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Why Australian banks are superior

Why Australian banks are superior

Why Australian banks are superior

There has been increased focus in the banking sector following the financial difficulties of some US banks. Portfolio Manager Brett McNeill explains what sets Australian banks apart from their US counterparts and why they continue to be an attractive investment for Djerriwarrh.

The impact of rising interest rates revealed some issues with the regulation and risk management of the US banking sector, resulting in the collapse of two US banks – Silicon Valley Bank (SVB) and Signature Bank.

Unlike many other global markets, the US banking system is highly fragmented with many small or regional banks which aren’t as well regulated as other global jurisdictions.

One of the key issues is the highly concentrated nature of some US bank deposit bases, as was the case with SVB which had a significant concentration of technology companies. A key principle of managing risk is diversification and this also applies to bank deposit bases.

The issue with a highly concentrated deposit base is that there is significant risk of deposits leaving at the same time if there is an issue with the bank or in a sector – such as the technology sector for SVB.

Using its deposits from technology companies, SVB invested in higher-returning assets like long-duration bonds which were accounted for as hold-to-maturity securities. This means the mark-to-market – or the adjusted value of the asset reflecting current market conditions – fell significantly as interest rates rose.

Many customers then grew nervous as concerns started to emerge about SVB’s health, starting a classic contagion “bank run” as depositors withdrew their money

What sets Australia’s banks apart?

The Australian banking sector is better regulated than in the US, making them less risky for deposit holders and equity investors.

Unlike the SVB situation in the US, Australian banks are required to regularly report a liquidity coverage ratio to APRA (Australian Prudential Regulation Authority), part of which requires them to estimate what portion of their deposit base could leave in a highly stressed scenario. Banks must then hold an equivalent of that estimate in high-quality liquid assets to cover the potential deposit flight under that stress scenario. The banks actually hold a buffer above that required amount – on average around $130 of high-quality liquid assets for every $100 they estimate could leave in a highly stressed scenario.

The high-quality liquid assets which the banks are required to hold include short-term government bonds and deposits with the Reserve Bank of Australia.

By contrast, SVB held longer-duration securities which are not liquid assets and therefore didn’t have the cash or cash equivalents to cover the deposit outflow, resulting in SVB having to sell those securities at a loss and worsening their capital position.

Importantly, APRA regulation requires the Australian banks to mark-to-market the changing value of their high-quality liquid assets.

Opportunity to add to our bank holdings

The Australian banks already have a good weighting within our portfolio and present a valuable source of fully franked income.

While none of the major Australian banks were directly impacted by the situation in the US, their share prices did take a hit as global markets became nervous about the sector.

As a result, we believe this has made our major banks a more attractive investment proposition meaning we added to our holdings through this period.

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