Foreign banks beat a retreat

Tight global economic conditions have caused some foreign banks to desert Australia, but there is evidence that institutions from Asia are moving in.

Foreign banks have for a long time been strongly represented in Australia’s cross-border financing activities. In the post-Second World War period prior to 1985, however, just two have operated continuously as authorised banks.

The Australian banking market was only truly opened up to foreign competition in 1984, with the relaxation of entry requirements and the granting of licences to 15 foreign banks during the 18 months that followed. One feature of the entry requirements was that foreign banks were required to assume subsidiary status, as Australian-incorporated subsidiaries of their international parents, meaning that capital had to be held locally.

Conditions on entry were further liberalised in 1992 when foreign banks were permitted to operate as a branches so that capital did not need to be held locally. Since the mid-1990s, the branch structure has become more popular thanks to the flexibility that it provides. In particular, it enables access to global funding, often from parent entities, and exposure limits, helping foreign banks to better meet the demands of large corporate clients.

The number of foreign banks in Australia has more than doubled since the early 1990s. Shortly before the onset of the global financial crisis there were 40 foreign banks in Australia and, as at May 2012, there were 48. This indicates that they increasingly saw Australia as an attractive place to conduct business, although the ravages of the GFC are now forcing them to reconsider their position in the local market.

A retreat

The foreign banks’ share of bank assets, such as household loans, commercial loans and securities and other banking business, grew from around 10 per cent in the mid-1990s to around 22 per cent by 2007. This was fuelled by a combination of acquisitions, organic growth and new entrants to the market.

By the end of 2011, this share had fallen to 12 per cent - roughly the same as it had been in the early 1990s. This recent change in the participation by foreign banks in Australia is evident in the syndicated loan market. The Reserve Bank estimates that the value of syndicated loans made available by foreign banks nearly trebled to $240 billion during the decade to 2008, but has since fallen by around 14 per cent. That may not be so noteworthy in the context of the de-leveraging that corporate Australia has undertaken since the GFC and the current environment of low credit growth. But it means that the estimated foreign bank share of the syndicated loan market had fallen from a peak of 14.8 per cent before the GFC to 9.97 per cent at the start of 2012 .

There are a number of reasons for this decline including:

HBOS’s sale in October 2008 of BankWest, at the time the largest foreign-owned bank in the country, to Commonwealth Bank of Australia. In one fell swoop, this re-nationalised a significant portion of foreign bank-owned assets.

  • The de-leveraging of corporate Australia since the GFC and the continuing low credit growth environment, making foreign banks’ Australian operations less profitable.
  • Pressure on foreign banks to de-leverage or reduce their international operations because of difficulties faced by their parents at home or elsewhere. For example, the UK’s Royal Bank of Scotland, Canada’s Toronto Dominion Bank and France’s Societe Generale and Credit Agricole  have all withdrawn or are winding down their Australian operations in response to worsening economic conditions.
  • Foreign banks are responding to relatively high, GFC induced, impairment rates in their favoured asset classes, including leveraged finance and commercial property (where aggregate exposures have been scaled back by about 60 per cent since their peak in 2009, compared with a 16 per cent  fall for all banks).

Consequences

The four largest domestic banks have warned in recent submissions to the Productivity Commission’s enquiry into the future of the Export Finance and Insurance Corporation that the flight of foreign banks is threatening to curtail the economy’s ability to reap the full benefits of the resources boom.

Australia and New Zealand Banking Group has estimated that $109 billion in debt is required to be raised this year alone to finance current resources and infrastructure projects. The submissions warn that the domestic banking sector does not have the capacity to fund this debt, due in part to constraints imposed by increased capital requirements under Basel III and the turmoil in financial markets which affect their access to, and cost of, wholesale funding. The retreat of foreign banks only exacerbates the issue, meaning that additional sources of capital are likely to be required to bridge the funding gap.

The funding gap also threatens Australian corporations looking to refinance maturing debt, in many cases under the same syndicated loans that foreign banks are looking to exit. Current estimates place the potential refinancing gap created by the foreign bank retreat at a minimum of $34 billion.

Changing of the guard

The picture, however, is not simply one of foreign banks beating a retreat.

Reserve Bank figures also show that, while the share of business lending by many European banks has fallen by about 4 per cent since early 2009 and about 8 per cent from pre-GFC levels, Asian banks have increased their share of that market by about 2 per cent during the same period. It is suggested that this growth reflects not just an increasing appetite by Asian banks to expand their existing Australian operations, but also new entrants arriving from China and other countries in the region. Of the seven new foreign bank licences granted since 2010, four have gone to Asian banks. The impact from this can be seen in the syndicated loan market, where Asian banks have increased their share of the outstanding value of loans to nearly 20 per cent.

Not all non-Asian foreign banks are giving up on Australia just yet. Two of the first to be granted licences back in 1985 have recently announced they would maintain or expand their operations. Last December, Lloyds Banking Group underscored its commitment by injecting $1.4 billion of equity into Lloyds International. More recently, at the end of March, the chief executive of Citibank’s Australian operations announced that it had no intention of pulling out of the local market and that the retail arm planned to hire staff and increase its assets and coverage.

Along with the increased presence of Asian banks and the continued commitment of some old hands, the funding gap may also be mitigated by the interest being shown in Australia by sovereign wealth funds. One example is the recent $3 billion financing of Queensland’s Wiggins Island Coal Export Terminal. Four overseas wealth funds participated in that transaction to the tune of $780 million − the same amount as the Australian bank lenders.

Given the threat that a debt funding gap poses to Australia’s economic health, it is to be hoped that we are seeing a changing of the guard rather than a retreat in the activities of foreign banks.