There have been several things that have caught my eye over the last day when it comes to interpreting the economic entrails. This post deals with one.
Jaime Caruana, general manager of the Swiss-based Bank for International Settlements, is reported as saying that Australian banks could not expect to be quarantined from changes taking place across the global system.The thing that really caught my eye is the requirement that mortgage lending be funded using long-term debt.
Now depending on the meaning attached to this, this would actually lead to a fundamental change in Australian banking. Older Australians will remember the Australian savings banks, banks who used generally short term deposits to fund housing. This is actually the Australian pattern.
In system terms, short term funds withdrawn from one bank simply went into another, so there was no system wide risk associated with short term lending. There could, however, be risks for individual institutions that might then translate into system wide risks if everybody tried to store their money under the bed. We saw this in the 1890s' crash and the associated asset bubble.
Now looking at the implications for Australia from the proposed change and working just from first principles. I stand to be corrected, of course, if I get things wrong.
If Bank A cannot use its retail deposits for mortgage activity including housing and has to borrow longer term, then on the surface it will pay more for funds, a cost that will have to be passed on.
Given the banks control over deposits, and excluding international borrowing, Bank A will actually need to access funds held by other banks, say Bank B, directly or indirectly. Bank B also wants to lend for housing, but also cannot use its deposit base. So Bank B will, directly or indirectly, lend Bank A money on a longer term basis, in turn borrowing from Bank A. We have a round robin in which interest rates go up, inter-bank dependency increased.
I accept that this may be simplistic, so please correct me if I have got things wrong.