Yesterday, soon after the RBA announced a cut in the cash rate, the big banks started to announce they would pass a portion of the 25 basis points to some mortgages, and also lift some term deposit rates. CBA and NAB were first off the rank, followed by ANZ and WBC. They would have pre-planned a response, by the way.
Lots has been written about how the banks are not passing the full rate on, but much of the discussion is ill informed. So we wanted to bring some perspective to the scene.
First, bank funding and the cash rate have become disconnected, such that changes to the cash rate do not mesh with the real-life treasury rates within the banks. This is partly because banks can access funding from several sources, including deposits, overseas capital markets, bonds and securitisation. You cannot assume an automatic cut in loan rates follows, just as you should not expect credit card rates (which have remained higher for longer) to follow. The RBA “rate lever”is actually quite weak – the dollar went up after!
There are a series of decisions which the banks take, weighing up funding, margin, profit and market/competition issues. They all do this independently, of course, but are functioning within the same market, and tend to act in similar ways – a sign of weak real competition, rather than collusion.
First we need to observe that the yield curve (a theoretical mapping of rates out over the next few years) is very, very low, thanks to an expectation of lower future rates, for longer.
Second, banks want deposits, because in the current uncertain international capital markets environment, they are local, and reliable. Some now have more than 60% of the book matched to deposits, much higher than pre-GFC.
Third, the regulators have been, and continue to push the banks to hold more capital, and capital costs.
Fourth, with demand easing for lending, and the battle centred on refinance and investment loans, banks are cutting their headline rates to get share, and in the process are cutting the once generous discounts from the headline rate.
Fifth, term deposits have a different impact on the bank’s balance sheet compared with call deposits, as a result of changes made last year to the liquidity rules and the upcoming Net Stable Funding rules.
Finally, we know that bad debts are rising, from mortgage defaults, especially in the mining centric states, from consumer debt, and from some corporates. We also know that major corporations are driving margins on their loans lower.
So, with all this in mind, they have to solve the complex equation.
First, they needed to give something to mortgage borrowers, it would be political dynamite not to do so. So they gave away about half the headline rate drop. Then they lifted term deposit rates, partly as a smokescreen, so they could argue they are sharing the gain. Actually, a quick calculation would show that in real dollar terms, giving away more on term deposits costs a lot less than cutting the mortgage rate further. So they can pocket the difference.
But next, for fixed rate mortgages, and term deposits, they are able to lock in generous margins, thanks to the shape of the yield curve. At a stroke, they are able to bolster and protect their absolute margins for the next 2-3 years. This double hedge means NIM is locked in to lift performance.
Some of this margin growth will be offset by the need to lift capital buffers, the rest is available for distribution, after offsetting rising losses, thus keeping dividend payouts in the target band, and so meet – especially investment managers – high expectations.
And there you have it.
