Debt Costs To Rise As Confidence Erodes

The Age

Tuesday March 18, 2008

By Leon Gettler, Financial Services Reporter

THE Bear Stearns crisis could force up funding costs for Australian banks, putting more burden on them to raise interest rates. And there are warnings that another wave of bad debt, possibly of hundreds of millions of dollars, might hit Australian banks next year because of changes in accounting rules.

Analysts and fund managers said the immediate consequence of the run on the fifth-biggest bank in the US, and its subsequent sale to JPMorgan at a bargain-basement price of $US2 a share, might well be a loss of confidence in Australian banks. The result: increased costs and more interest rate pressure.

It might also result in a loss of investor confidence. Argo Investments managing director Rob Patterson said: "At the end of the day, the banking system relies on confidence and the US situation is starting to become disturbing."

Mike Codling, a partner at PricewaterhouseCoopers, said this could result in money becoming more expensive for banks when they raised funds in global capital markets. Money gets more expensive as banks become less confident in the ability of each other to repay.

"If the banks need to pass on the funding costs to corporate borrowers, or if it becomes more difficult for the banks to fund credit growth and they have to pull back on lending to corporates, then clearly the corporates are going to feel pain; which will translate into credit losses," Mr Codling said.

But he said he did not expect losses to blow out significantly. "You would expect an ongoing uptick in credit losses; whether you expect them to be dramatic is debatable because they are coming off a very low base."

Many analysts believe banks will raise interest rates, even if the Reserve Bank sits back and does nothing, as they need to claw back costs. "Banks really don't have a lot of flexibility there," said one analyst who did not want to be named.

But JPMorgan analyst Brian Johnson said the bad debts could be large because of changes in accounting rules that came in three years ago. But that would not happen until next year.

Under the old accounting rules, banks could make provisions for losses that had not yet occurred. But, under international accounting rules, otherwise known as International Financial Reporting Standards, or IFRS, provisions for bad debts can be made only when the clients come out and admit they are out of money to pay off debt.

In other words, the accounting model for debt provisioning has gone from expected losses to incurred losses. And the problem is that this is more likely to happen with highly geared companies when the banks pass on more of their costs.

Mr Johnson said banks had not yet provisioned for bad and doubtful debts at this stage because of "the aberration of IFRS accounting". He said business would feel the pain when the banks' costs were passed on.

© 2008 The Age

Back to News Index | Back to Home