Australian banks may have their access to the cheapest sources of money reduced if the central bank winds down a special support measure and the pace of deposits slows, but analysts say the ongoing economic recovery will allow the lenders to absorb the possible increase in their funding costs.
Australian banks saw a decline in funding costs through 2020 following the central bank's policy measures to support the economy hit by the COVID-19 pandemic. The Reserve Bank of Australia, or RBA, reduced its benchmark cash rate by about 70 basis points over 2020 to 0.10% and announced a limited-period Term Funding Facility, or TFF, of A$200 billion at the benchmark rate to provide funding to the banks. The TFF window is scheduled to close in June.
Banks obtain funding from retail and wholesale deposits, debt and equity. The RBA said in a March 18 research paper that funding costs declined to historical lows over 2020, with wholesale debt costs and retail and wholesale deposit rates falling to new lows as a result of the central bank's policy measures. The banks' funding costs have declined in tandem with the cash rate, and hover close to 0.5% now, from over 4.0% in 2011, a chart in the report showed.
Martin North, principal at Digital Finance Analytics, said the RBA may extend the TFF to encourage more credit. "If not, then the banks will certainly need to tune their funding mix, and given the yield curve shape, funding costs will lift somewhat," he said. "My guess is about 30 basis points, rising to 1% as the TFF degrades."
The Australian economy's record run of three decades without a recession, the longest for any developed economy, was shattered by the COVID-19 pandemic as GDP contracted in the first two quarters of 2020. However, the nation's economy bounced back later in the year and is now looking at a strong outlook, fueled by the rising global demand for commodities that range from iron ore to copper. GDP returned to growth in the second half of 2020, and the government said in its May 12 Federal Budget that it expects the economy to grow 4.25% in the fiscal year that starts on July 1.
The pace of deposits, another source of cheap capital for banks, is likely to slow as economic growth picks up and Australians feel more confident about spending, Eleanor Creagh, Saxo Capital Market's Australian market strategist, told S&P Global Market Intelligence. "As the economy continues to recover, and reopening is well underway, households are spending more and saving less," Creagh said.
Measures came in handy
Major Australian banks reported that they increasingly leaned on deposits for funding. Commonwealth Bank of Australia, or CBA, said in its results for the fiscal first half ended Dec. 31, 2020, that its deposit funding ratio was 75%, up from 71% in the prior-year, as it continued to meet a significant portion of its funding needs from customer deposits. Customer deposits accounted for A$680.33 billion of CBA's A$909.5 billion of total funding for the half ended Dec. 31, 2020.
Australia and New Zealand Banking Group Ltd. said in its results for the fiscal first half ended March 31, that customer deposits accounted for A$570.4 billion of its A$906.7 billion in funding, up from A$561.3 billion in total customer deposit funding in Sept. 20, 2020.
The major banks have also drawn funding from the RBA's TFF. National Australia Bank Ltd. said its total TFF allowance was A$25.7 billion and it has drawn down the full initial amount of A$14.3 billion during fiscal year ended Sept. 30, 2020. The remaining amount remains available to be drawn down by June 30. Westpac Banking Corp.'s total TFF allowance was A$30 billion and it had drawn down A$22 billion.
TFF funding currently accounts for around 2% of the major banks' non-equity funding and they had drawn a total of A$63 billion by the end of 2020, the RBA said.
The lower funding costs also helped some of the majors improve their margins. Westpac said in its fiscal first-half results, that its net interest margin rose 6 basis points over the period to 2.09%. The bank attributed the improvement to lower funding costs, including from deposits and the use of the RBA's TFF facility. NAB also said that its NIM increased by 2 basis points, driven by lower funding costs. However, CBA said its NIM decreased to 2.01% from 2.11% in the prior-year due to the lower rate environment, though partly offset by lower funding costs.
"While I would expect to see some modest increase in Australian bank funding costs in 2021 and beyond, I believe the outlook remains largely benign for now," said Toby Grimm, managed portfolio analyst at investment company Baker Young. "Domestic household savings rates remain highly elevated, providing a source of deposit funding like banks have rarely enjoyed," he said. Even as the economy opens, some expenses such as leisure and travel may stay muted and enable savings to continue.
"There does not appear to be a shortage of liquidity — perhaps the opposite — and as such for now we see favorable conditions for banks continuing in 2021," Grimm added.