Depositors challenge basel III paradigm

Most financial services regulation fails because it is backward-looking. In seeking to address the problems of the last crisis, regulators often sow the seeds of the next.

So it is with Basel III. Much of the prudential framework – in particular in relation to liquidity - is built on the assumption that the future will echo the past. This is clearly unsupportable and, ironically, would attract the wrath of regulators across the world were it a claim made by a market participant.

In any case, market developments, particularly in relation to liquidity) are challenging this assumption even before the details of the Basel III implementation are finalised. A key liquidity tool under Basel III is the ‘Net Stable Funding Ratio’ (“NSFR”).

The NSFR seeks to ensure that banks develop a sustainable maturity structure of assets and liabilities. It assumes that some forms of funding are more stable than others. To achieve appropriate asset/liability matching, banks must secure sufficient “available stable funding” to match their “required stable funding.”

The Australian Prudential Regulatory Authority (“APRA”) is the regulatory authority charged with giving effect to the Basel III regime amongst Australian banks.

Under draft APRA APS210, many retail deposits – even ‘at call’ deposits – are considered to be highly stable. Provided that they fall within the government deposit insurance scheme and are in transactional accounts, they receive a 90% weighting when stable funding is calculated.

Even if ‘less stable’ and more subject to capital flight, they receive an 80% weighting – far higher than the 50% weighting to corporate deposits. Clearly, NSFR places a substantial premium on retail deposits.

This aspect of the NSFR regime has already been criticised. A comparatively large portion of national savings is channeled through superannuation funds. Because of this, it is generally recognized that greater funding of banks by the funds would be beneficial.

However, the Association of Superannuation Funds of Australia (“ASFA”) argues that NSFR unduly favours the self managed superannuation fund (“SMSF”) sector – given favourable treatment as retail depositors - over the APRA-regulated superannuation funds – given less favourable treatment as financial institution depositors.

This favouritism means that SMSFs will be able to demand a higher rate of return on their deposits than the larger funds. Not only does this disadvantage the large funds, but it also disincentivise them from funding banks.

With APRA estimating that Australia’s six largest banks alone have a combined stable funding shortfall of $420 billion, the outcome could be extremely problematic.

Industry criticisms aside, it is certainly far from clear that the historical stability of retail deposits will continue. Arguably, much of this stability arose from the relative ‘laziness’ of many bank depositors.

The regulatory premium on retail deposits will almost certainly result in increased competition and product innovation. This could fundamentally alter depositor behavior, making depositors more sensitive to yield and less stable, thereby undermining this key pillar of the Basel III regime.

Arguably, we have already seen the first example of this - again in Australia. Multiport recently reported that SMSF cash and short term deposits slumped from 26.7% of total SMSF assets in the December quarter to just 22.9% in the March quarter.

This represents a capital flight of $15.9 billion dollars of ‘stable funding’ in just three months. Whilst the bulk of these funds moved to equities markets against the backdrop of relatively positive Q1 investor sentiment, the principle seems clear.

There is a significant risk that retail deposits will not provide the stable funding base on which the Basel Committee and APRA is counting.

Developing a ‘one size fits all’ approach to prudential regulation of the international banking system is not easy. It might not even be desirable.

By placing such a premium on retail deposits, the regulators will fundamentally alter the way they are considered by market participants. It might be that ultimately nothing comes of this. But it might also be that we are sowing the seeds for the next crisis. 

Chris Andrews, Head of Funds Management, La Trobe Financial Services