Bank culture and a possible royal commission matter little to foreign funders

The greatest force in setting the banks' funding costs is the health and stability of broader financial markets.

by Jonathan Shapiro

The global financial markets have spoken.

On Friday April 7, Bill Shorten stunned the banks by revealing his intentions to launch a royal commission into the sector. The five-year credit default swaps of the big banks, a proxy for funding costs, was at 120 basis points. Such a move was a reckless political stunt that would undermine the faith of foreign investors in our financial institutions. Any move in that funding spread might reveal this anxiety. 

As of Monday, however, that spread is virtually unchanged at 116 basis points. The message from the funding market is that either they don't believe a royal commission is coming or they don't care. I am opting for the latter.

There are some goods reasons not to hold a royal commission into the nation's banks. It's expensive. It may not uncover anything we don't already know. We've already examined them through Senate committees and an extensive review of the financial system that proposed fixes. The corporate watchdog already has the power to pursue misdeeds.

Bank executives say a Royal Commission will spook foreign investors.

But the line, now pushed by Don Argus, that they'll spook our foreign debt funders is not one of of those reasons.

"People aren't thinking about how destabilising this may be seen in world markets," he told The Australian Financial Review. "If you look at the bank balance sheets, at the moment they're using overseas funding to predominantly fund their balance sheets. Overseas lenders may stand back and say, 'What's going on in this country? How stable is it?' "

Whether or not the big banks are rorting their customers simply doesn't rank as a factor in setting the cost and access of funding for Australia's banks. There's no evidence it ever will.

By far the greatest force in setting the banks' funding costs is the health and stability of broader financial markets. When investors are anxious about just about anything from Europe's banks to oil exposure to a China slowdown, Australian bank credit spreads dial up; and then dial down when everyone calms down.

At times, Australian bank bonds can underperform the bonds of banks in other countries or of Australian companies but they tend to do that in periods of risk aversion. There are very few occasions when events in Australia or the specific actions of the banks actually move the dial for funding spreads.

Australian bank spreads have moved in line with global credit markets

Even the near $20 billion of common equity raised in 2015 to shore up the banks was outweighed by the broader whims of the global markets. At April 1, 2015, just before the big capital raisings took place, credit default swap spreads were 60 basis points, but spiked to more than 100 basis points by September that year.

While Australian bank credit spreads have moved in lock step with broader global credit markets, there are justified concerns that in the future investors could grow weary of Australia-specific risk. That could centre on concerns about the risks in the housing market or the impact of a more severe slowdown in China.

An inquiry into the banking industry's conduct is unlikely to register.

Unlike banks in the US and Europe, Australia's banks have managed to remain profitable in the years following the financial crisis. They've also escaped the multi-billion dollar fines levied at their foreign counterparts, which have chewed up a large percentage of their profits.

Moody's estimated total fines at the world's largest banks totalled more than $US220 billion from 2008 to 2014 while litigation provisions as a percentage of capital varied from 50 per cent to 5 per cent of common equity.

It is far-fetched, but not inconceivable, that foreign investors will become anxious that a commission will be followed by huge fines that will erode the banks' capital bases. But the offshore experience is that it was shareholders, not creditors, who felt the pain.

There are two issues at play and it is important that both sides don't conflate them in an increasingly political debate.

One is that Australian banks' continued reliance on offshore funding is a permanent vulnerability of our financial system that we have to acknowledge and manage.

The second is whether the conduct failures of our banks warrant the extensive examination that a royal commission will bring and whether such a process will do any good.

But suggesting the latter would undermine the former is to suggest it is better to keep up appearances and cover up our banks sins from the world. That approach never ends well.

Read more: http://www.afr.com/business/banking-and-finance/financial-services/bank-culture-and-a-possible-royal-commission-matter-little-to-foreign-funders-20160418-go960g#ixzz46DlLs76m
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