March 31, 2020 09:54:33
It’s the sharpest and swiftest economic downturn anyone alive has seen — a sudden shutdown of large swathes of the economy, with a property price crash looming, businesses collapsing and jobless rates forecast to hit levels akin to the Great Depression.
Analyst Brian Johnson says Australian banks are holding more cash than they used toThe Reserve Bank will assist banks with liquidity if necessary and is offering at least $90 billion to support lending to small and medium businessesEconomist Gerard Minack says authorities and the RBA will backstop banks, meaning they won’t go out of business
All bearing down on a society that, outside of Switzerland, has the highest household debt levels in the world.
That spells big trouble for the Australian banks, right?
Maybe — but depending on how long it lasts, one leading analyst says it may not be as much trouble as some fear.
“Everyone panics, that’s the first thing,” respected banking analyst Brian Johnson, a managing director at the US-owned investment bank Jefferies, told the ABC.
“But when we actually look at their business models, banks go bust because they run out of cash. And the Australian banks have got a lot of cash, a lot more capital than they used to have.”
Leading analyst sees a few reasons for optimism
This veteran observer is no Pollyanna.
In the past, including in the run-up to the global financial crisis, he was very negative about the strength of Australia’s banks.
However, he sees a few reasons to be cheerful now despite the dire economic shock.
Firstly, whether by design or a fluke of fortune, the Australian banks cashed up before the COVID-19 crisis hit our shores.
“In January and February, the cost of funding for the Australian banks had gone down and the Australian banks exploited that,” Mr Johnson said.
“At the time I was puzzled, but they actually raised a lot more funding than they would normally require.”
Luck is his conclusion, though perhaps the banks saw it coming.
Either way, it means major banks here secured a lot of cash before wholesale funding markets all but froze in response to the economic fallout from the virus.
It will be six months before they need to tap the markets for funds again, Mr Johnson said.
RBA stands ready to assist if banks are low on cash
If the cash gets low, the Reserve Bank stands ready to assist.
Since 2015, in the wake of the global financial crisis, the RBA has offered Australian banks what’s known as the ‘Committed Liquidity Facility’.
In the RBA’s own words, it “entails the central bank committing to stand ready to provide a bank with liquidity against high-quality collateral that would otherwise be illiquid in the market”.
In other words, in times of distress, banks can bundle up loans into securities and park them with the central bank for a very modest fee, in return for cash.
This emergency line of credit is set at more than $220 billion this year — and if that’s not enough, the RBA would likely scale it up or set up something else if necessary.
The central bank is also offering term funding of “at least $90 billion” to the banking system to allow lenders to support small and medium-sized business, but it will also allow lenders to shore up cheap reserves.
Some 130 banks, building societies and credit unions can borrow from the RBA dirt cheap, at a fixed rate of 0.25 per cent, for funds equivalent to up to 3 per cent of their total outstanding credit to households and businesses, in the first instance.
“It’s not free money but it’s close to it,” Mr Johnson said.
Risk transferred to public sector after GFC
Since the global financial crisis, the Federal Government has also guaranteed bank deposits of up to $250,000, meaning the vast majority of peoples’ savings are protected.
In the wake of the GFC, regulators required the banks to lessen their reliance on short-term funding that had to be ‘rolled over’ relatively quickly, and secure more long-term funding in an effort to make the banking system, in the regulators’ words, “unquestionably strong”.
Measures to reduce risk in banking systems are being mirrored around the world as the states step in to protect financial institutions, after learning lessons from the GFC.
“What we can see around the world is the transfer of risk from the private sector banks to the public sector,” Mr Johnson said.
“The upshot is that the banks come through this not in great shape, but in a better position than some of their share prices would indicate.”
The transfer of risk from profit-seeking banks to the public sector raises some interesting philosophical and moral questions.
Profit is often viewed, and defended, as a reward for risk taking.
However, if and when push comes to shove, the institutions of the state are going to take on the banks’ risk in order to safeguard the economy, and how much profit is justified and what should the state demand in return?
Economist Gerard Minack agrees the banks will be safe, because the Government won’t let them fail.
“It’s a huge impact on the profitability of some of their lines of business,” Mr Minack said.
“[But] ultimately the authorities and the RBA will backstop them so we will have banks, they’re not going to go out of business.”
There are some big caveats to this relative optimism however.
One is the unknown duration of the crisis.
“If it lasts six months, I think we muddle through,” Jefferies’ Mr Johnson said.
But if it goes much longer? “Then expect Scott Morrison and Josh Frydenberg to step up to the dais again and again and pledge more money.”
“We will see depression-like economic data in the next three to four months,” Mr Minack said.
“The difference is that in the actual Great Depression, government policy actually exacerbated the downturn.
“Their response to the initial shock was to tighten fiscal policy, tighten the budget.
“Whereas now of course we’ve got massive loosening of both monetary and fiscal policy [with] policy makers acting in a proactive way.”
Overextended borrowers mean few buffers
However, it is possible the economic and financial impact will be so enormous that it overwhelms the fiscal and monetary policy response.
One of the things the global financial crisis demonstrated was the multiple feedback loops that happen in an interconnected global financial system, where all manner of bills and payments are packaged up, traded and sold throughout the world.
High levels of defaults could feed back into the financial system, causing potential chaos.
Graham Andersen from Mortgage Analytics believes the Government and central bank may have to step in to bail out the banks, if the economic shock continues to October or beyond.
Extreme levels of household debt also mean we come to the crisis with “few buffers”, Mr Minack argued.
While the major banks are offering a three to six-month grace period where customers can freeze payments on their mortgages, there are no guarantees banks will be willing or able to extend that if the crisis lingers on.
“We are going through a period where they will offer some forbearance to their borrowers but it’s all contingent on how long this goes on for and how generous they are,” Mr Minack said.
“It’s one thing to go easy on owner-occupiers, but the classic nurse or teacher with four or five investment properties we hear about – how long will the banks go easy on them?
“We don’t want to reward the imprudent — there are a lot of examples around the world and in Australia where people have absolutely pushed [and overextended] themselves in the belief that nothing will ever go wrong.
“This is obviously a huge sideswipe that no-one could foresee but ultimately shows that you need some buffers in the system, and we’ve taken out most of the buffers.”
Mr Minack also said a sharp decline in house prices could create a “powerful wealth effect” which may discourage people from spending even after the immediate economic shock passes.
“We’ve got virtually no household saving. We’ve all felt like we could save less because our houses were doing the saving for us,” he said.
“If we then see consumers start to rebuild their savings rate, then that could become an extended drag on the economy for some time.”
Or perhaps, freed from the confines of social distancing and shutdowns, we will eat, drink and be merry.
At least those of us who still have our lives and our livelihoods when the pandemic passes.
March 31, 2020 06:04:47