On January 1 the final element of APRA’s liquidity standard under Basel III came into existence, and SMEs need to be aware of its potential impact.
Known as the Liquidity Coverage Ratio (LCR), it seeks to ensure that Australia’s banks have sufficient liquid assets to cover liabilities that need to be repaid over the next 30 days. The goal is to fireproof our banks in the event of another financial crisis. The nature of other assets on a bank’s balance sheet will also affect the level of liquid assets that need to be held. These liquid assets need to be in a form that meets the High Quality Liquid Asset (HQLA) standard. Only Commonwealth and State Government Instruments (CGS) and Reserve Bank cash balances meet this standard.
What impact will this change have on SMEs?
According to the Reserve Bank of Australia, there is approximately $600 billion in CGS and RBA cash balances. After deducting for other systemic entities that require or desire CGS, APRA believes that there is approximately $175 billion that can be allocated to banks. APRA estimates that the banks will need approximately $450 billion in HQLAs in 2015. This shortfall is to be funded by the RBA’s new Committed Liquid Facility (CLF) regime. Under this regime, banks sign an annual agreement with the RBA guaranteeing liquidity to cover any monthly shortfall under the LCR. This comes at a cost of 15 basis points (.15%). While this cost is relatively small it may or may not be absorbed by the banks.
Whether or not a bank seeks to pass on this cost may be determined by a particular bank's level of short term liabilities and the quality of other assets on their balance sheet. Under LCR there is a need for banks to factor into their product pricing the cost of maintaining liquidity relative to the risk in any particular product. Lines of Credit are an example where pricing has increased due to perceived risk. This change will undoubtedly feed into other products pricing.
A further impact will arise from the banks' cost base. In addition to the cost of the HQLA, banks cost of funds may increase as they seek to shift more short term borrowing to longer terms. Over recent years we have seen competition for deposits with more attractive interest rates to be offered on longer term deposits. Retail and SME deposits are much 'stickier' than those of the bigger corporates, so we can expect to see these sectors targeted with more attractive rates.
There has also been an increasing prevalence of “notice of withdrawal accounts” where 30 days notice is required to withdraw funds. These changes will all feed into higher costs of funds for banks and will likely impact product pricing. As previously noted, banks need to hold additional HQLA to cover riskier loans. The rating system is very complicated but in essence different weighting is applied depending on credit quality, and the class of security provided.
This will undoubtedly lead to price increases such as we have seen with Lines of Credit. In recent years bank lending to SMEs has declined and it is hard to see this situation improving as the new risk weighting regime comes into existence. Whilst LCR is a necessary change to our banking system it will need to be reviewed if it has too great an impact on the banks' appetite to lend to SMEs.
Certainly an interesting year ahead for the banks as this new regime comes in.
