The banking system
The banking sector plays a central role in the Australian financial system. Banks transform short-term liabilities into long-term assets, but they must manage the liquidity, credit and other risks associated with this activity. This intermediation process is an important mechanism by which funds are channelled from savers to borrowers to facilitate business investment and household purchases of major assets, and to help businesses and households manage their liquidity requirements.
The effect of Basel III on bank funding
Some submissions argue that APRA’s approach to implementing Basel III capital has materially increased bank funding costs; however, these submissions do not quantify the effect new capital requirements have had on loan pricing. Submissions note that Basel III not only requires banks to use more capital funding, but that capital must be of a higher quality, which tends to be more expensive. Some submissions argue that APRA has taken a more conservative approach than in some other jurisdictions. While true, it can also be argued that APRA’s approach has, to some degree, reduced the risk premia paid by Australian banks on wholesale debt, which acts to reduce wholesale funding costs. Furthermore, as discussed in the Stability chapter, Australian banks’ actual capital ratios lie roughly in the middle of the pack when compared to other jurisdictions on a consistent basis.
On balance, it is difficult to ascertain whether APRA’s approach to implementing Basel III capital will materially affect Australian banks in terms of pricing or access to funding (domestically or internationally) or whether it has had a significant effect on loan pricing in Australia.
Under the liquidity coverage ratio (LCR), to be implemented in Australia from 2015, some banks will be required to hold unencumbered HQLAs to cover net cash outflows in a 30-day stress event.79 The proposed net stable funding ratio (NSFR) sets the required amount of longer-term funding against longer-term assets. The Inquiry notes that APRA has implemented a regime that is broadly in line with the Basel III liquidity framework.
An important aspect of the implementation of the Basel III liquidity reforms in Australia was the establishment of the Committed Liquidity Facility (CLF) at the Reserve Bank of Australia. Use of a CLF is allowed under the Basel rules for jurisdictions like Australia with insufficient HQLAs. This means those authorised deposit-taking institutions (ADIs) subject to the LCR are able to include the CLF amount towards meeting their LCR requirement. The CLF will also get some recognition in the proposed NSFR regime; third-party assets eligible for inclusion in the CLF will receive a treatment in the NSFR that reflects their enhanced liquidity characteristics.
Overall, the new capital and liquidity arrangements do impose extra constraints on banks’ balance sheets, although it is less clear that these constraints are having a significant effect on lending activities. The capital requirements means banks must use more capital funding than they otherwise might choose and the liquidity requirements place extra constraints on banks’ sources of funding and uses of that funding. This could limit banks’ ability to finance new projects and slow the rate of gross fixed capital formation. However, APRA’s approach may put downward pressure on the cost of funds for banks. Using more capital funding and holding more liquidity is more likely to enhance the stability of the financial system and give more confidence to wholesale investors and depositors, which is reflected in lower risk premia required by these providers of funds.
Funding credit growth
Several submissions, mainly from the banking sector, question how the banking system would fund higher economic growth in Australia.80 These submissions argue that ADIs would be unable to fund higher credit growth with new deposits. The ‘funding gap’ between credit and deposits is largely funded using wholesale debt. Some of this debt is issued overseas in foreign currency, which involves some risks if there are disruptions in these markets, such as the turmoil during the GFC. To ameliorate these risks, submissions argue that higher deposit growth should be encouraged, that further development of a corporate bond market is required, and that the superannuation system should be encouraged to allocate more funds to deposits and fixed income products.
Stewart, Robertson and Heath (2013) argue there is no reason to believe that higher demand for credit or reduced supply of deposits would disrupt economic growth.81 Lenders can change the interest rates they charge on loans, while the cost of different funding liabilities will be determined by investor preferences and the willingness of banks to supply different funding instruments.82 In its submission, ANZ states that markets for bank funding are generally efficient and do not impede the banking system’s ability to fund economic growth.83
In the view of the Inquiry, high-quality projects and viable enterprises would still be able to obtain funding through other channels if insufficient credit was available. But it acknowledges entities that are more reliant on loans, such as small businesses, would have some difficulty accessing funding.
Despite these arguments, the Inquiry acknowledges that the composition and stability of the funding for ADIs are important. A more stable funding composition enhances the ability of ADIs to fund long-term loans. The Inquiry recognises the need for some adjustments, particularly to tax, to ensure a more efficient allocation of funding in the economy.
Chart 3.7: Sources of bank funding
Note: Deposits in this chart are domestic deposits. Deposits of non-residents are included in Short-term debt.
