guy debelle : bank funding address by mr guy debelle, assistant governor ( financial markets ) of the reserve bank of australia, to the australian dcm summit 2012, sydney, 22 march 2012. * * * i thank chris stewart and cameron deans for their help. as you may be aware, last week the reserve bank published a bulletin article that documented recent developments in the structure and costs of the funding of the australian banking system. 1 the bank has published an article on this topic annually for a few years now, and also reports regularly on developments in the various components of bank funding in its quarterly statement on monetary policy. today, i am going to talk to that article and highlight some of its main findings. the discussion around bank funding costs can get confused at times. it is often unclear whether a participant in the debate is referring to movements in levels or in spreads, and if the latter, what exactly the spread is relative to. the article and my speech today provide some facts that can serve as a common foundation for discussion. the main points i want to highlight are : the level of the cash rate set by the reserve bank is a primary determinant of the level of intermediaries ’ funding costs ( and hence the level of lending rates ). however, there are other significant influences on intermediaries ’ funding costs, such as risk premia and competitive pressures, which are not directly affected by the cash rate. over the past year, funding costs have fallen in absolute terms but have risen relative to the cash rate. deposit pricing, particularly for term deposits, has been the major driver of recent changes in funding costs, reflecting the strong competition for deposits. this has obviously been welcomed by the savers in the population. there has been a rise in the spreads on wholesale debt issued by banks reflecting investors ’ concerns about the global banking industry. while spreads have narrowed recently, they are still higher than they have been over the past couple of years. let me start with the first point. the cash rate set by the reserve bank board is the short - term interest rate benchmark that anchors the broader interest rate structure for the domestic financial system. it is the front end of the risk - free yield curve off which other financial assets are generally priced. when the cash rate is adjusted up or down, the whole structure of interest rates in the economy moves up and down, with the effect most direct at shorter maturities. but the cash rate is clearly not the only determinant

. conversely, when conditions improve and term wholesale issuance picks up, short - term issuance declines, reducing the spread with further downward pressure from the improved market sentiment. bis central bankers ’ speeches if the lower spread between bank bills and ois is maintained, this should alleviate some of the upwards pressure, relative to the cash rate, on the cost of funding banks ’ aggregate loan books. overall cost of funding taking the costs of individual funding sources noted above, and weighting them by their share of total bank funding, provides an estimate of the overall change in the cost of funding banks ’ aggregate loan books. compared to mid 2007, the average cost of the major banks ’ funding is estimated to be about 120 – 130 basis points higher relative to the cash rate ( graph 7 ). most of the increase occurred during 2008 and early 2009 when the financial crisis was at its most intense. since the middle of 2011, however, there has been a further increase in banks ’ funding costs relative to the cash rate of the order of 20 – 25 basis points. the graph shows that a fairly large part of this increase comes from the pricing of deposits. graph 7 the increase in funding costs, relative to the cash rate, differs across institutions given differences in their funding compositions and the pricing of different liabilities. the available evidence suggests, for example, that the overall increase in the regional banks ’ funding costs since the onset of the financial crisis has been larger than that experienced, on average, by the major banks. this mainly reflects the larger increase in the cost of the regional banks ’ deposits and a more significant shift in their funding mix. banks ’ lending rates i have primarily focused on funding costs today, but in closing i will briefly touch on developments in lending rates. the bulletin article goes into this in more detail. the cost of funding is the most important factor that influences the lending rates banks set. but there are a number of other factors that affect pricing including : the credit risk associated bis central bankers ’ speeches with the various types of loans, the liquidity risk involved in funding long - term assets with short - term liabilities, and choices about growth strategies in different markets. for close to a decade prior to the global financial crisis, banks ’ overall cost of funds followed the cash rate closely, as risk premia in markets were low and stable. accordingly, interest rates on business and housing variable - rate loans tended to adjust in line with the cash rate. nevertheless, over this period there was a