Watch these 5 numbers to work out how banks feel about lending
There's been a lot of talk in recent weeks about how reluctant banks are to grow lending at the same rates they did before the recession. Some are asking: why aren't the banks lending again now that the economy is out of recession? Many have a nagging suspicion that activity in the residential and rural real estate markets are being held back by this lack of lending. (Updates with links to interactive charts)
The short answer is the banks are trying to preserve capital and reduce their leverage in an attempt to avoid the sort of losses they have suffered in the last couple of years with some loans going bad.
But how can we predict how cautious or otherwise the banks might be? What are the leading indicators of their nervousness and their appetite for risk?
Traditionally, most observers of the banks have looked at a set of key figures to work out how the economy and bank lending might progress. These included indices like the S&P500 or the Dow or the Official Cash Rate, the New Zealand dollar or even the Fonterra payout. They are still important, but there are other indicators in the post-Lehman world that are a tell-tale sign of where the banks might head.
1. The VIX
This is a derivative traded on the Chicago Futures markets that essentially measures the volatility on the S&P 500. Here is the Wikipedia definition of the VIX.When financial markets get nervous and bank stocks gyrate this is the one measure of 'fear' that many bankers and financial market players look at. It's sometimes called the Fear index. The European sovereign debt crisis has pushed it back up near the levels it reached in September and October 2008 in the wake of Lehman Brothers' collapse. Here's a chart of the VIX on YahooFinance.
2. CDS rates for Australasian Corporates.
This is an index that combines the various Credit Default Swap rates for Australasian corporate debt. Given that the biggest issuers of such debt are the big four Australian banks, this is a measure of how easy it is for Australian banks to raise long term debt in the offshore markets. When these big four banks, which include ANZ (ANZ and National) National Australia Bank (BNZ), Commonwealth Bank of Australia (ASB) and Westpac, find it difficult to raise funds overseas that makes it harder for them to lend easily or cheaply. Here's an interactive chart on our site with the CDS Index for Australasian Corporates.
3. LIBOR-OIS spread
This is a measure of the difference between the London Interbank Offer Rate (LIBOR) and the Overnight Indexed Swap (OIS) rate. LIBOR is a commonly used rate as a base for floating rate business loans. It is a measure of how confident banks are in lending to each other. The OIS is a measure of overnight cash that is essentially fixed by the central bank.
The gap between the two rates gives a quick measure of how comfortable banks are lending to each other. When they're relaxed with each other the LIBOR-OIS spread is low and they tend to be more relaxed with their customers. The LIBOR-OIS spread has widened in recent weeks as banks, particularly in Europe, have become nervous about the fallout from the European Sovereign debt crisis. Here's a chart of this measure on Bloomberg.
4 Mortgage approvals.
This is a measure in New Zealand of the amount of mortgage approvals granted each week by banks. It can bounce around depending on public holidays and seasonal measures, but the Reserve Bank's measures of the last 13 weeks compared to the same 13 weeks a year ago give a good leading indicator. Obviously not all approvals turn into loans, but it's a fair indicator. These numbers show bank approvals are down around 24% in the last 13 weeks from the same period a year ago. Here is a link to our interactive chart of mortgage approvals.
5. The Gap between 2 year fixed mortgage rates and variable rates
The two year fixed mortgage rate used to be the one banks used to fight each other for market share. Remember the 'Unbeatable' campaign that BNZ launched in the spring of 2004? It kicked off the mortgage wars in both 2004 and 2006 that fired up the housing market. The banks used to fund these relatively low 'promotional' fixed mortgage rates by borrowing in the 'hot' wholesale money markets offshore. From 2003 to late 2008 the average bank two year fixed rate mortgage was cheaper than the variable rate, which is based more closely on the Official Cash Rate set by the Reserve Bank.
The Global Financial Crisis showed how vulnerable our banks had become to that 'hot' market if it cooled suddenly, as it did in the wake of the Lehman Brothers collapse. All the banks got a big fright and have since then tried to reduce their reliance on the 'hot' markets by raising more money through longer term bonds and from term depositers locally. The Reserve Bank's move to a Core Funding Ratio, which prescribes the amount of funding the banks get from local and long term sources, is also pushing the banks to raise more money through term deposits. That ratio is currently set at 65% but will rise over the next couple of years to 75%.
One indicator of this extra cost is the gap between the average one year term deposit rate and the Official Cash Rate. This has risen to over 120 basis points in recent months as the banks strain to convince savers to put their money in term deposits.
This term deposit money is more expensive funding for the banks and is forcing the longer term fixed mortgage rates well above the variable rates for the first time in over a decade. The bigger the gap between the 2 year fixed rate and the variable rate, the more expensive the funding and the more cautious the banks will be.