Banks seek new fund avenues

MELBOURNE: The global financial crisis may not have blocked the flow of credit to consumers and businesses, but it has left banks scrambling for new ways to fund their loan books as credit demand picks up.

The big banks recently told investors in Hong Kong that although business credit in Australia was weak, overall credit demand would rise as domestic economic growth gathered pace.

While National Australia Bank's chief executive Cameron Clyne questioned the current level of real housing demand, Westpac's chief executive Gail Kelly said mortgage lending would continue to grow "at a reasonable level" in 2010.

But Sir Ralph Norris, boss of Commonwealth Bank of Australia, the nation's largest lender, cautioned that housing affordability would dictate mortgage growth in 2011.

With the Federal Government's wholesale funding guarantee officially ended on March 31, the risk that the price of rolling over wholesale term funding deals, used to fund loan books, will rise remains real, said PriceWaterhouse partner Mike Codling.

Politicians and the Australian Bankers' Association applauded the guarantee's success in safeguarding banks' access to offshore wholesale credit markets, which resulted in banks raising A$147 billion ($191 billion) and paying the Government A$1.3 billion in fees.

However, Codling pointed to Australia's continuing reliance on foreign funds to finance its current account deficit - funds that come at a price to the banks acting as intermediaries.

"There is a very real risk the price will continue to increase," he said.

As banks continue to roll over their wholesale debt programmes, which will become more expensive, the impact will wash through their funds transfer pricing and into their asset products, he said.

Those include mortgages and loans, and banks' concerns over funding costs amid constrained alternative funding sources led to interest rate hikes beyond those imposed by the Reserve Bank of Australia last December.

The RBA's March quarter bulletin noted that falling credit spreads offshore meant it was cheaper for the big four banks to raise unguaranteed funds in late 2009, but the price of rolling over term funding deals struck before the crisis hit remains high.

Norris said spreads were now running at 80 basis points, 50 basis points lower than one year ago.

"We're terming out [lengthening] our funding to between seven to 10 years. That comes at a cost," he said recently.

Meanwhile, lower-rated regional banks have to pay 200 to 250 basis points to issue new unguaranteed three-year bonds, with Bank of Queensland the most affected given its retail deposits fund just 64 per cent of its loan book.

Bendigo and Adelaide Bank and Suncorp Metway are less affected because they source more funding from retail deposits and joined the big banks and non-bank lenders in fighting an intense war for deposits from November to February.

Pricing competition moderated late last month said Norris, but Bendigo's chief executive Mike Hirst said rates offered on retail deposits were still unsustainable.

"The majors are certainly leading pricing in that area but I think it's unsustainable because they're paying 100 basis points [more] for retail deposits than what they can get in the wholesale market," he said. "It's a finite pool of funds.

"It's beyond me what the logic is behind what they're doing.

"If they want their loan books to keep growing how do they fund that if deposits aren't going to grow that fast?" asked Codling.

So what are the alternative funding options?

All eyes have been focused on the pace of recovery in the residential mortgage-backed securities market and whether the comments of Guy Debelle, RBA assistant governor, financial markets, that this will make regional and non-banks competitive will prove correct.

"There is a long way to go before you could say it will be a source of funding that would provide the non-majors with the amount of funding they need to be really competitive," Hirst said.

Increasing investor demand in March allowed Bendigo to upsize a residential mortgage-backed securities issue of US$1.1 billion ($1.6 billion) and BankWest to return to the market with a US$620 million issue.

But the market was still very expensive and remained closed to non-bank lenders, Codling said.

Meanwhile, banks continue to lobby the Government to overturn the Banking Act 1959's ban on issuing covered bonds.

Covered bonds operate in a similar way to residential mortgage-backed securities issues but are backed by mortgages or public sector loans that sit on banks' balance sheets.

Widely used in Europe, they would provide local banks with another funding source, but are not permitted in Australia because they subordinate the interests of bank depositors.

Some also hope the Henry review on Australia's tax system will help boost banks' retail deposit holdings by offering investors tax breaks for retail deposits.

But Norris said: "You'd have to be pretty brave to say that we'll see that happen."

- AAP