RBA says lower. CBA says higher

Australians have a number of favourite sporting past-times and bank bashing is one of them. The pollies were at it as usual last week but unusually, they were stirred into action by comments from the Reserve Bank. The RBA made it very clear that it is going to cut the official cash rate by 25 bps in September and it expects the banks to quickly pass the cut onto their mortgage borrowers.

The other bank basher was one of their own - Commonwealth Bank's Ralph Norris, blaming NAB and ANZ in particular, for blowing out the cost of borrowing offshore and thereby preventing the CBA from being able to fund the acquisition of the Australian operations of ABN Amro. There is an apparent contradiction here, given that the RBA is arguing that the banks' cost of funds has fallen in recent weeks.

Neither contention is correct.

The RBA is looking at the 90 day bank bill rate, which started to fall noticeably a week ahead of the last RBA board meeting, anticipating a softening in the RBA's monetary policy. Indeed, the 90 day bill rate now sits less than 4 bps above the cash rate. However, the banks do not fund their mortgage portfolios solely through the issuance of bank bills. There is also a good mix of longer term funding.

The dramatic fall in the bank bill rate is also interesting from the perspective that for the last four months the margin between the bank bill rate and the cash rate has averaged around 50 bps and now the spread has almost been eliminated. Liquidity in the global monetary system has not improved in the last four months and if anything, has possibly deteriorated: Libor spreads remain very wide. It is therefore unlikely that there has been any systemic improvement here, which suggests the bank bill market is pricing in a 50 bp interest rate cut in September. Should this not eventuate or when the market comes to the view that it is not going to eventuate, the 90 day bill rate will move sharply higher.

As for the cost of longer term funding, the credit spreads the banks have to pay on their borrowings have been moving steadily wider since the credit crunch began. In the domestic market, this is best exemplified in the two and four year parts of the curve. Bond issuance in May attracted a spread of 47 bps and 95 bps for two and four years respectively. By August spreads on two and four year bond issues had widened to 64 bps and 100 bps.

In offshore markets the trend is the same. In the one and three year parts of the curve, bond issues undertaken in May had credit spreads of 25 bps and 70 bps respectively. Bond issues with the same terms to maturity undertaken in July had credit spreads of 30 bps and 80 bps.
 
The banks' average cost of debt is continuing to steadily increase. And as for NAB and ANZ pushing out the cost of offshore borrowings, there may have been an initial reaction in the days immediately following their announcements but bond issuance since does not show any lasting impact and the CBA seems to be doing quite nicely.