THE Australian banks have always tapped debt markets to find money for lending that their deposits don't provide. They are cutting back now, but the day when they are totally deposit-funded is still far away.
Foreign loans taken out by Australian banks to fund their own lending accounted for 82 per cent of Australia's $521 billion net foreign debt load at the end of 2006, and the risk involved was laid bare by the financial crisis that followed.
The Australian banks survived. Their high credit ratings, sound balance sheets and geographic remoteness from the cauldrons of the crisis gave them borrower-of-first-resort status. A total credit market freeze would have caught them, however, and they've been working hard to boost their deposit bases and reduce their reliance on debt funding ever since.
It's being driven partly by global re-regulation that favours deposits, and partly by a recognition that investors and credit ratings agencies want the change. Westpac chief executive Gail Kelly described it this week as a shift from a lending culture to a deposit culture - the linking of lending growth plans to deposit growth, in effect - but the process is going to have its limits in this country if the financial system isn't overhauled.
The banks, as I mentioned, accounted for 82 per cent of Australia's $521 billion net foreign debt load at the end of 2006. Australia's net foreign debt rose further to reach $735 billion by the end of 2011 - but the banks' share of the debt load fell by 22 per cent from $427 billion to $333 billion, 45 per cent of the total.
Foreign debt rose even as our banks cut their foreign borrowings because public sector debt soared, from just $2.3 billion at the end of 2006 to $204 billion at the end of last year. That wasn't only because the Rudd government borrowed money for crisis stimulus. Public sector net foreign debt was $129 billion at the end of 2010, and rose 58 per cent thereafter because foreign investors were wading in and buying Commonwealth bonds already on issue.
The buying has been strong enough to push the Commonwealth 10-year bond yield down from about 5.5 per cent to 3.6 per cent, and the foreign money that is coming in has replaced the banks' overseas borrowings as the funding source that covers Australia's current account deficit. The banks, meanwhile, have cut their borrowing habit, but not beaten it.
Bank deposits grew from $670 billion in mid-2006 to $1327 billion in March this year, as companies reacted to the global crisis by paying off debt and hoarding cash in bank deposits, and as households took out global crisis insurance. Households were spending slightly more than they earned at the turn of the century, bridging the gap with debt. Now, they are saving about 9¢ in the dollar.
Westpac and the CBA in particular wrote home loans very aggressively during the crisis as non-bank lenders fell by the wayside, however, and the value of bank home loans actually doubled to $1100 billion between mid-2006 and March this year. The value of commercial loans rose from $400 billion to $690 billion, despite widespread corporate loan paybacks, and personal loans grew from $92 billion to $106 billion.
That loan growth meant that deposits only edged up as a percentage of the three loan categories over the period, from 64 per cent to 70 per cent. The balance, 30 per cent or $569 billion, is roughly how much lending the banks are still underpinning with borrowings of their own. Their annual non-deposit funding task is about 20 per cent of that total, or about $114 billion, because they turn their stock of loans over every five years or so.
The banks are borrowing more money locally now and raising funds with covered bond issues, but CLSA banking analyst Brian Johnson has been tracking the progress of the banks towards deposit nirvana closely, and on his tough measure of ''core deposits'' that exclude wholesale deposits they have a way to go.
After Westpac announced its 1 per cent rise in cash earnings on Thursday, he estimated that it had a core loan to deposit ratio of 186 per cent on a $405.5 billion loan book. ANZ's ratio is 199 per cent on Johnson's measure, NAB's is 180 per cent, and CBA's is 169 per cent.
Figures released by ANZ on Wednesday measured deposits more widely, and put ANZ's loan to deposit ratio at a market-leading 134 per cent, followed by CBA at 141 per cent, NAB at 153 per cent and Westpac at 160 per cent.
On either measure they are relatively high, however. Asian banks tend to be entirely deposit funded, and American banks are fully covered post-crisis because they haven't lent much of the liquidity the US Federal Reserve created for them. They had net loans of $US6.5 trillion and deposits of $US9.2 trillion at the end of last year, a loan-deposit ratio of just 70 per cent.
On the loan-deposit ratio measure, our banks most closely resemble the European banks, in fact. They can borrow more easily, and their balance sheets are stronger, but it's an uncomfortable coincidence.
What now? The banks will continue to bid for deposits and use the money to replace loan funding. Their overall funding costs will rise because deposits cost more than the loan funds they replace.
And it remains to be seen to what extent they can boost the loan-to-deposit ratios without rationing credit: there are swing factors and structural obstacles.
Deposits will be scarcer if companies start spending their idle cash, for example, or if households save less. The foreign money that is pouring into Australian bonds also needs to keep flowing. A full conversion to deposit funding would also require a restructuring of the $1.3 billion superannuation pool, to divert money from it to the banks: not happening in next week's budget.