Banks Face Pressure To 'unwind' Rates

The Age

Tuesday October 14, 2008

Vanessa O'shaughnessy and Eric Johnston

MAJOR Australian banks are expected to face renewed pressure to unwind any interest rate moves made above the Reserve Bank's cash rate, given that their funding costs are expected to fall with the Federal Government backing the financial system.

Meanwhile, consolidation in the banking sector is expected to slow with the Government guarantee on deposits and wholesale funding to unlock financing markets that have effectively been off-limits for small banks for months.

The program extends to deposits in Australian-owned banks, credit unions and building societies for three years. It also applies to locally incorporated subsidiaries of foreign banks such as ING, Rabobank and HSBC.

Banks yesterday welcomed the package, although most noted that Australia's financial system was in strong shape.

"While we would say such a move is unnecessary because our banks are well regulated and well capitalised, in light of other governments around the world taking similar steps, we welcome the Australian Government's moves," a National Australia Bank spokeswoman said.

As part of the program, the Federal Government will charge a premium so it can guarantee any wholesale funding raised by the banks. It is believed Treasury will set pricing for the wholesale guarantee on a case-by-case basis.

Analysts said the program should give an enormous boost for the banking sector, particularly regional banks such as Bank of Queensland or Suncorp-Metway that had effectively been frozen out of wholesale funding markets.

"These banks will now effectively be able to access wholesale funding at the same cost as the major banks and all at a AAA rating," said Deutsche Bank analyst Ross Brown.

But funding costs for all banks were expected to "fall significantly" he said.

This would enable them "to not only fully pass on future rate cuts but also to unwind most of the previous unilateral rate rises", Mr Brown said.

Short-term credit markets yesterday showed signs of thawing, but longer-term debt markets are still iced over.

The yield on Australian bank bills fell to a two-year low following a vast array of initiatives presented by major central banks, the European Union, and the British, US and Australian governments.

The yield on bills - which are used as an indicator of banks' short-term funding costs - has fallen about 25 basis points across the board.

Still, analysts said worldwide efforts to unlock credit markets would take time to have an impact on long-term debt markets. But even small moves in short-term markets were a positive.

Banks often pay a premium on top of the yield on Australian bank bills, particularly when they access funding for longer periods, such as nine months or a year.

A Commonwealth Bank spokesman said funding markets were "still very dislocated" and would take time to recover.

The market is betting the Reserve Bank of Australia will cut interest rates by up to 115basis points within the next year. And some commentators predict the RBA will cut rates by 50 basis points at its November meeting.

But ICAP senior economist Adam Carr said he was not convinced the Government actions announced to date would help in the long term, because of the "size and enormity" of the problems in financial markets and the global economy.

Yesterday's sharp drop on Australian bank bills was partially in response to the outlook for interest rates, Mr Carr said.

Separately, Australia's Big Four banks are likely to be hit with tens of millions of dollars of additional charges in New Zealand, which has intro-duced a deposit protection scheme.

The New Zealand program, which will be offered for two years, will cost 0.1% annually for deposits of more than $NZ5billion ($A4.63billion) .

The Big Four Australian banks control more than 90% of New Zealand's market.