Australian banks face a few strains

There's an interesting twist in the way the Basel III framework for bank regulation will be applied in Australia. This is because, unlike most western countries, Australia does not enough government bonds on issue for banks to hold to meet the liquidity requirements required under the Basel III framework.

Over the years running through to 2008, the Australian government ran budget surpluses and the stock of government bonds outstanding was negligible. During the global financial crisis occurred, the government's budget moved into deficit but these were small relative to budget deficits in other western countries and the Australian government has committed to return the budget to surplus in the next fiscal year. In gross terms, bonds on issue of the federal government and state governments are, respectively, 15% and 12% of gross domestic product. To meet a liquidity coverage ratio of 20% of their balance sheets, banks would need to hold bonds equivalent to 40% of GDP.

To address this shortage of high quality liquid assets (HQLA), the Australian Prudential Regulation Authority (APRA) proposes that Australian banks will be able to use a back-up liquidity facility provided by the Reserve Bank of Australia for the difference between their bona fide HQLA (cash, deposits with the Reserve Bank and government bonds) and the requirements of the new ratios from the Basel III requirements. And they are to pay a fee of 15 basis points for this liquidity facility.

Australian banks (along with the Canadian banks) are under much less stress than banks in other western countries: they had fewer risks when the global financial crisis first hit in 2008; they've maintained strong capital bases; bad debts are relatively small; and their direct exposures to the Euro-zone problems are very limited. Liquidity support provided by the Australian central bank to the banking system has been at normal levels for the last two years, whereas in Europe and the US it is at double to triple the levels that existed before the global financial crisis.

Australian banks are finding good opportunity to attract customer deposits, both retail and corporate. As a result, their deposit base has grown more strongly than their lending and the need to raise funds in wholesale markets has declined. Term deposits with banks have become a major asset holding of Australian households and for the 450,000 self-managed pension funds which between them account for almost a third of assets of the pension fund industry.

Australian banks have recently been given approval to issue covered bonds (on which the buyer has recourse to both the issuer and the secured collateral). Two of the major banks quickly took up the opportunity; however, their issues of covered bonds were priced at yields similar to those on senior unsecured debt issued by banks.

Market participants are expecting Australian banks to make sizeable issues of covered bonds next year - at yields below those on non-secured borrowings. In 2012, the banks have A$80 billion of debt maturing (almost half of it carrying the government guarantee that was introduced in the dark days of the global financial crisis and is closed to new debt raisings).

Three major banks reported their full year financial results in early November. Each was a strong result, with rates of return on equity in the 15% to 16% range and useful increases in dividend payments. Australian banks are looking for appropriate opportunities to acquire banking assets, particularly in Asia, should European banks be divesting such assets at attractive prices. 

Dr Don Stammer, director, ING in Australia