Deputy RBA Governor Guy Debelle, spoke at the Australian Financial Review Banking & Wealth Summit on “Recent Trends in Australian Capital Flows“. He highlights that Australian banks are still reliant on US funding sources, and this includes exposure to US commercial paper.
We therefore highlight that events there will impact banks here, especially changes in market rates (which are likely to be impacted by FED policy as we discussed earlier).
For more than a century, Australia’s high level of investment relative to saving has been supported by capital inflows from the rest of the world. These net capital inflows are the financial counterpart to Australia’s current account deficit. Foreign investment has been instrumental in expanding our domestic productive capacity and has been attracted by the favourable risk-adjusted returns on offer here.
Although net capital inflows have been a consistent feature of Australia’s balance of payments, the composition of both the inflows, as well as the outflows when Australians invest offshore, has varied substantially over time.
When I spoke about capital flows a few years ago, I discussed the significant changes in the composition of capital flows that had taken place since 2007. At that time, I highlighted three noteworthy developments: a marked increase in foreign direct investment in the mining sector associated with the mining investment boom; the significant change in flows to the Australian banking sector from sizeable inflows pre-crisis to around zero; and a substantial increase in foreigners’ purchases of Australian government debt.
To a large degree, these trends have continued over the past three years. But under the surface, there have been some significant changes in the composition of these flows in recent years.
The aggregate pattern of capital flows to the banking sector has not changed materially since I last spoke on this topic. Since 2014 – and indeed over the period since the financial crisis – there have been minimal net capital flows to or from the banking sector. Following the shift away from offshore wholesale debt towards domestic deposits that took place in the wake of the global financial crisis, the funding composition of banks has remained relatively stable. But notwithstanding this stability, recently there have been two noteworthy developments relating to short-term debt, both stemming from regulatory reforms.
Firstly, over the past year or so, Australian banks have reduced their short-term debt issuance in preparation for the introduction of the Net Stable Funding Ratio (NSFR) next year. The NSFR provides an incentive for banks to shift to sources of funding considered to be more stable and away from sources such as short-term wholesale liabilities.
Secondly, the composition of Australian banks’ short-term offshore funding has also changed following the implementation of US Money Market Fund (MMF) reforms by the Securities and Exchange Commission in October 2016. As a result of these reforms, the value of assets under management of prime MMFs (those that lend to banks) has fallen by US$1 trillion or around 70 per cent over the past couple of years. Some prime funds have switched to become government-only funds, that is, funds that invest only in US government debt. At the same time, investors have allocated away from prime funds to government-only funds. Although prime MMFs have maintained their exposure to Australian banks relative to banks globally (at around 8 per cent of total MMF exposures to banks), their holdings of Australian bank debt have declined from around US$100 billion to under US$30 billion currently.
However, in aggregate, Australian banks have continued to raise almost as much short-term funding from US commercial paper markets, despite the decline in MMFs. They have been able to tap other investors, in particular US corporates with large cash holdings, such as those in the technology sector.
