September 6, 2010
Banks may inflict higher mortgage rates on borrowers to offset the costs of new liquidity rules that are tipped to drive up the price of the safest financial assets.
To protect banks from future financial shocks, the Basel Committee, a global banking regulator, is requiring banks to boost their holdings of top-rated government bonds.
But new research from Citi shows that the health of state and federal budgets means red-hot demand for the bonds is likely to outstrip supply.
After a far stronger recovery here than in most developed economies, Citi’s conservative estimates found the big local banks would soak up nearly all the supply of federal and state government bonds.
By 2013, when Canberra issuance is tipped to start falling, Citi predicts a $27 billion shortage, which would be exacerbated by a likely flood of foreign demand for Australian government paper.
State government debt will also be highly sought, it says, as state budgets are on track to hold less debt as a share of output than the Commonwealth. Coupled with strong growth prospects, this is likely to make state government debt more attractive to foreign investors.
A Citi economist, Joshua Williamson, said that if left unaddressed the ”wafer thin” balance between supply and demand would drive up bank costs because bond prices would increase.
”There is not enough high-grade federal and state government bonds to satisfy regulatory demand, let alone the combination of regulatory and normal market demand,” Mr Williamson said.
”To the man in the street, it means that the banks may have to put up interest rates on their loans.”
In response to the proposed Basel rules, banks have called for regulators to broaden the definition of what is considered a top-tier asset.
Amid reports that the rules could be changed to cut the burden on lenders, staff from the Australian Prudential Regulation Authority will today give a presentation in Sydney on the future of banking regulation. But the CLSA analyst Brian Johnson said drastic changes from APRA were unlikely, even though the regulator may tweak the rules ”at the edges”.
Mr Johnson said the Basel reforms would cause Australian banks to cut leverage, after an asset boom that saw their leverage increase sharply over the past decade. The changes would also push up funding costs, squeezing margins if lenders were unable to pass on costs to customers.
Bank complaints prompted the Basel Committee to consider softening the rules in recent months, and the change in stance has been welcomed by Australian bank executives.
At a recent analyst briefing, Westpac’s chief executive, Gail Kelly, said regulators, including those in Australia and Europe, were ”taking a more pragmatic approach”. ”Regulators here are arguing the Australian situation and making some good ground there, so all of that is positive news for us,” she said.