He said the banking system could lose deposits in several ways. "One channel in recent quarters has been domestic fund managers allocating away from cash and deposits to other asset classes – particularly overseas assets," Mr Jolly said.

The funding retreat could force the banks to pay more to attract deposits from households and corporations or turn to money markets at a time when short-term interest rates have spiked to crisis-like levels.

The sharp rise in the bank bill swap rate has already forced the non-major banks such and Macquarie, AMP and Bendigo Bank to hit borrowers with mortgage rate hikes and prompted speculation that the major banks will be forced to follow. That could have consequences for the economy as more households are hit with higher borrowing costs.

Official data compiled by National Australia Bank shows that Australian-based managed funds are increasingly drawing down their cash balances as they divert funds from bank deposits and towards international assets.

In mid-2016 managed fund investments in cash, deposits and short-term securities of $325 billion were the equivalent to investments in overseas assets. Since then cash investments have risen modestly to $348 billion while overseas assets have shot up to to more than $475 billion.

Separate data from the Association of Superannuation Funds of Australia shows that large superannuation fund cash balances declined by $2 billion to $180 billion from March 2017 to March 2018 while investments in international shares increased by $57 billion to $396 billion.

The allocation of managed funds to cash and deposits has steadily fallen from 15 per cent in 2014 to 10 per cent in the first quarter of 2018. That level is close to an all-time low reached in 2007, just before the global financial crisis.


The decline in deposit growth highlights what is often considered the key weakness of Australia's financial system – a reliance on volatile capital markets to plug the funding gap between loans and savings.

Since the financial crisis, in which the reliance on wholesale funding was exposed, Australia's major banks have lifted their proportion of deposit funding from 50 per cent to decade highs of 65 per cent.

Analysts are becoming increasingly concerned that the banks are now lending money at a faster rate than they are able to gather deposits, increasing the call on the capital markets.

While official lending statistics show that the banks increased lending by 4.8 per cent over 12 months to May, deposits increased by just over 2 per cent, widening the funding gap. Household deposit growth was relatively stable at 5.6 per cent but financial and wholesale deposit growth, as measured by certificates of deposits, declined sharply over the period.

"So we have a picture of banks extending credit at roughly the same rate over the past year, but the slowdown in deposit growth has been much sharper," TD Securities senior interest rate strategist Prashant Newnaha said, declaring it a problem.

He added that the slowdown in deposit gathering, which began in June 2017, "has played a key role in the subsequent rise in cost of bank funding".


The banks faced two choices in response to slowing deposit growth – either lift deposit rates, or increase their use of the capital markets to meet demand for credit as their loan books have swelled to $2.6 trillion.

"Either measure should result in higher cost of bank funding," Mr Newnaha said.

The unusual increase in short-term funding costs is evident in a range of interest rate derivatives and money market rates.

The 90-day bank bill swap rate, which measures three-month cost of borrowing, increased to as high as 2.12 per cent last week. That rate is 60 basis points above the 1.5 per cent official cash rate setting, triple the typical premium of 20 basis points.

This is a problem for the banks because the higher short-term borrowing costs eat into their profit margins if lending rates remain unchanged.

The nation's smaller lenders, which are more sensitive to changes in short-term funding rates, have already responded by increasing mortgage rates by as much as 17 basis points.

Mr Newnaha also pointed to the fall in the household savings rate, which had reached as high as 10 per cent during the financial crisis but had declined to 2 per cent, as another reason to expect deposit growth to slow.


"The prospect of higher Australian mortgage rates, just as property price growth slows and moves into negative territory in certain areas, along with low wage growth means the Australian savings ratio is unlikely to turn higher any time soon."

In recent years Australian households have increasingly financed consumption by drawing on their savings.

"Now there is clear risk that a larger proportion of household income will be directed towards servicing higher mortgage repayments."