While busily undertaking their bank stress tests, it appears it has suddenly dawned on European bank regulators that regardless of the outcome of those tests there is another looming problem on the horizon: the small matter of up to $US5 trillion of existing bank funding that will mature and have to be refinanced over the next three years, about $US3 trillion of it by the end of 2012.
The issue is starting to get air play in the regulators’ reviews of the financial system as they start to think through the implications of a potential collision between the banks’ need to refinance maturing debts with the escalating calls on markets from governments to fund the measures they took in response to the financial crisis.
There is a real issue looming in Europe, where the banks being stress-tested because of their exposures to sovereign debt of dubious quality account for about half the borrowings that will need to be refinanced.
The problem — which has implications for the Australian banks — is one compounded by what the banks did before and during the financial crisis.
Ahead of the crisis, with the world awash with liquidity and cost of money absurdly low, there was a big incentive to borrow short term, which the banks (and non-banks) did. In the midst of the crisis, with governments providing short-term liquidity to keep their systems afloat, there was no real option other than short-term debt.
The global introduction of government guarantees with limited duration also contributed to what evolved from voluntary to involuntary short-termism.
And, of course, banks being banks, there were desperately needed trading profits available from borrowing short and investing long in an environment where central banks were leaning very heavily on the short end of the yield curve.
The Australian banks aren’t in quite as challenging a position as the Europeans or US banks, given that they have been able to exploit their status as among a handful of AA-rated banks to access markets and, as the markets have thawed, steadily and deliberately lengthen the maturity profile of their funding bases by paying a premium for five-year borrowings.
In fact, there has been a sensible mood of urgency about getting in ahead of the pack, with the Australian banks rapidly reducing the proportion of short-term funding in their books, increasing their deposit bases and paying the extra cost of securing more stable funding. Westpac, with the biggest wholesale funding task, has been particularly aggressive, regularly featuring among the biggest bank borrowers in the globe.
Nevertheless, depending on their balance sheet growth, the four big Australian banks will have to raise roughly $150 billion over the next two or three years — in competition with the rest of the international sector and governments.
The reliance of the Australian banks on wholesale funding from offshore markets is rightly seen as the most obvious threat to the stability of a system that is otherwise regarded as one of the most, if not the most, stable in the globe.
It is not helpful to the banks that they will be increasingly competing with sovereign issuers, which has implications for availability and the cost of funds. The implosion in markets for securitised debt and, from the Australian banks’ perspective, residential mortgage backed securities markets in particular, exacerbates the funding challenges.
The next Australian Treasurer might have to draw up some contingency plans for either supporting the banks again — there is already talk offshore of the possibility that governments might have to put in place a new round of funding guarantees — or responding to a credit crunch as the banks’ look to reduce their funding requirements by controlling the growth, or even shrinking, their balance sheets.
Perhaps Wayne Swan or Joe Hockey ought to have another look, or consider with more urgency, the ASX’s proposal for a retail bond market based on Commonwealth securities (see ASX’s retail bond advance, April 15) in order to try to develop a new domestic pool of retail funding for the banks and corporate sector. Measures to stimulate the RMBS market again might also be worthwhile.
We need a long-term and structural policy response to the demonstrated vulnerability of the Australian banks to disruptions in global funding markets, other than a credit crunch or another round of guarantees, although somewhat slower growth in credit than has been the recent norm, particularly to households, is by itself desirable and probable in the near term.
There is a vast amount of cash and liquidity sitting nervously on the global sidelines, so the global refinancing task is possible without necessarily causing more eruptions in markets and implosions in the banking sector, but there will be (at the very least) an extra cost involved in attracting those funds in a global competition between banks and governments.
Some of the Australian banks are already taking the view that whatever short-term funding they have is essentially irrelevant — in planning for their medium needs they need to get to the point where their reasonable expectations of growth are funded entirely with, at worst, borrowings that mature beyond 12 months.
Given the likely accelerated global scramble for term funding, and despite the prospective short- to medium-term cost, it is in the interests of the banks and their economies to pull forward their anticipated funding needs and temporarily abandoning the classic banking model (and depressing their profitability) by borrowing long to lend long.
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