Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 395

How the Reserve Bank scuppers retail depositors

The Reserve Bank of Australia (RBA) and Amazon have a lot in common in 2021. They have both positioned themselves as the premier high volume, low price, low margin product provider. They are redefining logistics in their distribution channels. Their current market position on price competition and sheer scale of influence unleashes factors of productivity improvement and makes it difficult for others to compete on traditional business models.

The message of 'lower for longer' interest rates has been heard loud and clear from a cheerful and optimistic Governor of the RBA, Philip Lowe, including an unrelenting expansion of its balance sheet. Last week alone it grew by another $10 billion to $344 billion. This is $66 billion higher since 30 June 2020 and deposits from Australian banks (in the form of Exchange Settlement balances) have risen by $94 billion.

The banking system is literally awash with cash and banks are turning away deposits while rapidly reducing the rates paid to savers. A cash flow optimisation strategy by the Government to stimulate activity is the current modus operandi, and it’s creating favourable conditions for risk assets.

RBA lavishes the funding

At the start of 2020, before COVID-19 struck, the RBA balance sheet was worth about 9% of Australia’s GDP, down from a peak of about 13% during the GFC. Following a year of bond purchases to hold down the three-year rate and fund government expenditure, the balance sheet has doubled to 18% of GDP.

But the RBA’s control of the supply and price of funds comes not only from the way it sets targets for low bond rates, but also its Term Funding Facility (TFF). It offers three-year funding to banks (actually, authorised deposit-taking institutions or ADIs) to reduce funding costs which are then passed on to borrowers. It is specifically aimed at ADIs if they expand their lending to businesses, notably small and medium-sized enterprises (SMEs).

The Reserve Bank largesse with loans and liquidity is changing the bank deposit market. The amounts involved are extraordinary, as explained by the RBA, with the funds available being:

“five times the dollar increase in SME Credit Outstanding from the three months ending 31 January 2020 through to the three months ending 30 April 2021”

Five times! And here’s why retail deposit rates have fallen. The interest rate for the TFF for three years is only 0.1%.

There is so much liquidity in the banking system that the bank bill rate, the benchmark against which many other facilities and securities are priced including bank term deposits and hybrids, is only 0.01%. That’s right … one basis point. Easy monetary policy has reduced the burden for borrowers and is now driving up residential house prices, but it has not helped the millions of savers and retirees who live on deposit income. As recently as a decade ago, term deposits offered a reasonable 4-5%.

An example of a big winner is Judo Bank, which made a pre-tax loss of $50 million in 2020. Judo Bank will draw on $2 billion of the TFF from an allocated allowance of $6 billion. Judo’s substantial growth of $1.3 billion in SME lending in the year ending 31 January 2021 has been multiplied by the factor of five and a supporting internal securitisation framework acceptable to the regulators has been reached. Judo is a startup bank but it will not have any funding problems for years.

Reducing Judo’s cost of funds will materially improve its profit as it has been competing aggressively for retail deposits, previously its main source of funding. It is currently paying up to 1.2% for retail deposits and attracting strong inflows as deposits up to $250,000 are protected under the Australian Government Guarantee (the Financial Claims Scheme).

Joseph Healy, CEO of Judo Bank, told Banking Day on 3 February 2021:

“Our focus on marketing term deposits of more than 12 months duration will continue but accessing the TFF will reduce our appetite for deposits of shorter duration.”

Judo Bank has a real economic advantage now to reduce its cost of funds and recalibrate its wholesale and retail pricing, probably to the disadvantage of current investors. However, actions will be tempered by the desire to build long-term relationships on both sides of the balance sheet to prepare for the day when the RBA is not as benevolent.

Banking system awash with cash

One reason the major banks have not tapped into the TFF in a bigger way is they are flooded with cheap retail deposits. The banks are literally saturated with deposits and are turning away institutional money so they can provide some capacity to their retail customers. As the chart below on bank funding shows, domestic deposits are now satisfying more of the funding needs of Australian banks than ever before.

What do banks do with their surplus cash, since they cannot lend it quickly enough? They deposit with the RBA at 0%. Funds on deposit at the RBA at 0% are $160 billion and rising rapidly, and we estimate they could rise to $360 billion by 1 October 2021. The RBA balance sheet is set to grow from $344 billion to a forecast $500 billion over the same time.

Traditional lenders to banks such as councils are finding it difficult to place their money. Each bank is travelling a slow, last kilometre in heavy congestion to position their middle market and retail pricing at the 'what we can get away with' level. The correct pricing and allocations of quotas to identified 'customers of the future' take up most of the strategic decision-making of bank treasurers and liability management committees at the moment.

Price discouragement strategies are the new playbook.

On the asset side, expect marketing campaigns on credit availability and price to be sweetened with loyalty recognition in many forms. St George’s “Switch banks, get a $4k thanks” campaign is the latest one.

Plenty of money to finance asset price surge

Cash investors realise they have no pricing power these days and they are evaluating their alternatives. Watching the billions of dollars of cash looking for a home each day leads to the view that the current debate raging around speculative asset bubbles is far too early in the investment cycle. We are now only emerging from a pessimistic phase and are in the early stages of an optimistic mindset. The euphoric phase is much further into the future.

Those wary of inflated prices should be more worried at the end of Governor Lowe’s three-year timeframe. The real economy will be the major beneficiary of all this liquidity and lending capacity over the next few years, until 2024 at least.

The post COVID-19 recovery period could parallel two key economic periods in our past: the ‘Roaring Twenties’ of a century ago and more recently, the post-WWII recovery period of the 1950s to early 1970s. Financial markets were heavily regulated and the real economy was the powerhouse of the global economy. In the latter stages inflation surged with the oil price shock of 1972 and interest rates violently adjusted to dizzying heights over a span of nearly two decades, but the inflationary consequences of central bank expansion are not on the short-term radar at the moment.

