A detailed look at bank funding costs

Funding It tough - A detailed look at bank funding costs
23 June 2009

• Bank funding has become more expensive from every source, with first wholesale then retail rates rising relative to benchmark rates. This has dampened the passthrough from OCR cuts to lending rates.
* Net interest margins have narrowed since the credit crisis began, as banks have not fully passed these cost increases through to lending rates to date.
* With bad debts on the rise, and banks not recouping these losses through higher lending margins, net profits have fallen.
* Net interest margins are similar for the major New Zealand and Australian banks.

The financial landscape has changed dramatically since the global credit crisis began in full force in August 2007. Investors who were previously happy to accept minimal returns on risky loans have become much more cautious, and are now demanding higher premiums from even the highest-quality borrowers. Central banks have responded by cutting their policy rates to extremely low levels, and in most cases the actual level of interest rates has fallen. But the gap between policy rates and market rates has widened, and is unlikely to return to pre-crisis levels any time soon.

The impact on market-traded assets is easily observed. But banks are more opaque: they pool together funds from a range of sources, at varying prices, and lend the money on to a range of customers - again, at varying prices that reflect the level of risk. As a result, it can be difficult to trace how banks' funding costs and margins have evolved, and even more so in these unusual conditions.

There's no dispute that banks' funding has become relatively more expensive during the credit crisis, which has hindered the passthrough from policy rate cuts to retail lending rates. But to date, we haven't seen a comprehensive answer to the question of "how much". This gap in the public knowledge has fuelled claims that banks are fattening their margins under the pretence of higher funding costs.

This article draws together the facts on both issues. As far as possible, we have used publicly available information, such as banks' disclosure statements and RBNZ survey data. We show that average lending margins for the major retail banks have narrowed, and that profits have fallen substantially in the last year. We also show that margins in New Zealand are similar to those in Australia, and that lending margins have narrowed by more in New Zealand during the credit crisis.

The second part of this article breaks down the banks' balance sheets to show how funding costs have risen during the crisis. This section is detailed by necessity, given the range of issues involved, and we recommend it only for readers who need to be thoroughly convinced. We show that funding has become more expensive across all sources, with wholesale funding costs rising immediately in the wake of the credit crisis, while retail funding has responded more recently.

A Detailed Look At Bank Funding Costs: Full Report With Graphs (pdf)

ENDS

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