The first foray of Australian banks into the wholesale term debt markets with government guarantees has crystallised what many feared -- a big jump in funding costs. Australian banks had to pay 120 basis points over swaps to issue the bonds in the last two weeks.

Citigroup said in its daily commentary that there was now a chance the Reserve Bank of Australia would have to cut deeper than expected to compensate for the Australian banks not being able to pass on cash rate cuts in full.

"This is mainly because, with bank wholesale funding costs having blown out in recent weeks, there now is a greater chance that market interest rates will not fall in line with the cash rate," Citigroup said.

"Indeed, in the current environment, the commercial banks can mount a plausible case against passing on the majority of the reductions in the official cash rate. RBA officials, therefore, may have to push the target rate lower than they would otherwise to get the same bang for their policy buck," Citigroup said.

New Zealand's banks, owned by the same Australian banks, have yet to issue such guaranteed bonds as their applications are still being processed.

But when they do, it's possible they will have to pay 300 basis points above swaps to issue guaranteed term debt, more than 250 basis points higher than before the credit crunch. That includes the 120 basis points being paid by the Australians plus the New Zealand fee of 140 basis points and a margin of 10-15 basis points above that. That has the potential to keep longer term fixed rates well above 6% even if the Official Cash Rate falls to 4%.

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