In the period leading up to the GFC, banks had been using a greater proportion of wholesale debt funding (particularly from offshore) than they do today. In part, this was because of the ease by which short-term debt could be rolled over. When funding markets were dislocated during the GFC, Australian ADIs found it difficult to roll over short-term debt and to obtain wholesale funding. It also became difficult to sell securitised loans; securitisation markets had become an important source of funds for smaller ADIs and non-bank lenders. These events made it more difficult for ADIs to meet the demand for credit and led ADIs to their funding risks.
Market pressures, including from ratings agencies, resulted in a shift of funding towards more stable sources, particularly retail deposits. Deposits now represent a larger share of bank funding than they did before the crisis, and banks increased the maturity structure of their wholesale debt to manage their liquidity risk better (Chart 3.7). The shift in the funding mix was driven by a re-pricing of bank liabilities, and some entities, such as superannuation funds, switched away from bank wholesale debt to wholesale deposits.85 However, more intense competition for deposits and the higher cost of alternative sources of funding led to an increase in the cost of deposits for ADIs.
Some of the difficultly in attracting deposits from households relates to the tax treatment of products that pay returns in the form of interest. Compared to other savings vehicles, such as housing and equities, returns from deposits are taxed unfavourably. In its submission, Westpac states:
Westpac recommends the Inquiry considers measures for tax equalisation between bank deposits and other competing savings options. The specific nature of these measures should be considered in the Government’s tax white paper process.86
At the margin, this results in ADIs having to offer higher interest rates to attract deposits, which raises the cost of funds and lending rates in the economy.
The relative unattractiveness of deposits to households has helped drive the trends in the composition of bank deposits (Chart 3.8). Deposits held directly by households have accounted for a declining share of total bank deposits. In contrast, the share of deposits from superannuation funds has been rising. Demand for deposits by superannuation funds has been driven by strong growth in member contributions and higher demand for liquid assets.
As mentioned earlier in this section, some submissions suggest that superannuation funds should allocate more of their assets to deposits and long-term wholesale debt. Some stakeholders argue that a lower share of deposits directly held by households and a higher share of deposits from larger superannuation funds may, in fact, make it more difficult for ADIs to write long-term loans. Given that deposits made by large APRA-regulated superannuation funds are less sticky than retail deposits, ADIs would be required to hold a larger quantum of liquidity if they were managing their liquidity risks prudently. Under the LCR regime, the marginal liquidity required against an extra dollar of a superannuation deposit would come from self-securitised assets that already exist on the balance sheet of the LCR ADIs. Given the superannuation sector will become an increasingly large source of deposits for the banking system, it is unclear to the Inquiry what effect this will have on the banking system and the flow of funds in the economy more broadly.
Chart 3.8: Sources of bank deposits87
The Inquiry seeks further information on the following areas:
- What effect is the implementation of the Basel III capital and liquidity regimes in Australia expected to have on the cost of funds, loan pricing and the ability of banks to finance new (long-term) loans? How large are these effects expected to be?
- What share of funding for ADIs is expected to come from larger superannuation funds over the next two decades? What effect might this have on bank funding composition and costs? What effect will this have on the ability of ADIs to write long-term loans?
79 Those authorised deposit-taking institutions (ADIs) with simple, retail-based business models are subject to a simple liquidity ratio requirement under the minimum liquidity holdings regime.
80 For example, PricewaterhouseCoopers 2014, First round submission to the Financial System Inquiry, page 64; Westpac 2014, First round submission to the Financial System Inquiry, page 45.
81 Stewart C, Robertson B and Heath A 2013, Trends in the Funding and Lending Behaviour of Australian Banks, Research Discussion Paper 2013–15, Sydney.
82 Stewart C, Robertson B and Heath A 2013, Trends in the Funding and Lending Behaviour of Australian Banks, Research Discussion Paper 2013–15, Sydney.
83 ANZ Bank 2014, First round submission to the Financial System Inquiry, page 1.
84 Australian Bureau of Statistics 2014, Australian National Accounts: Financial Accounts, December 2013, cat. no. 52320, ABS, Canberra.
85 Reserve Bank of Australia 2014, First round submission to the Financial System Inquiry, page 183.
86 Westpac 2014, First round submission to the Financial System Inquiry, page 48.
87 Reserve Bank of Australia 2014, First round submission to the Financial System Inquiry, page 183.
88 Australian Bureau of Statistics (ABS) 2014, Australian National Accounts: Financial Accounts, December 2013, cat. no. 5232.0, ABS, Canberra.