Contest for funds key to banks' well-being

Australia's big four facing tighter margins and increased regulation. Photo / Thinkstock

MELBOURNE - Banks posted record profits in 2010 but earnings growth in the coming year may be difficult as the big four Australian banks behind New Zealand's trading banks prepare to compete for funds with heavily indebted foreign governments.

Westpac made Australian history with a A$6.3 billion ($8.46 billion) net profit that pushed the big four banks' combined profits to A$21 billion in 2010. This was due largely to falling bad debts as the banks emerged from the economic slowdown.

But analysts warn earnings may be depressed next year as higher funding costs pressure the margins of the big four - Commonwealth Bank of Australia, Westpac, ANZ Banking Group and National Australia Bank.

On top of the competition from foreign governments in the coming years, the banks are having to refinance their debt at higher post-GFC rates and will pay a premium for longer-term debt as they seek to lock in funding.

"There's going to be a lot of demand for longer duration bank debt than what we've seen in the past," CLSA Asia Pacific analyst Brian Johnson said.

Credit Suisse's Jarrod Martin and James Ellis warned local banks could be crowded out.

This is at a time when the local banks have a huge funding requirement, with CBA and Westpac the fourth and fifth biggest borrowers in global debt markets, UBS analyst Jonathan Mott said.

The past decade saw banks lend more money to home buyers and businesses in Australia without matching the lending with savings. The funding gap was filled by a growing reliance on offshore debt markets.

When the GFC weakened regional banks and caused non-banks to fail, the role of sourcing foreign capital to fund the domestic economy fell increasingly on the big four. In 2010 the big four passed on interest rate rises to protect margins after funding costs climbed after the GFC.

Now a greater challenge lies ahead: having to compete harder in offshore credit markets against global banks and heavily indebted Northern Hemisphere governments expected to issue debt aggressively from 2012.

"Banks could find their access to flows of wholesale funding diminishes below critical minimum requirements (their annual refinancing tasks) which cannot easily be replaced by other funding sources," Martin and Ellis said.

"Ultimately that cost would be passed through to borrowers," Fat Prophets' analyst Colin Whitehead said.

So banks are under pressure to diversify their funding sources.

Lenders spent much of 2010 competing for more retail deposits and lobbying the federal Government to allow the issue of covered bonds.

Southern Cross Equities analyst T.S. Lim said with interest income still comprising two-thirds of total income, banks will keep diversifying into wealth management and institutional banking products and services.

"They're probably ... trying to position themselves for a new paradigm in banking."

Treasurer Wayne Swan's inclusion of covered bonds in his bank competition reform package was applauded by the market as a step toward easing funding pressures.

Covered bonds operate in a similar way to residential mortgage backed securities but are backed by mortgages or public sector loans sitting on banks' balance sheets.

Other parts of the reform package, such as the proposal to ban mortgage exit fees, will ease pressure on consumers but slightly strengthen bank revenue headwinds.

- AAP