Our achilles heel. We were happy for asset prices to surge so high we had to fund 40% of it from overseas? Well I'm afraid there's no such thing as a free lunch................and here are the consequences outlined below.
It's funny, this issue rarely gets mentioned by the bulls.................very hush-hush indeed. I can understand why.
HOMEOWNERS will become the latest victims of the European debt crisis, with the nation's banks increasingly unlikely to pass on future interest rate cuts in full as their own funding costs rise.
In a looming headache for the Gillard government, the major banks have escalated warnings that the eurozone crisis is starting to bite hard in Australia.
In the past week, banks have found their own attempts to borrow money on international markets increasingly difficult and are having to offer higher interest rates to investors to obtain funding they then lend to mortgage-holders.
Earlier this month, the National Australia Bank angered the government when it passed on only 20 points of the Reserve Bank's 25-point cut in official interest rates, citing increased funding costs.
Industry analysts and former bank executives warn that the ability of all banks to pass on future rate cuts in full is being further undermined by conditions in Europe, where AAA-rated Germany struggled to raise funds from bonds investors this week. Free trial
"We are right in the middle of a pretty serious crisis right now," ANZ chief executive Mike Smith told The Weekend Australian.
"This has all the makings of being very nasty."
Mr Smith, the new chairman of the Australian Bankers Association, refused to be drawn on the direction of interest rates but said the euro crisis was rolling through the global economy.
"There is a credit crunch in Europe now. It is spreading to Asia and it will spread here too," he said.
As the Australian stockmarket fell for its sixth consecutive day yesterday, with the S&P/ASX 200 down 1.5 per cent to close at 3984.30, there are growing calls for the Reserve Bank to cut rates from the current 4.5 per cent at its next meeting, on December 6.
Since January 2008, banks have either increased their mortgage rates faster then Reserve Bank rate rises, or failed to pass on several cuts in full in an effort to protect their margins.
Recent figures from RateCity revealed the big four banks had all increased their margins over the Reserve Bank cash rate by more than 100 basis points since October 2007.
Had the banks kept in lockstep with the Reserve Bank, rates would have fallen from an average 8.32 per cent to 6.32 per cent instead of the current standard variable mortgage rates offered by the banks of about 7.8 per cent.
NAB this month became the latest bank to move independently of the Reserve Bank -- in a decision Wayne Swan described as a "kick in the guts to working families".
Former ANZ chief executive John McFarlane told The Weekend Australian that if the wholesale funding pressures continued the banks would have no option but to pocket some of any official rates decrease.
"If rate reductions occur, the pressure would be on them to retain or increase margins if the market will permit," he said.
To preserve mortgage margins, he urged banks to refrain from discounting mortgages to increase market share.
"In the end, the whole industry's margins get driven to the lowest level," he said.
"In order to make them more attractive the industry's margin has to rise."
Brian Johnson, a veteran banking analyst at CLSA, said "the funding environment is bad" and far worse for regional banks and non-bank lenders, meaning the big four banks had little competition and would pass on "structurally higher funding costs to borrowers". He said banks would not pass on any official rate cuts in full due to this "pricing power", which was "good" for banks and their shareholders but bad for homeowners with mortgages.
Banks are wary of breaching the government's new price-signalling laws, which prevent them from indicating the direction of interest rates.
But senior executives at one of Australia's top four banks privately concede the rising cost of funding is likely to make it more difficult to pass on Reserve Bank interest rate cuts in full.
They say rising deposits only partially offset the sharply higher cost of raising funds overseas.
Markets are tipping the Reserve to cut rates by 25 basis points up to six times in the next seven months. JPMorgan revised its forecasts and now expects the bank to cut rates next month, followed by two more 25-basis-point rate cuts by March.
The banks will be under pressure from the government to pass on any cuts to stimulate the economy and help it meet its pledge to return the budget to surplus in 2012-13, which will involve cuts in spending despite risks to the economy.
The crisis in Europe is pushing up the costs of even safer debt, with the CBA, Australia's biggest bank by market capitalisation, this week pulling an issue of so-called covered bonds -- considered an exceptionally safe investment -- after the volatility made it too expensive.
HSBC chief economist Paul Bloxham said although the banks' reliance on offshore funding had reduced as deposits rose through the higher savings rate, the banks still financed 20c of every dollar from offshore wholesale markets, down from 30c in 2008.
He warned the repatriation of funds by anxious European banks meant they were less willing to be involved in funding for Australia's banks, putting pressure on their access to funds.
Macquarie analyst Michael Wiblin this week warned the "slow-burn issue" of a slowdown in the strong deposit growth due to lower interest rates and a slowing economy would also crimp lending next year "just as banks need to support the economy".
He added Westpac and ANZ's expensive inaugural covered bonds had placed a "stake in the sand" for unsecured wholesale funding costs next year, expected to be 100-150 basis points above current average levels.
Along with funding costs, banks are facing a competitive retail banking market and low credit growth, which analysts said was seen in CBA's $1.75bn first-quarter profit this month.
