by
Justin McCarthy | Nov 18, 2014
In December 2013, the Australian Prudential Regulation Authority (APRA) released a revised liquidity standard (APS 210) for all Australian Authorised Deposit-taking Institutions (ADIs). This standard encapsulated APRA’s views of the Basel III regulatory changes for global banks.
A centrepiece of Basel III and indeed APS 210 is the liquidity coverage ratio (LCR). While other countries have transitional arrangements over a number of years for adoption of the LCR, APRA requires the larger Australian ADIs to comply with it from 1 January 2015.
The LCR aims to ensure that an ADI can meet its liquidity requirements in a severe stress or ‘bank run’ scenario. The regulation requires an ADI to hold sufficient unencumbered high quality liquid assets (HQLA) that can be converted into cash within a day to meet all of the ADI’s liquidity needs for a 30-day stress scenario. The ratio of HQLA to the ADI’s expected net cash outflows during this period must exceed 100%.
The three key features (and implications for depositors) of the LCR are as follows:
1. 30 day horizon
The LCR looks at a 30-day liquidity period and any product or deposit with a 31+ day break or notice period intact will not be included in the calculation of liquidity required. ADIs will be required to hold low yielding HQLA for any deposit (or at-call money) which can be repaid or matures within 30 days. This makes these deposits ‘expensive’ for the ADI as it has to tie up a portion of its funds in low yielding HQLA.
Conversely, a deposit that has a 31+ day break or notice period requires no HQLA backing. As such, ADIs will place a higher value on the latter and will pay higher rates to attract those funds. Traditional at-call and short-dated term deposits, particularly from financial institutions, will receive the opposite treatment with rates expected to be significantly lower come 1 January 2015. Corporates will receive slightly better treatment especially where money on deposit can be proven to be ‘operational’.
Come 1 January 2015, the ability to break term deposits will become significantly harder with Product Disclosure Statements and terms and conditions expected to change to prevent the breaking of term deposits, with very few exceptions, the main one being personal hardship.
2. Depositor classification and ‘run off’ assumptions
There are vastly different ‘run off’ assumptions for various categories of depositors which will have a significant impact on the rates the ADIs will offer these different categories.
At one extreme are the ‘sticky’ retail deposits that APRA assumes will withdraw just 5% of funds in a crisis scenario. At the other end are ‘hot’ wholesale deposits from financial institutions that are assumed to see 100% of funds withdrawn at the first sign of a crisis.
It is important to note that for the purpose of the LCR calculation, this represents a differential of 20 times between the highest and lower risk deposit categories.
Again, the implications are clear. Mum and dad ‘retail’ deposits will continue to be in high demand and hence command higher rates. This typically covers deposits up to the $250,000 government guarantee amount. Self Managed Superannuation Funds up to this limit also attract positive treatment under APS 210.
However, the larger implications are for wholesale deposits and at-call money from larger institutions, particularly those classified as financial institutions. It is here where the traditional deposit product offering looks to be a dying breed, to be replaced by 31+ day break or notice period deposit products.
Corporations that can demonstrate a long term operational relationship will receive a 40% run-off assumption placing them in the middle of sticky retail and hot wholesale money. The focus here will be for corporate and potentially some financial institutions to prove the operational nature of portions of their funds on deposit and to argue for higher rates.
Another clear implication is that all wholesale depositors will have an incentive to do an accurate assessment of their real requirement for very liquid funds such as at-call or short dated term deposits, given the much lower rates expected on these come next year. This low returning portion of an investor’s portfolio should be minimised and as much as possible locked away for a minimum of 31 days to attract a better rate from the new breed of deposit products.
3. The LCR does not apply to credit unions, building societies and mutual banks, nor branches of foreign banks
Compliance with the 100% LCR is only required from what APRA terms the ‘scenario analysis’ ADIs. This essentially refers to the major and regional Australian banks and locally incorporated foreign subsidiary banks (such as HSBC Bank Australia Limited and Rabobank Australia Limited).
Branches of foreign banks that operate in Australia (such as Bank of China Limited) are only required to meet 40% of the LCR.
Credit unions, building societies and other mutual banks (technically termed ‘minimum liquidity holding’ or MLH ADIs) are not required to comply with the specific LCR.
As such, we expect the deposit rates from the branches of foreign banks and the MLH ADIs to be more competitive at certain points in time, especially for corporate and wholesale deposits. However, this will still be a function of demand and supply with many MLH ADIs currently very liquid and not in need of extra funding from the wholesale sector.
FIIG will monitor the rates offered by the 60-odd ADIs we raise funding for and advise investors of any opportunities from the branches of foreign banks or MLH ADIs.
What to watch for
The impending changes have already been occurring in the market, with many ADIs releasing 31+ day break or notice period products over recent months. We expect this to gather pace throughout December and early 2015.
Investors should consider the following list when assessing term despot investments now and into 2015:
- Make an accurate and realistic assessment of absolute liquidity needs and minimise the amount placed at-call or in short dated term deposits if the rates on offer are materially below those available with 31+ day break or notice clauses
- Where possible, maximise the amount with 31+ day break or notice clause. Possibly combine this with other sources of liquidity such as an allocation to high quality, liquid bonds that can be sold at short notice if emergency liquidity is required
- Maximise the amount on deposit through personal/retail or SMSF accounts and minimise the amount through deemed corporate or financial institution accounts. Likewise maximise the amount that can be classified as ‘operational’
- As with any regulatory change or new product development, be on the lookout for special rates that may be offered in the early stages to attract investors. Typically, the early adopters receive the best rates and this product is here to stay. It is not a fad.
