Your bank could raise its interest rate more than necessary. here’s why
Amid real cost of living pressures, how would you feel if you knew the big four banks were raising the cost of your mortgage to increase their profit margins?
It appears banks are using a lack of understanding of how monetary policy is implemented to charge mortgage borrowers more than their costs are actually increasing.
In short, the Reserve Bank has made the cost to banks of raising funds for their variable rate mortgage products more expensive.
What is also true is that currently the banks have overestimated this cost. Let me explain.
The RBA cash rate target
At 2:30 p.m. EST on Tuesday, the Reserve Bank of Australia announced that it was officially raising its cash rate target.
But that’s just that, a “target”.
Cash rate, on the other hand, is the interest rate on unsecured overnight loans between banks. It is a real interest rate in use on the financial markets. The higher it is, the more it costs commercial banks to borrow money at very short notice.
To be clear, the cash rate is different from the target cash rate.
And there is another rate to know: the Bank Bill Swap Rate, or BBSW.
The RBA cash rate and the BBSW have historically been highly correlated, i.e. they move in proportion to changes in RBA policy.
But the RBA has pumped so much extra liquidity into the money markets that it is no longer reasonable to expect the central bank to be able to have absolute control over the cash rate or the BBSW.
In the past, he would simply say that the “spot rate” is so-and-so (rather than having a “target”), because he knew he could vary the rate in the market without any problems. And the BBSW would be about the same.
A Commonwealth Bank spokesperson told the ABC that the cash rate set by the RBA is “a factor that determines our interest rates”.
“We consider a number of factors when evaluating our rates, which may include RBA cash rate, competitive environment, financing costs and customer feedback,” they said.
Are the banks taking too much from you?
Before I go any further, I want to clarify something: banks determine the amount of your monthly mortgage payment using various variables. It is a mathematical model.
What I mean here is that a key ingredient of this model is open to exploitation – that is, the difference between the cash rate and the target cash rate, and the BBSW.
At noon on May 6, the spot rate was 0.31% and the BBSW (one month) was 0.275%.
Both were below the RBA’s cash rate target of 0.35%, after around 48 hours of market movements.
Above all, the BBSW was 0.19% on Monday and 0.09% the previous Monday (April 25).
Thus, the real cost to banks – in terms of the cost of short-term money supply – rose from 0.09% to 0.275% (the rise in the BBSW rate). That’s a difference of 18.5 basis points.
Since the Reserve Bank made its interest rate announcement, all of the Big Four and other smaller banks have said they will pass on the Reserve Bank’s interest rate hike “in full.”
In other words, they each increase by 0.25 percentage points or 25 basis points what they charge borrowers on their variable mortgage rate products. This is more than the actual increase in the cost of funds which is 18.5 basis points.
It is important to note here however that the cost to banks does not necessarily increase strictly by exactly 18.5 basis points and, importantly, that the BBSW rate can change daily.
However, on the face of it, banks didn’t have to announce rate hikes of 0.25 percentage points, says BetaShares chief economist David Bassanese.
“You could say they’re looking for a cheeky margin expansion there,” he says. ” And why not ? If they can get away with it, good luck to them.
Of course, another obvious answer to that is, “Come on, the difference is three basis points – or 0.03 percentage points.” There is practically nothing to worry about!
It adds up fast
However, combined, the big four banks have more than $1.5 trillion worth of mortgages on their books. Variable-rate mortgages account for about 60% of that total, or about $960 billion.
So while a few basis points or a fraction of a percentage point might not seem like a lot, applied to hundreds of billions of dollars, it’s a nice extra profit.
Basically, this net profit is at your expense.
“Banks would say they need to maintain their profit margins and profitability. However, what we tend to see is that when interest rates go down, they don’t tend to pass on the full rates fall, whereas when interest rates rise, they do,” says Angela Jackson, chief economist at Impact Economics.
“Households are right to wonder whether or not they are getting the best deal on their home loan.”
Rising mortgage lending undermines economic confidence
And there are wider economic ramifications if banks can get away with adding a little more profit at the expense of their mortgage customers.
The problem is that, according to ANZ Research’s latest consumer confidence survey, even the thought of higher interest rates has caused consumer confidence to plummet.
“Strong inflation of 5.1% year-on-year was likely the main driver of declining confidence as it raises the prospect of interest rate hikes by the RBA in the near future,” said May. ANZ’s head of Australian economy, David Plank. 3.
“This is supported by the fact that trust fell by 9.6% among people ‘paying down their mortgage’, while for people who already own their home or are renting, trust fell by 4.7% and 4.2% respectively.”
The bottom line is that evidence shows that Australians, and particularly those with a lot of debt, become very anxious when faced with the prospect of being charged more… for anything.
That’s why the hip pocket nerf has been such a strong electoral talking point – many households are already struggling to pay the bills.
And the hip pouch nerve pain is real.