There is no doubt that ratings agencies are on the nose. And it is probable that today’s Moody’s downgrade of the big four banks will be interpreted tomorrow by the broader media as a petulant and late attempt to recapture some lost credibility by picking on our perfect banks.
Besides that, a one notch downgrade is unlikely to materially affect funding costs and will probably also therefore be dismissed.
These denials, however, will be a mistake. Moody’s analysis of the Australian banks’ vulnerability is pointed. In fact, it’s right on the money as it were, capturing both the past vulnerability and potential future problems, as well as solutions.
To put it bluntly, Moody’s is onto us.
“The downgrade reflects our view of the Australian banking system’s structural sensitivity to conditions in wholesale funding markets”, says Patrick Winsbury, a Senior Vice President based in Moody’s Sydney office.
“Australia’s major banks have relatively high levels of wholesale funding — at about 40% of liabilities on average — and the global financial crisis has underlined the speed with which shifts in investor confidence can impact bank funding,” adds Winsbury.
“While the major banks have reduced their sensitivity to disruptions in the wholesale funding markets, the Australian financial sector’s long-term, underlying reliance on offshore debt remains in place; and which Moody’s believes is better reflected at the Aa2 rating level,” says Winsbury.
That’s it in a nutshell. The same nutshell we at MacroBusiness has feared for months and months, wondering when someone would pick it up and crack it. But that’s not all, Moody’s goes on:
Australia’s major banks have worked to reduce their sensitivity to disruptions in wholesale funding markets by diversifying their investor bases, increasing the weighted-average tenors of their borrowings, and by increasing liquid assets. These improvements are likely to be reinforced bytighter regulatory requirements, although Basel III timelines are long.
Near-term growth in wholesale funding is also likely to remain restrained on subdued credit demand, ample deposit growth, and ongoing caution from the banks with regards to the potential for further volatility in wholesale funding markets.
Consequently, Moody’s expects the banks to continue reducing their wholesale funding requirements — in particular short-term wholesale funding — for the next 12-18 months.
However, the fundamental funding structure of the major Australian banks remains in place. Australia’s mandatory superannuation scheme will continue to capture retail savings, of which only a low proportion are available to fund the banks. This situation is due in turn to the low allocation– by international comparison — of superannuation savings to fixed-income investments and deposits.
Additionally, Moody’s notes that much of the recent increase in domestic deposits has come from the corporate sector. When the cycle turns and credit demand eventually picks up, the ratio of corporate deposits to loans may be expected to deteriorate. Retail deposit growth will then likely be insufficient to fund the banks’ needs, driving them to increase wholesale funding once more.
Moody’s also notes that Australia has heavy investment needs, and so is likely to continue to run a sustained balance of payments deficit, which is likely in turn to perpetuate the banking sector’s requirement for offshore funding.
Furthermore, with the domestic economy increasingly biased to the commodity sector, terms of trade that are exceptionally favorable by historical standards, and high asset prices, there is a potential for confidence shocks to impact the banks’ access to funding.
During the recent crisis, the banks demonstrated that natural economic stabilizers do permit them to adjust their funding mix. Nevertheless, the downgrade reflects Moody’s concern that — in a less liquid and more volatile post-crisis world– the banks’ sensitivity to market conditions is better reflected at the new rating level.
Ouch. Put this down as the China warning. Australia’s entire economic model is being peeled back here. For well over a decade, Australia’s banks have funded huge swathes of the current account deficit. As well, over the past two commodities booms, much of the export income has been leveraged up and blown on housing and fancy living. Moody’s is effectively calling the risks of this model to account. And they’re still not finished:
At Aa2, the major banks’ ratings continue to incorporate 2 notches of uplift from systemic support. Moody’s views bank supervisors and the government in Australia to be supportive by global comparison and the banks to have high systemic importance, as implicitly recognized by the government’s “Four Pillars” policy (which restricts M&A among the banks).
Moody’s also notes that creditor-unfriendly initiatives — such a bail-in legislation — are not on the policy agenda in Australia.
Heavens to Betsy. It’s finally out in the open. The big four are too big to fail and Moody’s rates the Australian government’s implicit guarantee of the banks’ wholesale debt (as well as the explicit deposit guarantee) as worth two ratings notches. Moreover, by phrasing it this way, Moody’s has essentially put the Australian government on notice that if its dares back away from that guarantee then it can count on the result. The further implication is that the Budget had better remain shipshape to provide the guarantee.
This is uncomfortable reading. But it’s better to listen now and endeavour to change things than stick our heads back into the sand.
