Macro and Australian equity strategist, Macro Strategy Advisors

Shane Lee

Macro and Australian equity strategist

Macro Strategy Advisors

Thematic (Sector/Industry)

Australia Financials / Thematic (Sector/Industry)

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<li>
Stay Underweight Banks. Despite valuation support, we remain unconvinced Australian Banks can outperform the broader market.  Sentiment towards the Banks is still being impacted by the Banking Royal Commission and self-imposed tougher lending standards are constraining both credit and house price growth.  Furthermore, there are still unanswered questions about fines and how these businesses will be regulated following the Commission.  We still expect there will be an opportunity to move back to neutral on the sector but it is still too early.</li>
<li>
Australian bank short-term funding costs have continued to rise even as global peers have seen some relief. The Federal Government’s bank levy seems to be the culprit, causing the bank bill to OIS spread to widen by a further 5bp since we published our note in April.  Over the same period, similar global spreads have eased by 19bp.  The major banks have been able to cope with the increase in funding costs due to their more diverse funding composition.  However, the smaller banks have passed these costs on to mortgage holders.  The Royal Commission backdrop and political pressure from the Government also means the Majors are under pressure to absorb the Bank levy and not lift mortgage rates.</li>
<li>
Unintended Consequences. The levy was designed to tax the 4 Major Banks and MQG, but it has also hit the smaller banks and they have been forced to pass the cost onto their customers.  The Government seems to have misunderstood that all banks tap short-term funding markets and that the smaller banks are more exposed to domestic short-term capital markets because they don't have access to offshore markets.  The major banks are also the key players in these markets and are the ultimate price-setters.</li>
<li>
The majors have tightened Deposit Growth in Response to the Levy. The levy is set at 0.015% of deposits (less those deposits covered by the Financial Claims Scheme), so Banks have an incentive to minimise deposits.  We estimate that growth in the broad deposit aggregate (M3-M) should be around 8.6% based on macroeconomic fundamentals, but data shows it is only 2.9%.  The major Banks seem to be diversifying away from deposits as a favoured source of funding in preference for longer-term bonds.  Some of this shift is merely a natural realignment of the funding composition that was in place during the 2008 crisis, but it also reflects a structural response to the levy.</li>
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Stay Underweight Banks. Despite valuation support, we remain unconvinced Australian Banks can outperform the broader market.  Sentiment towards the Banks is still being impacted by the Banking Royal Commission and self-imposed tougher lending standards are constraining both credit and house price growth.  Furthermore, there are still unanswered questions about fines and how these businesses will be regulated following the Commission.  We still expect there will be an opportunity to move back to neutral on the sector but it is still too early.

Australian bank short-term funding costs have continued to rise even as global peers have seen some relief. The Federal Government’s bank levy seems to be the culprit, causing the bank bill to OIS spread to widen by a further 5bp since we published our note in April.  Over the same period, similar global spreads have eased by 19bp.  The major banks have been able to cope with the increase in funding costs due to their more diverse funding composition.  However, the smaller banks have passed these costs on to mortgage holders.  The Royal Commission backdrop and political pressure from the Government also means the Majors are under pressure to absorb the Bank levy and not lift mortgage rates.

Unintended Consequences. The levy was designed to tax the 4 Major Banks and MQG, but it has also hit the smaller banks and they have been forced to pass the cost onto their customers.  The Government seems to have misunderstood that all banks tap short-term funding markets and that the smaller banks are more exposed to domestic short-term capital markets because they don't have access to offshore markets.  The major banks are also the key players in these markets and are the ultimate price-setters.

The majors have tightened Deposit Growth in Response to the Levy. The levy is set at 0.015% of deposits (less those deposits covered by the Financial Claims Scheme), so Banks have an incentive to minimise deposits.  We estimate that growth in the broad deposit aggregate (M3-M) should be around 8.6% based on macroeconomic fundamentals, but data shows it is only 2.9%.  The major Banks seem to be diversifying away from deposits as a favoured source of funding in preference for longer-term bonds.  Some of this shift is merely a natural realignment of the funding composition that was in place during the 2008 crisis, but it also reflects a structural response to the levy.


Dangerous Liaisons: Fallout from the Aussie Bank Levy