The banks are not ripping mortgagees off: Bartholomeusz

The Reserve Bank’s detailed analysis of the impact of the global financial crisis on bank funding costs ought to be required reading for all bank-bashing politicians and shock jocks. The big banks may not be selfless, but the analysis provides no evidence of selfishness.

The RBA, after a detailed review of the various components of the banks’ funding bases and margins, concluded that the banks have actually cut their home loan rates by more than the reduction in their cost of funds and that, while the reduction in business loan rates was less than that for housing loans, their net interest margins had, overall, risen only slightly.

There are many misconceptions about the way banks are funded and more particularly of the relationship between their funding costs and the RBA’s cash rate.

That’s partly because the decade leading up to the crisis (a decade of financial stability and, for the banks, volume growth) was something of an aberration because the banks’ funding costs so closely tracked movements in the cash rate. The RBA says that hadn’t been the case in the past, where lending rates moved independently of the cash rate.

There is a lot of detail on the retail and wholesale element of the banks’ funding, and on how their costs have moved over the period since the crisis developed in 2007. The bottom line to that analysis, however, is that since the RBA started cutting official rates last September, the interest rate on the banks’ outstanding liabilities has fallen by an average of about 330 basis points, about 95 basis points less than the reduction in the cash rate over the period.

In other words, the movements in the cash rate aren’t a great indicator of what the banks pay, on average, for their funds.

They have, however, reduced their home loan rates by an average of 385 basis points since September. As the RBA says, this is less than the 425 basis point reduction in the cash rate, but more than the reduction in their own cost of funds: their margins on home loans have been compressed.

The rates on loans to small business have fallen a lot less than the rates on home loans (230 basis points), which reflect the quite rational re-pricing of risk that the banks have been imposing as the economic conditions have deteriorated.

While overall net interest margins rose by 9 basis points, to 2.27%, the RBA study says this is only a little above the pre-crisis levels.

A little more than a decade ago, the major banks’ margins were closer to 4% than 2%. Pre-crisis, they were being compressed at the rate of about 10 basis points a year, with the banks offsetting the impact with cost-cutting, volume and fee-income growth. The RBA says that trend of reducing margin started slowing in 2004, suggesting that it was coming to an end even before the crisis hit.

One issue identified by the RBA – and one which the majors have tried to educate their constituencies about – is that about a quarter of their funding comes from long-term debt raised in capital markets. As cheap pre-crisis debt matures, it has to be replaced by higher-cost funds, which means the average cost of that part of its funding will continue to rise for some time.

The RBA says that the overall average cost of the banks’ outstanding long-term debt is now about 90 basis points higher, relative to the market’s expectations for the cash rate, than it was pre-crisis. It says that if bond spreads and hedging costs remain where they now are the average spread on the banks’ outstanding long-term debt would rise by a further 40 basis points over the next 18 months, before stabilising.

The RBA analysis provides no support for some of the more hysterical (in both senses) things said and written in response to Commonwealth Bank’s decision to increase its variable home loan rates by 10 basis points and move from having the cheapest rate to having the equal cheapest rate at a point where home loan rates are at historically quite low levels.

More significantly, it highlights the fact that bank funding costs are now moving quite differently to the cash rate, which means everyone will have to get used to the new reality: that home loan and business loan rate movements aren’t going to be tied as directly to the RBA’s official rates, in the period ahead, as they have been in the past. That’s not a matter of the banks being selfish, or evidence of profiteering; it simply reflects the new post-crisis reality of their funding environment.

This article first appeared on Business Spectator