Friday, November 4, 2011

Banks Making Huge Profits; For Now

Did anyone else wonder how the large banks in New Zealand and Australia are reporting such huge profits? In a time of economic shrinkage and supposed debt deleveraging, banks are making money hand-over-fist.

How? Banks make money by selling money; loans and fees. They raise money and pay interest, cheaply, and you loan that money and pay the bank interest. Only you pay more interest to them than they pay to their lenders. The difference is profit. ANZ had $1 billion dollars of difference last year. Not bad, I wish I was a bank.

So who's still borrowing money from banks? People who are paying off existing mortgages, businesses who want to access short and long term funding and people using their credit cards, plus other methods.

At the moment, banks are making huge profits because they have increased their margins taking advantage of cheaper funding available to them off-shore. But this will not continue, neither will the ability for people here to borrow more money. Customers are deleveraging, paying back debt, which will impinge on future profits.

The concerning aspect of banking leverage here is the over-weighting of real estate perched on their balance sheets, and the continuing lending going on in that area. A large portion of bank funding is not going into building economic activity. It is still fueling the misguided dream that Mum and Dad investors have that their house is their nest-egg.

That house prices are dropping, both here and in Australia, there is no doubt. The unemployment rate in Australasia is still somewhat low and perhaps those with jobs have a bit of a 'head in sand' mentality, that all will be OK. The world's leaders will fix this debt problem. So there is still a steady stream of borrowers. But when the turmoil in Europe reaches a crescendo, this stream of borrowers will dry up.

I think, when that 'fly in the ointment', Greece, has a catastrophic default, interest rates will rise. Institutions will not want to lend as easily as before, even if they continue to get cheap money from their Central Banks. New Zealand banks raise around 30% of their funds overseas and will need to head there again, soon, to raise capital. Unlike China or Japan, we aren't great savers down here and rely on overseas markets to fill funding gaps.

The CEOs of ANZ and ASB said yesterday that their banks had very little exposure to Europe. So what does this mean? If European sovereigns go down or banks go bust, then ANZ will survive quite nicely? Can't see it myself. If their is no counter-party risk for Australasian banks to a large European default, then perhaps gold really is  large lump of metal and we should use it as a door stopper

In my opinion, when real estate bombs completely, when jobs dry up and when Sovereigns around the world default, where will the money come from to cover customers deposits? MF Global was caught using customers deposits to pay down bets they had on European debt. Illegal? Seems not. MF Global is bust, but the CEO is still in line for a $12 million bonus.

Can we still trust the old banking model?


Gold in New Zealand dollars: $2217.40 per oz
Previous all time high: $2284.16 per oz (19 Aug, 2011)

Silver in New Zealand dollars: $43.41 per oz
Previous all time high: $59.19
per oz (30 Apr, 2011)
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