Retirees planning for spending in retirement who once believed the bond or term deposit part of their asset allocation would deliver income to live on now need to go up the risk curve, or draw down their capital. Banks will be awash with liquidity for years and will not compete for the retiree dollar.

Even the new banks who once paid up for deposits now have retirees in a judo hold with the RBA providing another source of cheaper funds. The RBA has become the equivalent of an online retailer who undercuts all other prices in the market.

 

Peter Sheahan is Director, Interest Rate Markets at Curve Securities Australia, with input from Graham Hand, Managing Editor at Firstlinks. This article is general information and does not consider the circumstances of any person.

 

7 Comments
Ruth
February 19, 2021

Peter, it's not clear to me why you think all this liquidity will wind up in the real economy. Is this because you think there will be a quick recovery and people will start spending? I'm not sure there'll be a quick recovery, and if people are fearful they will save not spend. Alternatively if they spend and we get higher inflation than we hope for, won't that encourage people into risk assets again? People spend in the real economy when they feel confident. Will they?

Peter Sheahan
February 19, 2021

Thank you for your question Ruth.

I see the blueprint of one of the most equitable recoveries ahead. The confidence underlying the current support of innovation, technology, flexible working conditions and sound export policy are capturing the attention of investors and consumers. Security of domestic supply of essential products that Australians are capable of producing is front of mind nowadays. Agriculture and commodity prices are replacing services in the headlines of daily commentary. The growth and inflation narrative are competing for centre stage at the moment. I think very impressive employment growth and unemployment less than 5% is within reach in the post COVID 19 recovery period.

Backing team Australia or simply backing ourselves and each other is going to tap this capital and consumption pool at well above recent trend pace and characteristically with a rush toward the end, whenever that is.

Ruth
February 19, 2021

Peter, thank you for clarifying your thoughts for me. I certainly hope you're right!

Michael Hall
February 19, 2021

Good article Pete

Paul Smith
February 18, 2021

And where are deeming rates? If the govt thinks they are correct levels then where are fed retirement bonds at that rate for retirees?

here
February 18, 2021

this credit creation & money printing seems to make a really good case to look into cryptos as a store of value, beyond the reach of governments & their reserve bank servants.

Jack
February 18, 2021

Thanks for pointing this out. Does the RBA really want me to take on extra equity risk because my CBA term deposit rolls over at 0.4%. That will look good when the stockmarket falls 40%. And don't start me on Bitcoin.

 

Leave a Comment:

     

RELATED ARTICLES

Australia’s economic outlook robust, but risks are rising

Yikes! Three critical factors acting on inflation and rates

RBA signals the end of ultra-cheap money. Here’s what it will mean

banner

Most viewed in recent weeks

Lessons when a fund manager of the year is down 25%

Every successful fund manager suffers periods of underperformance, and investors who jump from fund to fund chasing results are likely to do badly. Selecting a manager is a long-term decision but what else?

2022 election survey results: disillusion and disappointment

In almost 1,000 responses, our readers differ in voting intentions versus polling of the general population, but they have little doubt who will win and there is widespread disappointment with our politics.

Now you can earn 5% on bonds but stay with quality

Conservative investors who want the greater capital security of bonds can now lock in 5% but they should stay at the higher end of credit quality. Rises in rates and defaults mean it's not as easy as it looks.

30 ETFs in one ecosystem but is there a favourite?

In the last decade, ETFs have become a mainstay of many portfolios, with broad market access to most asset types, as well as a wide array of sectors and themes. Is there a favourite of a CEO who oversees 30 funds?

Betting markets as election predictors

Believe it or not, betting agencies are in the business of making money, not predicting outcomes. Is there anything we can learn from the current odds on the election results?

Meg on SMSFs – More on future-proofing your fund

Single-member SMSFs face challenges where the eventual beneficiaries (or support team in the event of incapacity) will be the member’s adult children. Even worse, what happens if one or more of the children live overseas?

Latest Updates

Superannuation

'It’s your money' schemes transfer super from young to old

With the Coalition losing the 2022 election, its policy to allow young people to access super goes back on the shelf. But lowering the downsizer age to 55 was supported by Labor. Check the merits of both policies.

Investment strategies

Rising recession risk and what it means for your portfolio

In this environment, safe-haven assets like Government bonds act as a diversifier given the uncorrelated nature to equities during periods of risk-off, while offering a yield above term deposit rates.

Investment strategies

‘Multidiscipline’: the secret of Bezos' and Buffett’s wild success

A key attribute of great investors is the ability to abstract away the specifics of a particular domain, leaving only the important underlying principles upon which great investments can be made.

Superannuation

Keep mandatory super pension drawdowns halved

The Transfer Balance Cap limits the tax concessions available in super pension funds, removing the need for large, compulsory drawdowns. Plus there are no requirements to draw money out of an accumulation fund.

Shares

Confession season is upon us: What’s next for equity markets

Companies tend to pre-position weak results ahead of 30 June, leading to earnings downgrades. The next two months will be critical for investors as a shift from ‘great expectations’ to ‘clear explanations’ gets underway.

Economy

Australia, the Lucky Country again?

We may have been extremely unlucky with the unforgiving weather plaguing the East Coast of Australia this year. However, on the economic front we are by many measures in a strong position relative to the rest of the world.

Exchange traded products

LIC discounts widening with the market sell-off

Discounts on LICs and LITs vary with market conditions, and many prominent managers have seen the value of their assets fall as well as discount widen. There may be opportunities for gains if discounts narrow.

Sponsors

Alliances

© 2022 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.