- Don’t discount the branches of foreign banks or MLH ADIs who from time to time may offer competitive rates for the traditional deposit products, given the LCR does not fully apply to those ADIs. There are now over 10 credit unions and building societies that are rated investment grade and considered very safe places to invest deposit or at-call money.
- The ease and low cost of breaking term deposits that has prevailed for many years is expected to come to an abrupt halt come 1 January 2015, so be sure to have other sources of liquidity if this is a possibility.
- Be aware that ADIs will monitor the behaviour of depositors and over time (later in 2015 and beyond) will reward deposits that remain in place and penalise those that are seen to be ‘hot’ money. Where the difference in rate is small, it may pay to remain loyal in the long run.
For further information on the pending changes or to review current deposit rates available, please contact the Short Term Money Market team on 1300 337 674 or email to td@fiig.com.au.
Copyright The contents of this document are copyright. Other than under the Copyright Act 1968 (Cth), no part of it may be reproduced or distributed to a third party without FIIG’s prior written permission other than to the recipient’s accountants, tax advisors and lawyers for the purpose of the recipient obtaining advice prior to making any investment decision. FIIG asserts all of its intellectual property rights in relation to this document and reserves its rights to prosecute for breaches of those rights.
Disclaimer Certain statements contained in the information may be statements of future expectations and other forward-looking statements. These statements involve subjective judgement and analysis and may be based on third party sources and are subject to significant known and unknown uncertainties, risks and contingencies outside the control of the company which may cause actual results to vary materially from those expressed or implied by these forward looking statements. Forward-looking statements contained in the information regarding past trends or activities should not be taken as a representation that such trends or activities will continue in the future. You should not place undue reliance on forward-looking statements, which speak only as of the date of this report. Opinions expressed are present opinions only and are subject to change without further notice.
No representation or warranty is given as to the accuracy or completeness of the information contained herein. There is no obligation to update, modify or amend the information or to otherwise notify the recipient if information, opinion, projection, forward-looking statement, forecast or estimate set forth herein, changes or subsequently becomes inaccurate.
FIIG shall not have any liability, contingent or otherwise, to any user of the information or to third parties, or any responsibility whatsoever, for the correctness, quality, accuracy, timeliness, pricing, reliability, performance or completeness of the information. In no event will FIIG be liable for any special, indirect, incidental or consequential damages which may be incurred or experienced on account of the user using information even if it has been advised of the possibility of such damages.
FIIG provides general financial product advice only. As a result, this document, and any information or advice, has been provided by FIIG without taking account of your objectives, financial situation and needs. Because of this, you should, before acting on any advice from FIIG, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If this document, or any advice, relates to the acquisition, or possible acquisition, of a particular financial product, you should obtain a product disclosure statement relating to the product and consider the statement before making any decision about whether to acquire the product. Neither FIIG, nor any of its directors, authorised representatives, employees, or agents, makes any representation or warranty as to the reliability, accuracy, or completeness, of this document or any advice. Nor do they accept any liability or responsibility arising in any way (including negligence) for errors in, or omissions from, this document or advice. Any reference to credit ratings of companies, entities or financial products must only be relied upon by a ‘wholesale client’ as that term is defined in section 761G of the Corporations Act 2001 (Cth). FIIG strongly recommends that you seek independent accounting, financial, taxation, and legal advice, tailored to your specific objectives, financial situation or needs, prior to making any investment decision. FIIG does not make a market in the securities or products that may be referred to in this document. A copy of FIIG’s current Financial Services Guide is available at www.fiig.com.au/fsg.
An investment in notes or corporate bonds should not be compared to a bank deposit. Notes and corporate bonds have a greater risk of loss of some or all of an investor’s capital when compared to bank deposits. Past performance of any product described on any communication from FIIG is not a reliable indication of future performance. Forecasts contained in this document are predictive in character and based on assumptions such as a 2.5% p.a. assumed rate of inflation, foreign exchange rates or forward interest rate curves generally available at the time and no reliance should be placed on the accuracy of any forecast information. The actual results may differ substantially from the forecasts and are subject to change without further notice. FIIG is not licensed to provide foreign exchange hedging or deal in foreign exchange contracts services. The information in this document is strictly confidential. If you are not the intended recipient of the information contained in this document, you may not disclose or use the information in any way. No liability is accepted for any unauthorised use of the information contained in this document. FIIG is the owner of the copyright material in this document unless otherwise specified.
The FIIG research analyst certifies that any views expressed in this document accurately reflect their views about the companies and financial products referred to in this document and that their remuneration is not directly or indirectly related to the views of the research analyst. This document is not available for distribution outside Australia and New Zealand and may not be passed on to any third party without the prior written consent of FIIG. FIIG, its directors and employees and related parties may have an interest in the company and any securities issued by the company and earn fees or revenue in relation to dealing in those securities.