they could access debt markets they would have paid a steep premium.

It was the pre-crisis environment that mis-priced the smaller institutions’ access to debt, rather than the structure of the guarantee.

At a broader level, while it is easy to blame the majors for the extent of their offshore borrowings to essentially fund their over-sized home loan books, the true culprit is our national propensity for living beyond our means. The chronic current account deficit has to be financed somehow, and it is the majors that are the conduits for that funding.

It is an issue complicated and exacerbated by changes in the structure of the Australian financial system wrought by the introduction of compulsory superannuation, which has to some degree diverted savings from the banks to more diversified super fund portfolios. (The majors’ plunge into wealth management over more than a decade has been attempt to least get an exposure to the earnings from the diverted savings streams).

The banks can get some access to the more than $1 trillion now sitting in those funds, but it is more expensive and more volatile wholesale access and the extent of domestic wholesale funding is limited by the traditional emphasis of Australian funds on equities and, to a lesser extent, commercial property.

To reduce the majors’ reliance on offshore funding, therefore, we would need to reduce national consumption, increase national savings and create more incentives within the domestic financial system for investing in fixed interest securities rather than equities and commercial property. That would have happened with a big bang that would have sunk business and the housing sector had the majors not been able to continue to borrow through the crisis.

The big banks have been gradually weaning themselves off the guarantee. NAB and ANZ last used it early last year. CBA and Westpac have utilised it more recently because they have the bigger funding task and exacerbated it last year by aggressively chasing home loan market share growth.

However, there is a natural disinclination to locking in an extra 70 basis points on borrowings that won’t mature for three to five years. As Wayne Swan said at the weekend, the government has collected $1.1 billion from the guarantee so far – but the funding raised means there is another $4.4 billion locked in.

One could quibble with the timing of the removal of the funding guarantee, given events of recent weeks, where we’ve seen the emergence of what could develop into a full-blown sovereign debt crisis in Europe that could spread into a broader re-infusion of fear into the global financial system and destabilise debt markets again (Is saving Greece even possible? February 8 and Paying our debt to Europe, January 21).

Also, the market for debt is going to be crowded, with a risk that those governments that conducted large-scale bail-outs of their financial systems and effected massive stimulus schemes to blunt the economic impacts of the crisis will crowd out non-government borrowers and cause a spike in borrowing costs.

A more leisurely timetable for withdrawing the guarantee – on that was better coordinated with the wave of new prudential rules that will be imposed globally on banks and that perhaps involved a steady increase in the cost of the guarantee to ‘encourage’ the banks not to use it – might have been a neater option.

As it stands, if offshore wholesale funding markets were to become dysfunctional again, the government would inevitably have to reintroduce the guarantee.

The retail deposit guarantee is being left in place until at least October next year. Given that the crisis has reinforced the conviction that has always existed that there is an implicit guarantee of big bank deposits anyway, there would be a risk of igniting another rush for absolute safety if the deposit guarantee was removed.

In any event, the crisis and the necessity of introducing the guarantee says that what has been implicit should probably be made explicit – and funded at arm’s-length from the taxpayer. Before the crisis the Rudd government was looking at the possibility of introducing a deposit insurance scheme.

One suspects that there will considerable discussion about the introduction of an industry funded deposit insurance scheme (which in practice the majors would try to turn into a depositor-funded scheme) between now and October 2011. Hopefully there won’t be discussion about the need to reintroduce the wholesale funding guarantee because of a renewed crisis in debt markets.




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