Australian Sovereign Funding Guarantee Needs To Be Restructured

Post by Sharat on July 28, 2009 · Under Australian Economy, Business News, Capital Markets, banking, interest rates · Comment

Market analysts and regulators have suggested that the largest banks in Australia pay the lowest rates in the world for access to Australia’s sovereign guarantee of funding given by the Federal Government.

The comments were made by both the Reserve Bank of Australia (RBA) and the financial regulator the Australia Prudential Regulation Authority (APRA). The view expressed adds more voices and adds further pressure on the Government to change either the structure of the sovereign guarantee by increasing fees, or as some in the private sector have suggested, ceasing the scheme entirely.

Smaller regional banks in Australia have lobbied the government to make structural changes to the scheme arguing that the current arrangement for sovereign backed wholesale credit market funding is both anti competitive and distortive of domestic credit markets.

The scheme which was introduced in October of last year in response to the freezing of credit markets globally, gives Australian financial institutions access to Australia’s AAA sovereign rating, in return for a fee paid to the Government which provides a guarantee on debt obligations.

Currently the way the guarantee operates means that higher rated banks pay less for the use of the guarantee than lower rated banks. This means the Big Four banking groups, which themselves are rated AA pay additional 70 basis points for debt guaranteed by the Federal Government. Smaller regional banks have been paying between 100 to 150 basis points for the right to be able to issue debt with a sovereign guarantee.

The scheme has had the unintended consequence of becoming a large revenue earner for the Government, having generated more than $1 billion since the introduction of the guarantee in October.

Australian banks have made extensive use of the guarantee, issuing more than $108 billion in securities backed by the Australian government since October. The vast majority of that debt issuance has been by the Big Four banking groups.

Australia has now become the world’s fourth largest issuer of sovereign guaranteed debt after France and the UK. The US is the world’s largest issuer of the asset class, with more than $333 billion worth of paper issued.

Australia’s central bank the RBA and its financial regulator APRA together in a joint submission to the Australian Senate both noted that many nations, including the US had restructured the way their governments have priced the wholesale funding guarantees.

AA rated banks from other countries were on average paying 20 to 40 basis points more in funding costs than their Australian rival for access to similar guarantee schemes.

‘‘Given the changes that have taken place elsewhere, the pricing of the Australian guarantee now looks relatively low for AA-rated banks,’’ the Reserve Bank and APRA said in their submission.

The central bank and the regulator also noted that the scheme had produced the largest differential in fees charged to regional banks and the Big Four banking groups.

Regional lenders claim that the higher fees that they are required to pay hurts their business model and threatens any economic recovery.

Investec, a private fund manager in its submission suggested that the higher cost of funding for regional lenders is “choking” otherwise viable economic activity and suggested that the cost of funding for small regional banks could make their existence unsustainable.

The RBA did however credit the scheme with reviving the ability of Australian banks to finance themselves with long term credit, a market which all but ceased to exist in the immediate aftermath of the Lehman Brothers bankruptcy in October.

Given Australia’s dependence on foreign capital, the resumption of credit flows had a profound effect on the financial system. ‘‘The ability to access wholesale term funding has underpinned the stability of the financial system,’’ it said.

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