RDP 2019-09: Australian Money Market Divergence: Arbitrage Opportunity or Illusion? 7. Conclusion

Opportunities to arbitrage across Australian money markets have seemingly widened and remained persistent in recent years. However, using a broad and comprehensive methodology for evaluating such opportunities indicates that arbitrage trades would have generally been unprofitable for major Australian banks. Once asset-specific funding costs are taken into account, or if money market desks are self-funded, profit opportunities are less apparent. An increase in debt funding costs relative to the cash rate has been a significant driver in reducing profitability of money market trades. A higher proportion of equity funding (which is more costly than debt) has also been a factor. Furthermore, there is a significant opportunity cost involved in undertaking money market trades when compared with higher-return business activities, such as lending for residential housing. This is reflected in the large share of mortgage and commercial loans that characterises the balance sheets of the major banks.

Consequently, money market rates may continue to diverge unless arbitrage becomes more profitable for banks, or non-bank participants replace banks as the principal arbitrageurs in these markets.