'Big four' face test on rate cut stance

Arguments by the big four banks that higher offshore funding costs have prevented
them from passing on interest rate cuts in full may face a use-by date as credit
markets react to the results of US bank stress tests.
Local banks say they cannot pass on in full the Reserve Bank of Australia's 425
basis points in cuts since September because of the rising cost of term debt funding
in offshore wholesale markets and higher cost of deposits.
About 40 per cent of the banks' funding requirements comes from offshore wholesale
debt markets, but global consulting group KPMG says the local banks are increasing
their reliance on long-term debt markets.
"Competition in household deposits continues to be fairly aggressive," financial
services partner Michelle Hinchliffe told journalists.
"The banks continue to look to replace their short-term wholesale funding with
retail deposits and long-term wholesale funding."
The big four banks took only six months to raise over 80 per cent of their total
2009 term funding requirements.
Their funding costs argument gained strength when credit markets froze after the
liquidity shock caused by Lehman Brothers' collapse last September.
But recent signs of a thawing in credit markets mean the cost of funding could
become cheaper as credit spreads narrow and banks no longer need the government
guarantee.
"Quite recently three of the banks have managed to raise further funding without the
government guarantee so there could be an easing in the markets which will enable
them going forward to raise that funding and not have to pay that additional 70
basis points," Ms Hinchliffe said.
But another liquidity shock or protectionism on the part of investors could prevent
a total thaw in credit markets, she added.
The results of the US Federal Reserve's stress tests on 19 of the US biggest lenders
will be key, PricewaterhouseCoopers' banking and capital markets leader Michael
Codling said.
Due for official release late Thursday night, leaks of the results suggest Bank of
America (BofA) and Citigroup will need to raise $US34 billion and $US50 billion in
fresh equity respectively.
"The fact that BofA is going to have to go to the market for so much more capital as
maybe some other US banks will, it just puts a strain on the amount of available
capital and funding and the number of people chasing it," Mr Codling said.
"We're just not out of the credit crunch yet."
Mooted plans to fill the shortfall by converting the US government's preferred
shares into common stock will not make a difference, he added.
"Shoring up their balance sheet will involve either funding or capital," he said.
Scarcity of capital offshore will see the local banks continue to try to raise their
share of deposit funding - currently at least 54 per cent of total funding - which
is expensive, he said.
On short-term funding costs, the spread of 90-day bank bill rates have dropped from
over 140 basis points last October to below 50 basis points, KPMG said.
Bank bill rates partially reflect expectations of moves in Australia's official cash
rate, and is the rate banks charge (and collect from) each other.
Their business customers are charged a margin on top of this rate if they wish to
swap their fixed rate loans for variable rate loans, and vice-versa.
The local banks have ramped up the margin charged to corporate and business
borrowers as defaults emerged at the top end of town and started to migrate to the
small business sector.
Wider net interest margins also reflected the higher cost of replacing the term
funding that was raised prior to the credit crisis, KPMG's head of banking Andrew
Dickinson said.