We keep hearing about smaller banks increasing interest rates.
Even though the Reserve Bank of Australia (RBA) has kept interest rates on hold, at a low 1.5%, for almost two years.
Bendigo Bank is the latest to do so.
Their reason: higher funding costs.
And, as The Sydney Morning Herald reported, larger banks are starting to feel the pinch too.
‘This week’s spate of interest rate hikes is the result of a significant lift in the banks’ cost of wholesale debt, which is an important source of funding for the sector.
‘In recent months other banks that have increased their mortgage rates include Suncorp, Bank of Queensland, ME Bank and ING.
‘Major banks acknowledged the higher funding costs in their half-year results in May, and since then analysts say the pressure on their funding has remained, squeezing profit margins.’
As banks keep facing higher funding costs, it is likely that rates will keep going higher. But they are also facing a shortage in funding.
Let me explain.
As you can see in the chart below, in 2016, 60% of the banks’ funding came from domestic deposits and 20% from short term debt.
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This is a different scenario from 2008, when 40% of their funding came from deposits, and about 35% came from short-term debt.
As the RBA explained since the financial crisis banks have increased their deposit funding share. This is because they are a more ‘stable form of funding than short-term debt’.
The increase in funding has come from either direct household deposits and super.
But, both of these are now dwindling.
Higher Debt Taking It’s Toll
You see, higher mortgages, higher costs of living, and low salary growth are taking their toll. Not only are Australian households in higher debt, they are also saving less. As you can see in the graph below, the Australian savings ratio has dipped in recent years.
Source: Trading Economics
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Households are saving less.
Yet super funds are also taking their business elsewhere…abroad.
As reported by The Australian Financial Review (AFR):
‘Australia’s banks will be forced to find an additional $70 billion of funding as superannuation funds shift out of cash into international assets while indebted households draw down on their savings.
‘The widening of the so-called “funding gap”, which measures the difference between bank loans and deposits, comes amid a crisis-like blowout in short-term funding that is increasing bank funding costs and has already prompted the non-major banks to enact “out-of-cycle” mortgage rate rises.’
This funding gap is quickly getting bigger. As you can see in the chart below it has jumped from $390 billion on the second quarter of 2017 to $457 billion in the first quarter of 2018.
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Banks are lending money out, but they are not getting deposits at the same rate.
As the AFR continued:
‘While official lending statistics show that the banks increased lending by 4.8 per cent over 12 months to May, deposits increased by just over 2 per cent, widening the funding gap. Household deposit growth was relatively stable at 5.6 per cent but financial and wholesale deposit growth, as measured by certificates of deposits, declined sharply over the period.
‘”So we have a picture of banks extending credit at roughly the same rate over the past year, but the slowdown in deposit growth has been much sharper,” TD Securities senior interest rate strategist Prashant Newnaha said, declaring it a problem.
‘He added that the slowdown in deposit gathering, which began in June 2017, “has played a key role in the subsequent rise in cost of bank funding”.’
Banks are facing a double whammy of higher costs, but also lower deposit growth.
What Are The Options?
Well, as the AFR concluded, banks can either offer higher interest rates to attract more saving deposits from homes and businesses…or they can turn to the short-term market.
Both options will mean higher interest rates.
Higher mortgage rates will mean that households face higher mortgage costs, which could decrease savings growth even more.
Higher rates with no wage growth could also mean that borrowers applying for new loans face higher scrutiny. Which could make it harder to get a home loan.
Yet the big banks could also be hesitant to increase rates after facing heat from the Royal Banking Commission.
That’s why we could see also banks slowing down lending.
Which could mean we see house prices keep going lower.
Editor, Markets & Money