Monday, March 17, 2008

Deposit bases, credit rationing and the Australian banks

Back in December in The Balance of Payments, Australia and the sub-prime crisis I discussed the reasons why a US financial crisis affected Australian domestic liquidity. Since then, the crisis has eased. However, in so doing it has created another interesting set of dynamics.

Reduced access to international liquidity increases the value of domestic liquidity. Financial institutions that can access that liquidity gain relative to those who cannot. In an Australian context, it is the major banks with their big relatively passive domestic customer deposit bases who are the real winners.

Despite the slowing economy, both households and businesses still need to borrow. With reduced availability of funds, the major banks with their control over deposits begin to ration credit and can also increase interest rates. This allows for reduced risks in combination with increased margins.

Of course, if the economy really slows even the big banks will be affected by the overall reduction in the demand for funds. But at this stage in the cycle, the immediate flow-on effect of the sub-prime crisis is increased bank profitability.

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