RBA: Banks loath to supply liquidity in money markets
Australia's central bank has blamed the rise in short-term funding costs on structural influences such as strong demand for Aussie dollars in the FX swap market and banks’ reluctance to supply liquidity in money markets.
According to the Reserve Bank of Australia's August Statement on Monetary Policy released on Friday, the lower demand for bank bill paper by end-investors is also cited as impacting bank bill swap rates.
All up, these dynamics have lifted bank funding costs, but the RBA sees the rise as small in an historical context.
Interestingly, the Bank argued that an apparent drop in demand for the major banks’ bills from investment funds as one factor contributing to the rate rise.
“Over recent years, investment funds have become the dominant holders of bills, as banks have reduced their holdings of other banks’ paper," the Statement said.
“Since late last year, some investment funds have shifted their asset allocation away from bills towards global equities.”
The Bank also claimed the lower demand has been accompanied by the major banks reducing their issuance since late 2017 just as bill issuance by other lenders has increased, providing some competition.
Sharper movements more prevalent
However, the RBA conceded that the increased issuance by other banks - including foreign banks operating locally - has been apparent since early 2017, whereas the behaviour of BBSW rates has changed most noticeably only over recent quarters.
The Statement referred to longer-run, structural developments that could help to explain why sharper movements in interest rates in Australian dollar money markets have become more prevalent of late.
First, banks, including in Australia, have become more reluctant to supply liquidity in money markets.
In other words, SoMP said, banks appear less inclined to be ‘market makers’, which stand ready to buy and sell in money markets, thereby absorbing movements in demand and supply.
“This is likely to be partly the consequence of changes in banking regulation following the global financial crisis (which were intended to encourage market participants to price the risk involved in market making appropriately).”
The RBA also claimed the greater focus on bank conduct in money markets also appears to have played a role.
"As a result, liquidity – the capacity to buy or sell at short notice without significantly affecting the price – has declined."
Costs remain low
While acknowledging that the rate rise has led to an increase in banks’ overall funding costs, the RBA argues that banks’ funding costs have increased by less than the increase in money market rates and remain low by historical standards.
The Bank pointed out that retail deposit rates are little changed and so the “overall increase in funding costs is significantly less than the 20 basis point increase in BBSW rates.
In addition, the RBA said interest rates on some bank assets are also linked to BBSW rates, limiting the impact that higher funding costs have had on banks’ net interest margins, according to the SoMP.
Since Australian banks raise a significant amount of their funding in foreign currency, which they convert into Australian dollars via cross-currency swaps; the cost of doing this has increased in recent months, which also adds to banks’ overall cost of raising funds.