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A deep dive into the unintended, but valuable free kick handed to businesses few realised.

When the world got sick with Covid, central banks stepped up to combat the economic meltdown heading our way. The RBA has been widely applauded for unleashing the biggest stimulus packages in our history, and on a relative basis, in the world (bar one) as Matthew Cranston from the AFR detailed last year.

The cornerstone policy was the $100bn Term Funding Facility (TFF) announced in March and subsequently increased to $200bn in September. The three-year funding scheme intended to support the economy by lowering the cost of borrowing provided to banks to approximately 0.00%. This ‘free’ funding removed the need for Banks to enter the wholesale markets and has been replacing maturing (and relatively expensive) term wholesale funding.

As of 21 April, $96.7bn of the total available $190bn has been drawn with expectation of near full utilisation by the 30 June expiry date.

Term Funding Facility Components

In total, three components were introduced to support the banking sector by providing ‘free funding’ to banks. They are;

  1. Initial allowance – 3% of the 3-month average Total Credit Outstanding to January 2020.
  2. Additional Allowance – based on the dollar increase of Business Credit Outstanding, until 30 April 2021.
  3. Supplementary Allowance – 2% of the 3-month average Total Credit Outstanding to July 2020.

For simplicity we will use the term ‘free ‘funding as the cost of funding is the asset swap spread over benchmark for a given term, and with outright 3yr TFF cost at 0.10% and benchmarks around the same, the cost of the funding is close enough to zero.

Source: RBA Statement on Monetary Policy November 2020

Initial and Supplementary Allowance

From the perspective of a bank CFO or Treasurer, the prospect of locking in 3-year free funding is a gift. Unsurprisingly, as the window on the initial 3% allowance was closing, the banks collectively drew down $43 billion [~40%] in the last month representing a total of 98% utilisation. We expect similar behaviour as the expiry of the supplementary allowance approaches in June.

To incentivise banks in continuing their lending support to businesses, the RBA created an additional allowance for new lending into the segments as follows;

  • SME businesses with turnover under $50.0m per annum attracts $5 free dollars for every incremental $1 lent.
  • Large businesses with turnover greater the $50.0m $1 free dollar for every incremental $1 lent.

The RBA’s reward of additional free money for additional lending to businesses poses an interesting conundrum.

Is the additional allowance a carrot for the banks?

Free 3yr funding is an attractive carrot. However, the initiative does not appear to have had quite the intended success with just $6.5bn of additional lending to small and medium enterprises. This is entirely understandable given the turmoil many SMEs have endured resulting in weak demand for  more debt.

Or is it a stick for SMEs?

The RBA’s ‘5 for 1’ free funding kicker causes problems when considering customer refinancing.

Did the RBA unintentionally give the SME borrowers a huge stick to leverage: 30 times more powerful than anyone realised?

Intended versus potential usage of the TFF

Intention behind RBA Policy:  New lending to SMEs

Customer A increases their debt to support business growth and job opportunities.

Additional $1.0m lending
RBA (taxpayer) provides bank 5 x $1.0m
=  Total of $11.0m lending for SME
=  $5.0m ‘free’ funding for Bank
Customer A supported
The bank needs to source just a portion of the new $1.0m from wholesale funding sources. Assuming constant portfolio funding proportions, this is $160k [~16% of total] from wholesale funding markets. However, the bank receives $5.0m in wholesale funding for zero cost. $4.84m in additional free money to be lent elsewhere (or, just lowering the blended portfolio funding costs further).
RBA supports business: objective achieved.
However, a potential situation could have occurred as follows…
Customer A respectfully asks for pass through of TFF funding benefit with a margin reduction
Bank refuses
Customer re-finances to a new bank
The bank loses $10.0m balance sheet assets (lending facilities).
In addition to losing a customer with $10.0m in lending facilities, the bank is further penalised with a $50.0m reduction to their free money pot.
This means an effective 5x reduction in their Additional Allowance ‘free’ money.
Customer A has become 5x more important to keep happy!

The 30x impact on wholesale funding access

At the portfolio level, wholesale term funding accounts for approximately 16% of the original $10.0m loan. So when the $10.0m is refinanced, notionally there is about $1.6m of ‘freed up surplus wholesale funding’. As wholesale funding is expensive then in normal times this surplus would theoretically be returned to wholesale markets with a neutral impact on blended portfolio funding costs. All liabilities previously funding the asset are returned.

In RBA TFF times, when a customer refinances, (and assuming the Bank had a positive additional allowance amount) then they lose access to $50.0m of free TFF funding – that is 30x the original wholesale funded amount! [$1.6m 16% of the initial $10.0m]

On a dollar-for-dollar basis the access to (or loss of) free wholesale funding impact swells to 30X [$50.0m/$1.6m = 30].

5x notional = 30x wholesale funding equivalent

Alternatively, for the bank onboarding this new customer, on a cost-of-funds ‘margin-for-margin’ basis, the $1.6m wholesale funding component of the loan (relatively expensive funding) is replaced with $50.0m access to free 3-year funding. On a new customer stand alone pricing basis, this impact on overall margin is sizable.

Is it time to ask for your share of the taxpayer cheap funding spoils?

Now is the time to approach your bank to have an open discussion about your margins, and particularly discuss RBA TFF. But not for the reasons mentioned above as that window has closed, rather to discuss that many other less contentious factors driving your lending margins. If you want to know what to ask get in touch.

Cheap funding snowball

Think of the multiplier effect if one bank had decided to offer full margin pass through to attract new SMEs? Every new customer would bring with it 30x equivalent access to TFF funding. SMEs margins could have been significantly subsidised by the access they brought with them with the potential to create an exponential snowball effect.

Unlikely this formed  any part of the intention behind the RBA TFF objective b. to encourage ADIs to support businesses during a difficult period, ADIs will have access to additional low-cost funding if they expand their lending to businesses over the period ahead.

And fortunately no bank exploited this unintended distortion for which the window has now closed.

Author

  • Dan is the Managing Director at BankEdge. He has a unique end-to-end combination of banking technical valuation skills and client-sales-advisory experience gained over nearly two decades of managing client accounts whilst working in a major Australian bank followed by as an independent banking consultant.

Daniel Chalmers

AboutDaniel Chalmers

Dan is the Managing Director at BankEdge. He has a unique end-to-end combination of banking technical valuation skills and client-sales-advisory experience gained over nearly two decades of managing client accounts whilst working in a major Australian bank followed by as an independent banking consultant.

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