Joint Submission from the RBA and APRA to the Inquiry into Bank Funding Guarantees 3. Effect of the Guarantee Arrangements

3.1 Deposit Markets

The announcement of the Government guarantee arrangements on 12 October 2008 had a clear effect of stabilising confidence in ADIs. The effects were seen most immediately in movements in deposits, to which the guarantee immediately applied. In particular, following the announcement there was a reversal in potentially destabilising deposit outflows from a number of ADIs that had been evident in early October. By guaranteeing all deposits under $1 million, the FCS reduced the incentive for depositors to move away from ADIs that they perceived as being at risk.

The guarantee also supported overall ADI deposit growth, adding to the pre-existing trend. Deposit growth at ADIs had been picking up over 2008, consistent with growing risk aversion by households and businesses amid the uncertain environment (Graph 2). In September 2008, around 30 per cent of households in the Westpac-Melbourne Institute Survey of Consumer Sentiment nominated banks as the wisest place for savings, up by 10 percentage points over the year, as household preferences moved away from riskier assets such as real estate and shares (Graph 3). This is not an unusual reaction in periods of uncertainty; an increase in the perceived safety of banks was also evident in the early 1990s.

Following the guarantee announcement, there was a further sharp increase in deposit growth, and the share of households nominating banks as the wisest place for savings also increased. These developments are likely to reflect both the guarantee reinforcing the security of deposits, and the extremely uncertain global and domestic environment in late 2008 following the failure of Lehman Brothers. More recently, as nervousness has eased, both the pace of deposit growth and the share of households nominating banks as the wisest place for saving have fallen.

Another factor supporting overall deposit growth is that ADIs have responded to funding pressures by competing aggressively for deposits. As a result, interest rates available on deposits are at historically high spreads to market rates (Graph 4). Part of the increase in deposit funding is likely to reflect switching from short-term wholesale debt instruments, which have fallen as banks concentrate on accessing funding through deposits and long-term wholesale funding.

There has been interest in the evolution of deposit market shares among different categories of ADIs in the period since the introduction of the guarantee. Australian banks have gained market share during this period (Graph 5) with deposits of the regional and smaller Australian banks growing more quickly than those of the four majors (Graph 6). Most of the gain in market share by Australian banks during 2008 was at the expense of subsidiaries and branches of foreign-owned banks. Credit unions and building societies (CUBS) also lost some market share in the period leading up to September, but this stabilised after the introduction of the guarantee.

3.2 Deposit-like Products

Outside the ADI sector, there are also difficulties in separating the effect of the guarantee from pre-existing trends.

• Available data show a significant outflow from mortgage trusts in October 2008, and the fall would have been larger if the majority of large funds had not suspended redemptions in the month. However, the trend of outflows from mortgage trusts was well established from early in the year, with a large mortgage trust suspending redemptions as early as March. These developments had parallels in the early 1990s, with significant outflows from a range of unlisted public trusts prompting at least one large failure, and the imposition of a blanket 12 month redemption freeze.
• Cash management trusts have also been in focus, with some concerns that the guarantee would lead to a run on this asset class. In the event, however, any effect has been muted. Available data suggest that funds under management fell only slightly in the months following the guarantee, and as at May 2009 aggregate outstandings were only a few percentage points below the level in September.
• Among Registered Financial Corporations (which are not regulated by APRA), liability growth has fallen in the wake of the guarantee announcement. There has also been a decline in debt securities issued. These movements are largely accounted for by a number of relatively large RFCs shrinking their operations, such as the ANZ-owned finance company Esanda being brought into the bank. As with a number of the movements already discussed, a shrinking in RFC liabilities is not unusual by the standards of past periods of uncertainty, with RFC liabilities also contracting for a number of years in the early 1990s.

3.3 Debt Markets

With extreme risk aversion prevailing in global financial markets, ADI's access to funding through long-term bond issuance was heavily curtailed, particularly in offshore markets. In the period between the Lehman Brothers collapse and the guarantee announcement there was only $0.2 billion in offshore long-term issuance by ADIs, in contrast to the average monthly offshore issuance of $6½ billion in the 12 months to August 2008 (Graph 7). Rather, banks were sourcing funds during this time through increased use of short-term wholesale markets and market operations of the RBA. The dearth of long-term issuance continued during the period between the guarantee announcement and the time the GS became operational in late November.

The GS enabled ADIs to, once again, access wholesale long-term funding. In the early months of the GS issuance was very strong, as ADIs caught up on their funding plans and sought to lengthen the maturity structure of their liabilities. Issuance volumes then eased for a few months, but have picked up again more recently as the yield spread above government securities that investors demand for guaranteed bank paper has continued to narrow (Graph 8). The ability to access wholesale term funding has underpinned the stability of the financial sector, and the provision of credit through the economy.

Over this period there has been relatively little unguaranteed issuance. While this has increased recently, the banks for the most part have found it more cost-effective to issue guaranteed debt. For example, for a bank rated AA− or higher, available data suggest that the yield for issuing 5 year bonds unguaranteed has always exceeded the yield on guaranteed bonds by more than the guarantee fee of 70 basis points (Graph 9). For 3 year bonds, however, the cost differential has been smaller, with the yield spread generally close to the guarantee fee.