The funding model used by large Australian banks is considered undesirable, but the banks are restricted by economic conditions, regulations and tax rules from making any significant changes to it. This is the conclusion of a report, entitled The Future of Australian Bank Funding, prepared by KPMG and the Australian Centre for Financial Studies, which was released yesterday.According to the report, options for bank funding structures are limited by two main factors. The first is the ongoing national balance of payments deficit, which necessitates capital inflow in the form of foreign investment.Banks are the main conduit for financing the current account deficit. Despite the strength of the resources boom foreign funding requirements will remain substantial for the foreseeable future. The second factor is the significant ongoing flow of household savings into superannuation funds. While a part of these funds finds its way back to the banks, the ultimate effect is to increase the importance of capital markets relative to bank balance-sheet intermediation.The Australian big bank funding model is regarded as undesirable for a couple of reasons. First, deposit funding is low by international standards, currently around 57 per cent of total liabilities. Second, the reliance on funding from international capital markets is high by international standard. An average of around 22 per cent of liabilities is due to non-residents. Much of the offshore funding is sourced from other financial institutions. This is treated as high run-off risk under Basel III proposals for calculating liquidity coverage ratios.Since the financial crisis, regulators and ratings agencies have asked whether a model involving significant international wholesale market funding is sustainable. Would further upward pressure on funding costs expose banks to significant funding and liquidity risks?The authors of the report believe there are problems with all the alternatives. But branches and subsidiaries established in countries where savings levels are high, as is the case in many Asian countries, provide the potential for a transfer of funds back to Australian balance sheets.However, interest withholding tax on funds raised from foreign depositors has an influence on bank funding patterns. The 2010, the Australian Government Budget announced there would be future reductions in the tax rate applied to certain transactions. But retail deposits made by foreign depositors in Australia will still be subject to 10 per cent withholding tax. Tight limits on covered bond issuance will limit the usefulness of this type of funding for big banks, and the high cost of issuing small amounts will make it difficult for smaller institutions to tap into the funding source. In the meantime, there remains a national requirement for financing the balance of payments deficit that banks are best placed to meet.