IMF Warns Aussie Banks About Defaults

October 16, 2009

The International Monetary Fund (IMF) has injected fuel into the debate over the timing of the peak of banks' bad debts by warning Australian banks could lose $33 billion due to household and corporate defaults.

In two reports on Australasian banks' vulnerabilities, the world's financial system watchdog advocates both Australian and New Zealand banks undergo tougher stress tests to mitigate a potential surge in defaults and ensure they can roll-over short-term external debt.

A deterioration in Australian banks' asset quality since early 2008 shows corporate solvency risks have risen to the extent that expected corporate default losses could reach two per cent of gross domestic product (GDP) based on historical recovery rates of around 40 per cent, the IMF said.

Banks' losses could touch two per cent of total March 2009 loans, or $33 billion, the IMF's Elod Takats and Patrizia Tumbarello wrote in a report released on Thursday based on information available in July.

New Zealand's banks - most of whom are subsidiaries of Australia's big four - face mounting exposure to heavily indebted households whose assets have been hit by a slump in house and equity prices.

The risk of a spike in default rates in New Zealand has jumped over the last year, leading the IMF to recommend banks undergo "extreme" stress tests and increase their capital if needed.

Australian banks should also undergo more extreme stress test scenarios than previously applied by the Australian Prudential Regulation Authority, the watchdog said.

The IMF's comments support those of some local bank analysts suggesting bank share prices may have climbed too high because brokers have priced in a complete normalisation of margins and bad debt charges in 2010.

Credit Suisse's Damien Boey said on Monday history showed bad debt charges peakED a few quarters after nominal GDP started to recover off its lows.

Australian banks rely on domestic and offshore wholesale funding to fund around 50 per cent of their balance sheets, with about 60 per cent of this coming from offshore investors.

The IMF said total short-term external debt of all Australian financial institutions climbed to $400 billion, or a whopping 35 per cent of Australia's GDP, by March 2009 before the banks embarked on a pricing war to attract retail depositors.

"A key remaining vulnerability is the roll-over risk associated with sizable short-term external debt," it said.

But while the IMF's report acknowledges the difficulties faced by the big four banks in accessing offshore wholesale markets after Lehman Brothers' collapse in September 2008, it stops short of echoing comments in a book by Professor Ross Garnaut and David Llewellyn-Smith released last Monday that the big four banks were nearing insolvency.

The authors claim the big banks told the federal government last October that if it did not guarantee their foreign debts, they would not be able to roll it over as it became due.

"Some was due immediately, so they would have to begin withdrawing credit from Australian borrowers," they wrote.

"They would be insolvent sooner rather than later."

New Zealand's high current account deficit and short-term foreign debt levels means if 40 per cent of maturing debt, worth $NZ48 billion ($A38.7 billion), held by banks failed to be rolled over in 2009, a financing gap could arise, the IMF said.

"New Zealand banks have been relatively successful in rolling over offshore debt, but there are some signs of strain."