What the hell are the banks’ funding costs?

Andrew Pegler – 26 November 2010

Are the banks just gouging scoundrels or is there something to this “funding costs” malarkey?

As we all know the big four banks shared a $22 billion dollars profit this year, which is pretty good work if you can get it. The Super funds were happy and shareholders were grinning, but then they went and wrecked it all by saying something like let’s hike above the RBA. The torrent of abuse from the general public has since steamrolled into a national argy bargy that even went global as it sucked the oxygen out of Gillard’s overseas jaunt. While the punter in me hears the howls of outrage, the contrarian was keen to explore this curious claim that the big four had hiked beyond the RBA because of these mysterious “funding costs”. So what the hell are they?

PricewaterhouseCoopers (PWC) has just finished a door-stopper on the major banks’ results and one of their pointy heads fronted up to Alan Kohler on Inside Business the other week to explain what “funding costs” mean. Here’s the plain English translation.

The cost of borrowing has gone up

Banks get some of the money they lend to us from big banks overseas. This source of green has become more expensive since the GFC forced a re-assessment of global risk. In other words, the fear that it may all go pear-shaped again has forced bankers to up the interest they charge other banks to cover their behinds. The big four are just passing this on.

A war for deposits

Another large part of the funding puzzle is deposits. The GFC has driven up overseas funding sources, forcing banks to rely more on our humble deposits. These longer-term sources of funds, like term deposits that can go out to five years and are highly likely to be rolled over upon maturity, are making up this shortfall. This has fuelled a price war that’s forced banks to pay more for our deposits.

Bank expenses are rising

According to the PWC report, bank expenses in general rose by 7.5% in the last two years and they gotta find ways to pay for these.

People aren’t borrowing much

Home lending hasn’t been so slow since the early eighties and business credit has gone backwards for the last two years. Over the past 25 years, credit has grown 12% a year but next year it’ll only be about 5-7%. Credit (lending money) is basically how banks make money.

Hopefully that gives the contrarians out there something to mull over.