Australian Banks: Clouds On The Horizon

Feature Stories | Apr 14 2023

Australia’s banks are expected to report solid earnings in the coming weeks but enjoy it while it lasts, analysts suggest, as clouds build and headwinds pick up.

-Little fear of systemic risk for Australian banks
-Bank crisis will nevertheless impact credit conditions
-Peak margins and earnings now upon us
-The mortgage cliff is just one problem

By Greg Peel

On March 8, Silicon Valley Bank in the US announced it had sold securities at a loss and would thus look to raise capital. The opposite occurred. Fearing bank insolvency, depositors rushed to withdraw their funds and within 48 hours, the US regulator shut the bank’s doors.

The SVB experience set off a chain reaction across the US and global banking systems. Both US government bodies and US major banks were forced to step in to avert another Financial Crisis. Then in an unrelated matter, Credit Suisse announced accounting discrepancies and in the prevailing mood, also threatened to go under before being rescued by compatriot UBS.

Investor nerves were left very raw, and Australia was not immune. The ASX200 plunged -6.3% between March 8 and March 20, led by the financials sector.

Following assurances from central bankers there was no longer anything to fear, particularly in Australia, the ASX200 has since returned to the level from which it fell. However, the rebound has been led more by the resource sectors than financials, which have to date recovered only around a third of the lost ground.

Investors remain nervous as to what’s ahead for the banking sector globally, and locally.

Australia by Comparison

Deposits have been flowing out of all US banks since early last year, as interest rates have risen sharply. Deposit rates have failed to keep up with other “cash” investments on offer, such as money market funds and short-term notes/bonds. In SVB’s case, when outflows started to be an issue, it was forced to sell part of its investment US Treasuries.

At a substantial loss, given the investments were made at near-zero rates and the subsequent surge in yields has significantly reduced their value. The announcement it would be raising capital sounded an alarm bell to depositors, and there followed a run.

As at end-March, US deposits had fallen -US$655bn or -3.6% since peaking in April 2022, notes Jarden, primarily driven by the withdrawal of term deposits for which banks failed to pass through higher rates. I think we’re all familiar with the concept.

But that said, Australian banks have passed through relatively more rate hikes to deposit rates than their US counterparts, Jarden notes, and options for cash management outside the Australian banking system are limited. There are no large Australian money market funds (MMF).

Australia's large and competitive term deposit market means that while the cost of deposit funding is on the increase, Jarden does not see a risk of material outflows from the banking system. That said, we are seeing a shift out of at-call and into term deposits. While this presents downside risk to bank margins and profits, the deposits are maintained within the system and do not raise risks of insolvency.

Comparing US Fed and APRA data, Jarden finds 60% of RBA rate hikes have been passed through to Australian deposits compared to 25% in the US. The average deposit yield locally rose to around 2% compared to only 1% in the US. The spread from US deposit rate to cash rate has arisen to around 3% -- the highest since the late 1980s Savings & Loan crisis (See: Australia And The US Banking Crisis; https://www.fnarena.com/index.php/2023/03/23/australia-and-the-us-bank-crisis/).

The Australian spread has risen to around 1% post-GFC, reducing any incentive to seek better returns on cash investments outside banks.

US MMFs have seen the highest weekly inflows on record, outside the initial covid panic, to a level reaching 28% of bank deposits. Not only are Australia’s MMF options negligible by comparison, the size of Australia’s short-term security market (government bills, commercial paper) is tiny compared to the US. Jarden finds the total value of other “cash” investments equates to 3.6% of bank deposits, compared to in excess of 20% in the US.

But wait, there’s more.