tuesday sell off?, page-43

Treggs

For wholesale funding, banks have two options - borrow in AUD or borrow in FX, say AUD. They actually do both and they both cost about the same. Works like this.

- The bank can borrow in AUD, at say 90 day BBSW plus 150bps for 5 year money. 90 day BBSW is the local bank bill reference rate for 90 day money (effectively the rate at which banks will lend to each other for 90 days in AUD) and usually sits around 25-50 bps above the RBA cash rate depending on expectations of cash rate increases. So at the moment BBSW is about 5% (probably at bit higher after yesterday). So to borrow 5 year money the banks will pay 6.50% (the 5% plus the 150bps margin for credit risk). The rate paid will be reset quarterly based on BBSW at the time, so as floating rates increase the banks pay more.

Or the bank can borrow in foreign currency, lets say US$. In this case, the will borrow 5 year money at say US LIBOR plus 150bps. Given US LIBOR is about 30bps, this means the banks will pay a total of 180bps or 1.80%. This 4.50% less than the AUD borrowing. However, the bank needs AUD to lend out so it will hedge the USD back into AUD by executing a USD/AUD floating cross currency swap. The swap is an agreement to sell USD now and buy AUD now and to buy USD and sell AUD in 5 years time. During the 5 years the terms of the swap will be to pay a US$ Libor and receive AUD BBSW (the actual rate can vary around the flat by about 20bps, which can provide a small benefit or cost to borrowing in foreign currency but is absoutely at the margins.) The cost of of the swap is 4.50% a year which is the difference in borrowing rates. Thus no benefit in borrowing in foreign currencies.