Tuesday 18 November 2014 by Justin McCarthy Opinion

Is this the end of the traditional term deposit?

From 1 January 2015 an important change to banking regulation will commence and it has significant implications for term deposits, with the use of 31+ day break or notice clause to become common place and a large divergence in deposit rates expected.

In December 2013, the Australian Prudential Regulation Authority (APRA) released a revised liquidity standard (APS 210) for all Australian Authorised Deposit-taking Institutions (ADIs). This standard encapsulated APRA’s views of the Basel III regulatory changes for global banks.

A centrepiece of Basel III and indeed APS 210 is the liquidity coverage ratio (LCR). While other countries have transitional arrangements over a number of years for adoption of the LCR, APRA requires the larger Australian ADIs to comply with it from 1 January 2015.

The LCR aims to ensure that an ADI can meet its liquidity requirements in a severe stress or ‘bank run’ scenario. The regulation requires an ADI to hold sufficient unencumbered high quality liquid assets (HQLA) that can be converted into cash within a day to meet all of the ADI’s liquidity needs for a 30-day stress scenario. The ratio of HQLA to the ADI’s expected net cash outflows during this period must exceed 100%.

The three key features (and implications for depositors) of the LCR are as follows:

1. 30 day horizon

The LCR looks at a 30-day liquidity period and any product or deposit with a 31+ day break or notice period intact will not be included in the calculation of liquidity required. ADIs will be required to hold low yielding HQLA for any deposit (or at-call money) which can be repaid or matures within 30 days. This makes these deposits ‘expensive’ for the ADI as it has to tie up a portion of its funds in low yielding HQLA.

Conversely, a deposit that has a 31+ day break or notice period requires no HQLA backing. As such, ADIs will place a higher value on the latter and will pay higher rates to attract those funds. Traditional at-call and short-dated term deposits, particularly from financial institutions, will receive the opposite treatment with rates expected to be significantly lower come 1 January 2015. Corporates will receive slightly better treatment especially where money on deposit can be proven to be ‘operational’.

Come 1 January 2015, the ability to break term deposits will become significantly harder with Product Disclosure Statements and terms and conditions expected to change to prevent the breaking of term deposits, with very few exceptions, the main one being personal hardship.

2. Depositor classification and ‘run off’ assumptions

There are vastly different ‘run off’ assumptions for various categories of depositors which will have a significant impact on the rates the ADIs will offer these different categories.

At one extreme are the ‘sticky’ retail deposits that APRA assumes will withdraw just 5% of funds in a crisis scenario. At the other end are ‘hot’ wholesale deposits from financial institutions that are assumed to see 100% of funds withdrawn at the first sign of a crisis.

It is important to note that for the purpose of the LCR calculation, this represents a differential of 20 times between the highest and lower risk deposit categories.

Again, the implications are clear. Mum and dad ‘retail’ deposits will continue to be in high demand and hence command higher rates. This typically covers deposits up to the $250,000 government guarantee amount. Self Managed Superannuation Funds up to this limit also attract positive treatment under APS 210.

However, the larger implications are for wholesale deposits and at-call money from larger institutions, particularly those classified as financial institutions. It is here where the traditional deposit product offering looks to be a dying breed, to be replaced by 31+ day break or notice period deposit products.

Corporations that can demonstrate a long term operational relationship will receive a 40% run-off assumption placing them in the middle of sticky retail and hot wholesale money. The focus here will be for corporate and potentially some financial institutions to prove the operational nature of portions of their funds on deposit and to argue for higher rates.

Another clear implication is that all wholesale depositors will have an incentive to do an accurate assessment of their real requirement for very liquid funds such as at-call or short dated term deposits, given the much lower rates expected on these come next year. This low returning portion of an investor’s portfolio should be minimised and as much as possible locked away for a minimum of 31 days to attract a better rate from the new breed of deposit products.

3. The LCR does not apply to credit unions, building societies and mutual banks, nor branches of foreign banks

Compliance with the 100% LCR is only required from what APRA terms the ‘scenario analysis’ ADIs. This essentially refers to the major and regional Australian banks and locally incorporated foreign subsidiary banks (such as HSBC Bank Australia Limited and Rabobank Australia Limited).

Branches of foreign banks that operate in Australia (such as Bank of China Limited) are only required to meet 40% of the LCR.

Credit unions, building societies and other mutual banks (technically termed ‘minimum liquidity holding’ or MLH ADIs) are not required to comply with the specific LCR.

As such, we expect the deposit rates from the branches of foreign banks and the MLH ADIs to be more competitive at certain points in time, especially for corporate and wholesale deposits. However, this will still be a function of demand and supply with many MLH ADIs currently very liquid and not in need of extra funding from the wholesale sector.

FIIG will monitor the rates offered by the 60-odd ADIs we raise funding for and advise investors of any opportunities from the branches of foreign banks or MLH ADIs.

What to watch for

The impending changes have already been occurring in the market, with many ADIs releasing 31+ day break or notice period products over recent months. We expect this to gather pace throughout December and early 2015.

Investors should consider the following list when assessing term despot investments now and into 2015:

  • Make an accurate and realistic assessment of absolute liquidity needs and minimise the amount placed at-call or in short dated term deposits if the rates on offer are materially below those available with 31+ day break or notice clauses
  • Where possible, maximise the amount with 31+ day break or notice clause. Possibly combine this with other sources of liquidity such as an allocation to high quality, liquid bonds that can be sold at short notice if emergency liquidity is required
  • Maximise the amount on deposit through personal/retail or SMSF accounts and minimise the amount through deemed corporate or financial institution accounts. Likewise maximise the amount that can be classified as ‘operational’
  • As with any regulatory change or new product development, be on the lookout for special rates that may be offered in the early stages to attract investors. Typically, the early adopters receive the best rates and this product is here to stay. It is not a fad.
  • Don’t discount the branches of foreign banks or MLH ADIs who from time to time may offer competitive rates for the traditional deposit products, given the LCR does not fully apply to those ADIs. There are now over 10 credit unions and building societies that are rated investment grade and considered very safe places to invest deposit or at-call money.
  • The ease and low cost of breaking term deposits that has prevailed for many years is expected to come to an abrupt halt come 1 January 2015, so be sure to have other sources of liquidity if this is a possibility.
  • Be aware that ADIs will monitor the behaviour of depositors and over time (later in 2015 and beyond) will reward deposits that remain in place and penalise those that are seen to be ‘hot’ money. Where the difference in rate is small, it may pay to remain loyal in the long run.

For further information on the pending changes or to review current deposit rates available, please contact the Short Term Money Market team on 1300 337 674 or email to td@fiig.com.au

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