Wayne Swan could save borrowers a little pain. Photo: Alex Ellinghausen

“It’s a kick in the guts to working families” said Wayne Swan last month when National Australia Bank declined to pass on the full interest rate cut to its customers.

Of the 25 basis point cut, NAB held back 5 points for itself. So what would the Treasurer say if he knew there was another culprit costing borrowers across the land an extra 10 to 20 points on their mortgages? “Kick in the guts…who me?”

That’s right, the government is costing borrowers billions of dollars a year in fees via the wholesale funding guarantee.

By the end of October, Treasury had raised $3.2 billion. And although the scheme was closed to new debt in February 2010, it should deliver well over $5 billion all up by the time the last of the guaranteed liabilities matures in 2015.

It’s a rollicking good earner for Wayne – and especially so now, what with the $20 billion budget hole to be unveiled today as part of the widely leaked mid-year economic and fiscal outlook.

The government has a strong case to charge the banks for the pleasure of taxpayer backing. No other businesses enjoy the same breaks as the banks. But the banks aren’t absorbing the cost. Rather, they are passing it on to their customers.

Borrowers pay

So it could be said that home borrowers are disproportionately funding Wayne’s budget. But the real discrimination appears to lie, not in the quid pro quo of the guarantee, but in its discriminatory structure. That is, the big banks carry less of the burden than the smaller banks.

Bank of Queensland chief David Liddy told a parliamentary committee early this year, “If the government guarantee on wholesale funding were flattened to the fee that the major banks pay for all remaining payments, BOQ would be able to immediately reduce our variable mortgage rate by 20 basis points”.

The same venue heard this from the Australian Bankers’ Association:

“surprisingly, investors seemed to ignore the guarantee when deciding what interest rate they would demand on the guaranteed bonds from smaller banks”.

In other words, the big investors who buy our bank bonds look straight through the guarantee and price the bonds on the credit ratings of the particular bank, rather than off the sovereign guarantee curve.

Fairer competition

A BusinessDay investigation into the wholesale funding guarantee has found that, were the guarantee to be made identical for all banks, borrowers would be better off, the impact on the budget would be relatively small and this flatter playing field could even stimulate lending competition.

When the charges were first introduced at the nadir of the global financial crisis in early 2009, Australia was different to many other countries. The schedule of fees for the pleasure of accessing the guarantee was set at 70, 100 or 150 basis points depending on the bank’s credit rating.

In a submission to the government’s banking inquiry at the time, both the Reserve Bank and APRA (Australian Prudential Regulatory Authority) jointly made it clear that the gap was unusually large.

And nothing, despite government promises to review the scheme and petitions from the disadvantaged banks, has been done since to rectify this imbalance.

Large gap

In contrast to Australia’s guarantee, other schemes with fees at the higher end, including the United Kingdom, have since lowered their fees, partly due to concerns about the competitive implications for their banks of charging high fees.

Internationally, fees on comparable schemes have converged at around 90 to 110 points, above the 70 basis point charge for AA-rated Australian banks. Our fee structure also has a relatively large differential between banks with different ratings.

The maximum differential was double the premium that the market was charging at the height of global financial turmoil.

“The unintended consequence around that,” Suncorp told the government committee, “is essentially that the assumption was that everyone would be priced off the sovereign curve for the pricing; however, the market looked through that and essentially priced against the credit ratings of the various institutions, and on top of that was a fee differential”.

This fee structure then had an unintended consequence of a “double dip” on any non-AA-rated bank, as the credit markets “looked through” the guarantee to the issuer’s underlying credit rating anyway.

For example, on its first issue the Bank of Queensland paid 150 points to the government for the fee on top of 115 points to the market. By comparison, the major banks were paying around 75 points to the market and only 70 points to the government for the guarantee.

When the guarantee was first announced, some fine sentiments were voiced:

“The deposit and wholesale guarantees contain features and variables that may require refinement or adjustment in light of market developments. These include the setting of the appropriate fee level and structure, the threshold for the deposit guarantee and the overall coverage of the scheme. The deposit and wholesale guarantee scheme will be reviewed on an ongoing basis and revised if necessary.

“Details of the scheme, including participating institutions and the liabilities that are covered will be made available on a suitable public website.”

Interestingly, there has been no revision despite the following unanimous Senate committee recommendation back in May:

“The Committee believes providing temporary guarantees for bank funding was the correct response to the global financial crisis but it could have been introduced more adroitly. The differential pricing for the guarantees exacerbated the ‘flight to quality’ to the major banks and had an adverse impact on competition.

Then there was this:

Recommendation 20 12.36 The Committee recommends that, to increase the competitiveness of smaller lenders, the Government immediately standardise the fee for all borrowers under the wholesale funding guarantee to a uniform rate of 70 basis points.

This recommendation remains comprehensively ignored. BusinessDay put a list of questions to Treasury and the Reserve Bank, to which the responses were mostly evasive.

Treasury response

On the matter of reviewing the scheme, as promised, Treasury responded that some changes had been made “however, they were limited to facilitating the closure of the Scheme”. Bear in mind that the guarantee still running until 2015.

“Treasury reports periodically to the Deputy Prime Minister and Treasurer on the status of liabilities guaranteed under the Scheme. These reports are tabled in Parliament.

“The Guarantee Scheme is currently the subject of a Post Implementation Review. This is scheduled to be completed in 2012.”

This Post Implementation Review, apparently slated for completion sometime in the following 12 months, seems to be news of sorts. But small bank mortgage holders should not hold their breath. This kind of evasive response – both the RBA and Treasury did not even bother answering some questions – suggests the government has little intention of doing anything.

A banking source estimates that if the government were to level the playing field, borrowers would benefit and the effect on government revenues would be minor.

Under the scheme rules, fees are payable on the average daily value of guaranteed liabilities over the preceding month. For September 2011, institutions participating in the Scheme paid guarantee fees of $76 million, taking the cumulative fees paid to $3.08 billion.

Rate cut scope

The above figures, prepared for BusinessDay from APRA and Treasury data by banking sources, show the scope for smaller lenders to reduce their interest rates in the event of a flattened guarantee structure. It is based on the approximate situation at the end of September (approximate because Suncorp’s borrowings were not all in Australian dollars).

The analysis excluded Investec with wholesale funding guarantees totalling $1.55 billion because it does little home lending, as well as the smallest fry, Arab Bank ($200 million), Heritage Building Society ($680 million) and the Bananacoast Community Credit Union ($40 million).

Macquarie Bank’s transactions are also stripped out of the mix as it got out of home lending during the GFC and its fillings are large and extremely complex.

What would be the cost to the Australian government of reducing the guarantee fee to 70 basis points for everyone? Setting aside Macquarie again, for the rest, we are dealing with roughly $7 billion for Suncorp (a reduction of around $20 million) and $20 billion for the others.

All up that’s $160 million that could be passed on to borrowers in annual relief from Treasury’s gouging.

From those other than Macquarie, that’s an annual reduction of $180 million in the government’s coffers. It would even be less because some of the transactions would be maturing over the next eight months.

Such an adjustment to the fee schedule would not only be a benefit to borrowers in the Treasurer’s home state of Queensland but could even be a fillip to competition, assisting the small players to take it up to the big banks.