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 pump up their profit margins?
It appears the banks are using a lack of understanding about how monetary policy is implemented to charge mortgage borrowers more than their costs are actually rising.
In short, the Reserve Bank has made the cost, for the banks, of sourcing funds for their variable rate mortgage products more expensive.
What’s also true is that, as of right now, the banks have overstated what that cost is. Let me explain.
The RBA’s cash rate target
On Tuesday at 2:30pm eastern time, the Reserve Bank of Australia announced it was formally raising its cash rate target.
But it’s just that, a “target”.
The cash rate, on the other hand, is the interest rate on unsecured overnight loans between the banks. It’s an actual interest rate in use on financial markets. The higher it goes, the more it costs the commercial banks to borrow money in the very short term.
To be clear, the cash rate is different to the cash rate target.
And there’s one more rate to know about: the Bank Bill Swap Rate, or BBSW.
The RBA cash rate and the BBSW have, in the past, been highlight correlated – that is, they move proportionately to RBA policy changes.
But the RBA has pumped so much extra liquidity into the money markets it’s no longer reasonable to expect the central bank can have absolute control over the cash rate or the BBSW.
In the past, it would just say the “cash rate” is such and such (rather than having a “target”), because it knew it could move the rate in the market without any problem. And the BBSW would be roughly the same.
A Commonwealth Bank spokesperson told the ABC that the cash rate set by the RBA is “one factor that determines our interest rates”.
“We consider a number of factors when assessing our rates which may include the RBA cash rate, the competitive environment, funding costs and customer feedback,” they said.
Are the banks taking too much from you?
Before I go any further, I want to make something clear: Banks determine what your monthly mortgage repayment is using a variety of variables. It’s a mathematical model.
My point here is that one key ingredient in that model is open to exploitation – that is, the difference between the cash rate and the cash rate target, and the BBSW.
As of midday on May 6, the cash rate was sitting at 0.31 per cent and the BBSW (one month) was 0.275 per cent.
Both were below the RBA cash rate target of 0.35 per cent, after roughly 48 hours of market movements.
Crucially, the BBSW was 0.19 per cent on Monday and 0.09 per cent the previous Monday (April 25).
So the actual cost for the banks — in terms of the cost of sourcing short term money — has risen from 0.09 per cent, to 0.275 per cent (the rise in the BBSW rate). That’s a difference of 18.5 basis points.
Since the Reserve Bank made its interest rate announcement, every big four bank and other smaller banks have stated they will pass on the Reserve Bank’s increase in the cash rate “in full”.
In other words, they are each raising what they charge borrowers on their variable mortgage rate products by 0.25 percentage points or 25 basis points. That’s higher than the actual increase in the cost of funds which is 18.5 basis points.
It’s important to note here though that the cost for the banks doesn’t necessarily strictly go up by exactly 18.5 basis points and, importantly, that BBSW rate can change on a daily basis.
However, prima facie, the banks did not have to announce 0.25 percentage-point rate hikes, 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 response to this is, ‘C’mon, the difference is three basis points — or 0.03 of a percentage point’. That’s hardly anything 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 make up about 60 per cent of that total, or roughly $960 billion.
So, while a few basis points or a fraction of a percentage point may not sound like much, applied to hundreds of billions of dollars, it makes for a tidy extra profit.
Crucially, that tidy profit is at your expense.
“The banks would argue 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 rate cut, while when interest rates go up, they do,” says Impact Economics lead economist Angela Jackson.
“Households are right to question whether or not they are getting the best deal on their home loan.”
Rising mortgages undermine economic confidence
And there’s broader economic ramifications if the banks can get away with adding on a bit more profit at the expense of their mortgage customers.
The problem is that, according to ANZ Research’s latest check on consumer confidence, even the thought of higher interest rates saw consumer confidence plummet.
“The strong inflation result of 5.1 per cent year on year was likely the primary driver of the drop in confidence as it increases the prospect of interest rate hikes by the RBA in the near future,” ANZ’s head of Australian economics David Plank said on May 3.
“This is supported by the fact confidence dropped 9.6 per cent amongst people ‘paying off their home loan’, while for people who already own their home or are renting confidence dropped by 4.7 per cent and 4.2 per cent respectively.”
The bottom line is that the evidence shows Australians, and especially those with lots of debt, get very angsty when faced with the prospect of being charged more… for anything.
It’s why the hip pocket nerve has been such a strong election talking point — many households are already struggling to pay the bills.
And the hip pocket nerve pain is real.