A Bad Idea Coming to an Australian Bank Near You

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We have our eye on two major points to begin the week. The first is that the most interesting election in the world this year may be in a communist country. A political drama is playing out that could have a much greater impact on Australia’s future prosperity than anything that happens in America. We’ll introduce you to the main players in this drama tomorrow.

Today, we need to talk about how the never-ending European debt crisis is making Australian banks more deposit dependent and prone to taking risks that don’t look like risks but are. The end result of this change in Australian bank behaviour will be lower loan growth (and lower house prices) and more bad investment decisions. This is how a debt crisis on the other side of the world has an everyday impact here.

As usual, this chain of analysis begins with the managed failure of the common currency in Europe. Take Thursday’s failed Italian bond auction. The Italians sold €4.9 billion in three-year government bonds paying 3.89%. That interest rate was 41% higher than the 2.76% they had to pay for a similar bond issue last month.

Still, 3.89% doesn’t seem like so much, does it? If there were an imminent debt crisis in Italy, short-term interest rates would soar. In fact, in a real crisis, the government would have to pay double-digit interest rates just to borrow. And that’s assuming anyone would lend them money.

It’s a good thing (and probably not an accident) an Italian now runs the European Central Bank (ECB). Italy must borrow a grand total of €450 billion this year. You read that correctly. €450 billion. There’s only one place the Italians can get that kind of money on short notice.

Italian officials said they declined to sell the whole €5 billion issue on Thursday because they didn’t want to pay higher interest rates. “We made the choice not to take all of the demand because we do not have the urgency to raise funding at rates that we do not believe are right,” said economics minister Vittorio Grilli.

Poor Mr Grilli had better realise that what government ministers think are the “right” interest rates and what investors are going to demand are very different things. Our guess is the only way the Italians can sell €450 billion in new bonds this year is if the ECB buys them. Private investors know that any investment in the European Welfare State is suicide.

Now let’s connect this with ANZ’s decision to raise the interest rate on its variable mortgage loans six basis points to 7.42%. Six basis points isn’t a lot. It’s just six. But ANZ is really doing this to establish the principle that it can set interest rates independently of the Reserve Bank of Australia (RBA).

It will probably come as quite a surprise to some people (like Wayne Swan) that the RBA doesn’t determine the price of money. But Aussie banks aren’t surprised. Australian banks borrow abroad to loan at home. When they borrow abroad in, say, Europe, they pay the market rate. What the RBA says about interest rates doesn’t affect the price of money in the European banking system.

The debt crisis that began in 2007 has already forced Australian banks to rely more on local deposits. Westpac is a good example. It wants to raise its share of the deposit market and expand its business into “wealth management”, according to Eric Johnston in today’s Age. That’s exactly the sort of thing you’d do if you were preparing your business for many years of much lower credit growth. You’d try to make money in more traditional and conventional ways (instead of blowing up a housing bubble with money you borrowed overseas).

This could take us directly to a discussion of how Australian house prices will behave in an era of lower credit growth. But we’ll side step that issue for today. We merely wanted to say that morons who suggest Australia was unaffected by the GFC in Europe simply aren’t paying attention. The GFC has been here all along. The result is lower bank lending and more focus on “wealth management”.

But “wealth management” isn’t nearly as safe and respectable as it sounds. You shouldn’t expect Aussie banks to take less risk in the future just because they can’t afford to blow up house prices anymore. What’s happening with pension funds could be a good predictor of what will happen in the “wealth management” arms of Australian banks.

Regards,

Dan Denning

for The Daily Reckoning Australia

From the Archives…

What the News on Bond Yields Say About the “Resolved” Eurozone Crisis
2012-04-13 – Eric Fry

The Art of Selling Stocks
2012-04-12 – Chris Mayer

Misguided Faith in an Economic Recovery
2012-04-11 – Joel Bowman

Beware the Big Government Debt Switcheroo
2012-04-10 – Dan Denning

The Discount Rate: Borrowers, Lenders and Bonds
2012-04-09 – Nick Hubble

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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6 Comments on "A Bad Idea Coming to an Australian Bank Near You"

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sam lau
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Great information article. Its amazing how main stream media fails to educate most australians.

Biker
Guest

DD: “The end result of this change in Australian bank behaviour will be lower loan growth (and lower house prices) and more bad investment decisions.”

Reduced loan growth, certainly. Reduced residential construction likely.

Lower house prices? Why? How does Dan explain reduction in supply resulting in lower prices? A: He doesn’t… .

DD: “This could take us directly to a discussion of how Australian house prices will behave in an era of lower credit growth. But we’ll side step that issue for today.”

Unsurprising, if yer floggin’ gold!~ :D

X
Guest
Good article, but sorry, this paragraph contains some half-truths and some mistakes. >>It will probably come as quite a surprise to some people (like Wayne Swan) that the RBA doesn’t determine the price of money. The RBA does determine the price of money for AUD denominated paper. It’s just that there is not enough AUD denominated paper to cover the mortgage books of the big four. >> But Aussie banks aren’t surprised. Australian banks borrow abroad to loan at home. When they borrow abroad in, say, Europe, they pay the market rate. Not true. Aussie banks pay at least 50… Read more »
Biker
Guest

Not ignoring your expert, experienced views on that other thread, ‘X’.

The DRA censor is up-to-his-old-tricks!!~ :D

“Your comment is awaiting moderation.”

Sharp contraction? We’re well-placed to take advantage of your property crash fantasy, son.

Stillgotshoeson? You mean that Irish fella who cursed me with incurable diseases and a broken-neck bike accident on this very site? :D :D :D

You’re a _desperate_ mob, you lot!~ ;)

X
Guest

Yes Biker, your comment got approved on the other article … twice!

On a separate note. Seems to be a lot of voters on this site. A lot more than commentators anyway.

The voting seems rather at odds with the articles, which leads me to believe that either _someone_ (!!!:D :D !!!) is attempting to game the system, or the majority of readers here come to read articles they completely disagree with.

I _suspect_ it’s the former.

Biker
Guest

Conspiracy, without a doubt, ‘X’.

Do you mean DRA’s journos and staff are all deliberately giving me The Thumbs Down because I’m a property bull??!~ ;)

Most of my recent comments have completely disappeared into the ether, ‘X’, but I’m used to that. I simply post them on other sites to demonstrate that the bears can dish it out, but have an allergy to taking it… . :D

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