Debating bank solvency in the crash of 2008: reprised

Philip Bayley
With corporate Australia so reliant on the banks for debt funding, it is no surprise that the banks, in turn, are reliant on international bond markets for their funding. The Australian banks account for A$112 billion of the A$115 billion of total international bond issuance this year that is left after deducting the issuance of corporate Australia.
 
In this context, it is not surprising that the call for this reliance to be decreased is growing louder. John Schubert, chair of the board of Commonwealth Bank, is the latest senior bank representative to make this call.

We also had Ross Garnaut, a well-connected public service and academic economist, telling us last week that our big four banks were at risk of becoming insolvent prior to the Commonwealth government announcing that it would guarantee the banks' bond issues, last year.

Garnaut said the banks were at risk because of difficulties in rolling over their maturing bonds in the international bond markets and raising funds elsewhere to meet their liabilities.

This is a highly contentious claim and there has been no official acknowledgement, nor will there be.

However, the claim cannot be discounted when looking at the bond issuance numbers for the banks last year.

After issuing almost A$60 billion of bonds in the lead up to September 2008 in international markets, the banks issued less than A$1.8 billion in the month of September and virtually nothing in October and November.

Although the provision of a government guarantee was announced in early October, the banks did not issue bonds again in international markets until the guarantee became available in December 2008.

Also in the domestic corporate bond market, bank issuance ceased in September, after almost A$25 billion of bonds were issued prior to September. Issuance started up again in October.

The numbers don't prove that the banks were insolvent or even close to it but they do at least indicate that bond issuance had become difficult and very expensive, compared to what the banks were accustomed to.

The figures on the Reserve Bank's repo activity at the time also show a sharp increase in reliance on repo funds by the banks, so clearly funding was becoming a problem.

See the chart below.

In this context it is not surprising that the banks are now calling for a reduction in their reliance on the international markets: but what are they doing about it?

Issuance in international markets is at record volumes and the call from CBA's John Schubert comes just a week after his bank made the largest international issue that has been undertaken by an Australian bank at US$4.0 billion.

The only emerging trend is lengthening the term to maturity, with CBA and Westpac having both recently issued ten-year senior debt.

The banks have suggested that bank deposits should receive more favourable tax treatment, such as that that is extended to fully franked equity dividends and geared investments. This may, but more likely won't, get a guernsey in Treasury's review of the taxation system.

The banks will probably have to find another way of making deposits and saving accounts more attractive.

National Australia Bank's announcement of further fee reductions is a step in the right direction; raising deposit rates would help too.

Both moves will make it easier to raise mortgage rates ahead of increases in the official cash rate.

Offshore debt was attractive to everyone pre-GFC because it was cheap and plentiful, but now changes have to be made. Moreover, if corporate Australia moves towards funding itself, that will take further pressure off the banks.