15/10/2008 - 22:00

Onus now on banking sector

15/10/2008 - 22:00

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PLUNGING international stock markets have been the most visible manifestation of the global financial crisis of the past month, but an equally worrying trend has occurred in debt markets.

Onus now on banking sector

PLUNGING international stock markets have been the most visible manifestation of the global financial crisis of the past month, but an equally worrying trend has occurred in debt markets.

Obscure metrics most people had never heard of until recently - like LIBOR, the TED spread and the bank bill swap rate - evidence the dramatic changes in debt markets.

These changes could have a greater impact on the real economy than the plunge in equity markets.

They all show that banks have become much less willing to lend to each other, let alone to small and medium business operators.

LIBOR, or the London Interbank Offered Rate, is the interest rate that major international banks charge each other.

Earlier this year it was about 60 basis points above the 'overnight index swap rate'. Last week it rocketed to above 360 basis points.

That tells us that banks are charging each other much higher rates of interest when they do business with each other.

LIBOR is doubly important because corporate loans are often set at a margin above the interbank rate. That means if the LIBOR rate goes up, then corporate borrowers automatically pay more.

The TED spread tells a similar story. It measures the margin between bank borrowing costs and the US Treasury's borrowing cost.

It has been relatively volatile over the past year, fluctuating between 60 basis points and 200 basis points. In the past month it has climbed to more than 400 basis points.

The blowout in interbank lending rates is one reason why Australia's banks said they could not afford to fully pass on the Reserve Bank's 100 basis point cut in the official interest rate.

The official cash rate is just one factor that dictates the banks' overall funding costs. Interbank or wholesale lending rates are another critical factor.

The Rudd government's extraordinary policy response to the global financial crisis was driven in large part by these trends in debt markets.

What was notable was the government's willingness to go beyond the policy responses that had been widely advocated within Australia. Its bold response makes Australia a world leader in dealing with the global crisis.

Guaranteeing all bank deposits for three years as well as borrowings by the banks in international markets will put downward pressure on the banks' funding costs.

The big question now is whether the Australian banks, and international banks active in the local market, respond positively to this unprecedented level of support.

Ironically, it could be argued that the Australian banks did not need this kind of support. As a group, they are in a very solid financial position, with modest bad debts on their commercial books, very few non-performing housing loans and the prospect of continued solid earnings.

They would be the envy of banks in most other countries around the world, yet because of the global nature of the financial crisis, the government felt compelled to act.

With taxpayers providing an open-ended guarantee of their liabilities, Australia's banks have no reason to hold back in their lending activity, although reckless practices should be avoided at all costs. After all, it was reckless lending over many years that has driven many banks in the US and other countries to the brink of failure.

What is needed is financial support for business and consumer borrowers, who would have had money thrown at them a few months ago but are now battling to gain support from their bank.

The banks, when they conduct their credit assessments, should have a close read of several economic commentaries that have been released during the past week.

The IMF and the OECD, for instance, are predicting the Australian economy will grow at just over 2 per cent in 2009. That is well ahead of the US (0.1 per cent growth) and Europe (0.5 per cent growth).

The big upside for Australia is our exposure to China and other emerging economies, which are expected to sustain economic growth much higher than the Western economies.

The IMF has predicted that China will grow by about 9 per cent in 2009, which is below recent levels but very creditable in most people's language.

Similarly, it has predicted that India's economy will grow by 6.9 per cent next year and the south-east Asian nations as a group will grow by 4.9 per cent, despite Singapore slipping into recession.

The Chamber of Commerce and Industry WA agrees that the China story will continue to sustain the WA economy, and has maintained its growth forecasts for the state economy.

The slower global growth means that the runaway increases in commodity prices that have fuelled project investment in WA will not be repeated.

Commodity prices are more likely to stabilise and possibly even fall, but let's not forget they have experienced huge increases in the past four or five years.

The message for banks and business in WA is that we should remain cautiously positive, despite the gloom in financial markets.

STANDING BY BUSINESS. TRUSTED BY BUSINESS.

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