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BFCSA: RBA running out of options, and the banks aren’t helping

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RBA running out of options, and the banks aren’t helping

The Australian 12:00am May 13, 2019

Michael Roddan


Not content with a record run of inaction on official interest rates now stretching to 30 months, the Reserve Bank last week made an unusual plea to the banking sector, asking the lenders to do the central bank’s job for it.

With the economy slowing — there was next to no growth over the second half of 2018 and all indicators are pointing towards a tougher first quarter — discussion has rightly turned to how the RBA plans to counteract stalled household spending and slowing credit growth.

The cash rate has been on hold at a record low of 1.5 per cent since 2016 and, amid the gloomy economic outlook, financial markets are now pricing in two cuts by the end of the year — a projection the RBA acknowledged it has now factored into its own economic forecasts, which were downgraded on Friday.

With so little firepower left at its disposal to help stimulate economic activity, the RBA is evidently reluctant to cut interest rates further.

In a statement after last Tuesday’s board meeting, RBA governor Philip Lowe made a not-so-veiled plea to the banking sector to lend a hand in relaxing financial conditions.

Yesterday Scott Morrison announced the latest move to get banks lending again with a pledge that the federal government would make up the difference for borrowers who couldn’t save a full deposit.

It comes on top of efforts to bring down sky-high interest rates for farmers and small businesses borrowers with a suite of government supports for a lending sector that already benefits from a significant amount of public protection.

Last week Dr Lowe noted long-term bond yields were at historically low levels, short-term bank funding costs had “declined further” and “some lending rates have declined recently, although the average mortgage rate paid is unchanged”.

The otherwise innocuous comment appears to be an attempt at jawboning the major banks — Commonwealth Bank, Westpac, ANZ and National Australia Bank — to stop putting profit growth before the health of the economy.

While the market may be interested in the next move of the RBA, it seems the central bank is more preoccupied with the companies that control 80 per cent of the local mortgage market.

Despite lowering the cash rate to a record low, the banking sector has for years stifled the transmission of the RBA’s monetary policy by failing to pass on the savings to customers.

Before the global financial crisis, the difference between the RBA cash rate and what the banks charged borrowers was a margin of less than 2 per cent. Since 2008, that profit margin has progressively increased and now sits at close to 4 per cent.

The same has happened to small business borrowers. In 2007 the margin for small businesses was about 200 basis points. From 2008, this blew out to around 400 basis points and remained there.

Just days before the RBA board meeting, as ANZ announced a $3.5 billion profit for the first six months of the year, the bank’s chief executive Shayne Elliott said perhaps the RBA should further reduce official rates to give borrowers “breathing space” to make their mortgage repayments and to “give a bit of juice into the economy”. As the boss of the country’s third-largest lender, he already has the power to do this himself.

Indeed, there is good reason for the sector lowering rates sooner rather than later. While some bank funding costs are tied to the RBA cash rate, they are also highly dependent on rates in the short-term money market.

But here short-term interest rates have tumbled to their lowest point since 2017 — before the banking royal commission began.

Short-term funding rates rose during Kenneth Hayne’s banking inquisition and stayed higher for the course of the one-year royal commission.

This prompted ANZ, CBA, Westpac and NAB to lift mortgage rates by between 12 and 16 basis points during the inquiry.

Curiously, now that short-term rates have tumbled, there hasn’t been a comparable adjustment to ease the squeeze on borrowers.

At the same time rates for long-term funding — a significant driver of overall bank funding costs — have also fallen, mostly as the outlook for global interest rates has turned lower on a benign inflation outlook.

Maybe it’s not so curious. As Swinburne University’s Professor Abbas Valadkhani has found, the banking sector will pass on only about 85 per cent of each RBA rate cut to borrowers.

When the central bank hikes rates, banks will over-egg the increase and pass on 120 per cent of the costs to customers.

The sector’s stifling of the RBA’s only tool to manage financial conditions — the cash rate — has also intensified since the global financial crisis, despite the increased importance of transmitting easier or tighter financial conditions into the economy. Prior to 2008, it took the banking sector just a week to respond to an RBA rate change. After the global financial crisis, that blew out to 2.4 weeks.

Former chair of the House of Representatives economic committee, Liberal MP David Coleman, found that since the turn of the millennium, the banking sector had made 19 changes to interest rates when the RBA had not made a decision.

As luck would have it, 18 of those changes were detrimental to consumers, leaving mortgage rates 2 per cent higher than they would otherwise have been.

Dr Lowe’s belated request to the sector to lend a hand revealed the starkly different approach taken by the RBA and its counterpart across the ditch.

Last week the Reserve Bank of New Zealand cut its official interest rate and RBNZ Governor Adrian Orr said it was “much better for monetary policy just to get on with its job” and cut rates rather than waiting for further evidence of weak economic activity.

While not content to sit on his hands, Orr has also been far more critical of the excesses of the banking sector.

When he announced plans to tackle taxpayer subsidies for the banking sector, Orr called out the high profitability of the New Zealand banks. Unluckily for the Kiwis, the Australian banking oligopoly also controls the market in New Zealand.

“The return on equity for banking is incredibly strong and we would even hazard to say over and above the risks they are holding themselves as private banks. There is an aspect in most OECD countries of the ability to free-ride — where returns can be privatised and losses can be socialised,” Orr said.

The closest Lowe has come to this sort of jawboning was in February, when he questioned how profitable the banking sector was compared to international peers.

“I don’t know how long that’s sustainable,” he said.

Putting people before profits won’t come easy for the banks, even when the economy is struggling. Over last month’s reporting season, the major banks’ first-half profits were a combined 4 per cent weaker than in the same period last year.

While credit growth has slowed to record lows — partly because interest rates are too high and loan applications are increasingly rigorous — profits have taken a hit from billion-dollar remediation and compensation programs for conduct issues related to the royal commission.

The banking sector’s huge profits have long been supported by interest rate gouging and other misdemeanours.

With generous shareholder dividends coming under increasing pressure to be lower, it’s difficult to see just why the big banks would start listening to the RBA now.



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