Wednesday, November 24, 2010

Wednesday column: The Governor won't back the banks

Reserve Bank governor Glenn Stevens might even enjoy his appearance before the parliament's economics committee this week.

For once it won't be about him.

Usually he is asked never-ending variants of questions designed to establish whether he plans to move the cash rate.

On Friday he will be asked instead about other banks' business.

Have their costs been rising, as they say they have? And have they been rising fast enough to force them to lift their rates above the cash rate as Wayne Swan and Joe Hockey say they have not?

The banks seem to think Stevens is on their side, gleefully quoting (part of) what he and his board have had to say whenever it suits their case.

Others who have looked more carefully at all of what he has had to say believe he is closer to Swan and Hockey than to the big four.

Friday will give him an opportunity to explain what he knows at length. His staff probably know more about the finances of the big four banks than anyone else, including each of the big four themselves.

Here's what I think he will say...

In aggregate, the big banks' funding costs have been little changed for six months. That six month time period is important because it means their costs have moved little since they last put up rates in May. It gives them no cover for an extra rate hike on the ground that costs have been increasing.

"Little changed" were the exact words used in the Bank's most recent quarterly statement released just two weeks ago. They remain its most current all-encompassing assessment.

But they sweep up a number of (partly offsetting) changes.

Banks can be thought of as getting their funding from three quite different sources.

Long-term borrowing is getting more expensive. As existing long-term loans expire the banks have to replace them with newer more expensive ones, pushing up long-term borrowing costs. The Bankers Association seized on this observation in the latest Reserve Bank board minutes, incorrectly saying the Bank had confirmed "the cost of banks' funding has increased beyond the official cash rate". It had not, because long-term borrowing was only part of the story.

Banks also borrow short-term. Right now they are lucky. Short-term borrowing costs have been sliding in the past six months, after earlier soaring during the crisis. They have now almost slid back to pre-crisis levels.

And banks borrow from depositors. After climbing relative to the cash rate during the crisis, deposit rates stablised early this year and have moved sideways since.

Completing the picture has been a move away from one funding source to two others. Banks are relying less on short-term borrowing and more on long-term borrowing and deposits.

The net effect? That's where we began. Taking everything into account the Bank believes the costs facing the big four are "little changed" after six months.

"Little changed" provides little justification for the extra hikes the banks imposed in November. Governor Stevens will probably say so - if asked - on Friday, much to the discomfort of the big four and their cheerleaders.

But he will be able to offer them something.

The Bank believes the costs facing the big four are set to gradually rise from here on. It isn't certain, because something unexpected could happen, but with the costs of both deposits and short-term borrowing looking to have stabilised, the only trend set to continue is the creeping increase in the cost of long-term borrowing as old loans expire and are replaced by new ones.

It is an argument about the future, a qualified forecast about future cost increases. And it would have scarcely any effect on what the banks charged right now if the market was competitive.

The big four know it is not. Had the other three not followed the Commonwealth in imposing their own outsized rate increases this month, it probably wouldn't have lost too many customers to them. Westpac claims not to have lost many when it did it and wasn't followed by the NAB in December.

That's because despite all that Swan has promised it is still difficult to switch banks. He says he'll get it right in his second attempt next month. We'll see.

And Westpac and now the Commonwealth know the other big banks are likely to follow them in any event.

There are certainly fewer to keep track of. During the financial crisis St George fell to Westpac and BankWest to the Commonwealth.

Curiously from about the moment those takeovers got approved the margins charged by the big four turned fat. It is apparent in the Reserve Bank's chart. Before the takeovers customers paid them a net interest margin of 2.2 per cent. After, it climbed to 2.5 per cent - the worst deal since 2004.

It's been a good crisis for the banks. Last month in an appearance before a different parliamentary committee Treasury official Jim Murphy asked rhetorically, "If there are increased costs, should they be absorbing
them at this time? Everyone else had to face the global financial crisis."

Murphy is working on Swan's package.

Published in today's Age

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