Will the “War for Deposits” intensify in Australia and New Zealand?

     

Most developed global economies have seen a sharp drop in interest rates since the Global Financial Crisis with some regions seeing near-zero or even negative interest rates. Fortunately, Australia and New Zealand have seen a less aggressive drop in interest rates, resulting in a close convergence of both economies.

Australia Interest RateOver the past 5 years, Australia has seen base rates drop from 4.75% in 2011 to an historic low of 1.5% today. The fall has been rather smooth and gradual over this period and the expectation is that we will see further drops in 2017, potentially settling at ~1% in the third quarter of next year. 

A slightly different path can be seen in New Zealand, with stagnation of interest rates between late 2011 and 2014. This was followed by a sharp increase, swiftly followed by a sharper decline, which continues today. At a current base rate of 2%, New Zealand is also experiencing historically low interest rates with the likelihood of a further cut in 2017.

New Zealand Interest RateIn this period, average Australian deposit rates have broadly tracked the Official Cash Rate, falling from ~4.3% to ~2.3% in 2015. Although a little more erratically and less aggressively, New Zealand deposit rates have also fallen in this period, from an average of ~4.2% in 2012 to ~3.8% in 2015.

Deposit Interest Rate in New ZealandDeposit Interest Rate in Australia

But what about the 2016 trend to date? There is strong evidence that the correlation between the Official Cash Rates of both countries and average deposit rates is becoming less stable. Average deposit rates in Australia this year are trending somewhere in the region of 2.9%, almost 60 bps higher than in 2015 when the Official Cash Rate was 1% higher. Similarly in New Zealand, average deposits rates are expected to be broadly similar to last year, despite a sharp fall in the Official Cash Rate.

This widening of the jaw between Official Cash Rates and average deposit rates is undoubtedly placing interest income pressure on banks. In Europe, when interest rates fell sharply after the financial crisis, deposit rates rose sharply in a bid to attract more deposits to support balance sheet stability. The volatility of commercial and institutional deposits in banks across Europe saw a flight to safety of deposits out of banks and into more stable havens because of the downgrading of these banks.

With large holes appearing in the funding of banks and a slower pace of assets decreasing in size, the markets saw significant rises in retail deposits rates to attract these funds to close this gap. The expected outcome of this strategy was naturally P&L pain as banks held large deficits on interest income and margin. Over time, this changed with deposit rates falling, equally as fast, while assets were deleveraged. In a timeframe of 3-4 years, banks experienced extreme volatility in balance sheet and P&L standings.

The experience in Australia and New Zealand is somewhat different. While we are seeing the divergence of Official Cash Rates to deposit rates in both markets, it is not to the extent that we saw elsewhere across the globe. There are a number of reasons for this:

  • The underlying stability of the banking sector in both countries has been largely positive over the last 10 years. However, while the AAA rating from Standard and Poor’s on Australian Sovereign still stands (since the turn of the 21st century), the outlook for this rating is now negative (since mid 2016). Likewise in New Zealand, its AA rating, but with a stable outlook, persists. This means that the banks did not see the balance sheet volatility experienced in other countries and as a result did not experience the outflows of institutional funds experienced in banks globally.
  • Assets continue to grow in banks in both countries as economies continue to expand and lending, particularly in the housing market, continues to grow.

So, what are the driving forces to the heightened deposit rates in Australia and New Zealand? There are a number of factors driving this pricing:

  • Australia and New Zealand banks have a high proportion of institutional and wholesale funds on their balance sheets. Part of the restructuring of banks across Europe saw the proportion of this type of funding reduce from ~50% to ~30% after the Global Financial Crisis. However, in Australia and New Zealand, the average proportion of wholesale/institutional funds is higher than average European levels, leaving an exposure in retail deposits. In order to improve stability, increase liquidity coverage, and reduce reliance on wholesale funding, the banks in both countries are now seeking to improve their base of retail deposits. These deposits provide better stability and liquidity coverage and hence a “war for deposits” has started in both markets.
  • Unlike Europe, there is a growing home lending market with increasing property values and loan demand. As these assets grow, the banks need to proportionally grow their funding base to support current and future demand.
  • Basel III has had a significant impact on the strategies for funding in both regions. Under Basel III, the deposits business ceases to be solely a volume and margin game. The fight for deposits is the fight for sticky retail deposits that will improve stability, reduce outflow factors, and provide the capacity for banks to service the growing demand for credit.

As the trend continues, the outlook for 2017 is likely to see reductions in Official Cash Rates in both regions, but flat or even higher deposit rates. The differential between liquid cash deposits and fixed term deposits is likely to widen, encouraging customers to lock in deposits and support banks’ demand for stickier funds.

Banks in both regions are now looking to optimise deposit portfolios – i.e., find the optimum balance between competing demands of margin, customer expectations, volume, and stability. This is not an easy conundrum to solve, but the use of data analytics is a necessity for solving it.

In our experience, banks in both regions want to improve their capability to use consumer behavioural data, transactional data, market data, and competitor data to design a strategy for deposits and determine the optimum approach to both deposits retention and acquisition. Without a scientific approach to this conundrum, there is a danger that the market will “overprice” deposits, solely reacting to market factors. This will potentially cause the same P&L issues we have seen in Europe and North America.

Nomis is working with banks in both countries to execute optimum portfolio strategies with expected results to include improvements in net interest margin of ~8/10 bps under current market conditions. On portfolios of hundreds of millions of dollars, these improvements contribute to significant bottom-line results.

Learn more about Price Optimization and Basel III.
Look for Nomis at the event: Australia Retail Credit Association

About The Author

Damian is a career banker with more than 25 years of experience. He spent most of his career with Bank of Ireland where he held a number of senior roles, including Head of Deposits and Current Accounts, Head of SME Banking and Head of Customer Management and Customer Analytics. At Nomis, Damian is Managing Director responsible for the APAC region.