Why Aren’t the Banks Passing on the Full Rate Cut?

Once upon a time, mortgage holders relied on the monthly Reserve Bank of Australia (RBA) meeting to tell them whether or not their home loan interest rate would go up or down.

However, in recent years, financial lenders have made decisions independent of the RBA, frustrating many mortgage holders.

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Out of Cycle Interest Rate Cuts

A case in point is the ANZ Bank’s decision to move its rate decision out of the traditional cycle on the first Tuesday of the month to the second Friday of each month, clearly distancing its decision from the RBA’s.

According to ANZ’s website, the decision for the change of date stems from bank funding costs, which are “less directly related to movements in the RBA’s cash rate.” The site adds, “The price we pay for customer deposits and for the domestic and international wholesale funding that we rely on to continue to lend to customers, have become increasingly important since the GFC.”

Indeed, Australian banks source a fairly large proportion of their lending funds internationally from international wholesale markets and securitisation loans, leaving them vulnerable to overseas economic fluctuations and uncertainties. International wholesale capital markets purchase the mortgage debt from Australian lenders with the goal to receive the interest revenue from the loans. The Australian banks and lenders use the proceeds of the loan’s sale to provide additional loans to more borrowers.

What Leads The Banks Down This Road?

Since the GFC and the US sub-prime mortgage crisis, such international securitisation loans are no longer considered a safe investment and this has affected the way banks make decisions on their official mortgage interest rate. In order to fill the gap left open by risky securitisation loans, many banks and lenders turned to deposits. These deposits include term deposits, transaction accounts and savings accounts and in recent times banks have battled each other in an effort to secure such accounts from consumers.

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This explains why we have seen interest rates on savings accounts and term deposits skyrocket. Of course, this was great news for those with no mortgage and a bit of cash behind them, such as retirees, but there were two sides to the coin. Payment for the high interest rates on deposits needed to come from somewhere and many banks and lenders financed this cost by choosing to not pass on the full RBA rate cut to their home loan consumers.

In addition, just like we borrow from the banks, they themselves borrow from each other; and when there was a heighten risk of sovereign default (such as what has occurred post-GFC in Europe and the US), the default risk on the bank’s own borrowing capacity also rose. To compensate for this risk, the banks increase the interest rate they charge each other, which in turn limits their ability to move as freely as the RBA on rate cuts.

What Else is Having an Effect?

Changes to international banking regulations are also having an effect on lenders determining interest rates.  Financial institutions are now required to maintain additional capital reserves (i.e. funds to offset the risk of money being loaned out). This means lenders have to have huge amounts of capital on its books to satisfy the new regulations. This has put a strain on financial institutions raising capital, which has in turn increased costs that they pass on to the home loan borrower.

The Future Role of the RBA

So where does the RBA appear in all of this? Well, in terms of controlling interest rate movements in the financial sector – it doesn’t. In a world where banks source so much of their funding overseas rather than domestically, and the need to turn a profit in order to satisfy the bank’s shareholders, the declining power of the RBA to influence mortgage rates has become more evident.

That said, the RBA is still the bellwether for interest rates and even when financial lenders deviate from this benchmark, such as the case on Tuesday, when Westpac slashed its standard variable rate by 0.28 per cent immediately after the RBA lowered the official cash rate by 25 basis points. The banks are not deviating by much.