The Australian Bankers’ Association (ABA) yesterday said that the current debate over bank interest margins and bank funding costs is missing much needed balance and accuracy.
It is important to note that, despite contrary assertions, bank interest margins remain at extremely low levels.
Graph 1 illustrates this point. The latest data (up to September ’08) shows that the overall margin between bank assets and liabilities is lower now than when the global financial crisis commenced in August 20071, although the margin has ticked up slightly.
While margins for various lending products and amongst institutions will inevitably vary, overall, the margin earned on total bank lending is still extremely low by historical standards.
Since the credit crisis commenced, banks have faced continual pressure on their cost of funds. The three sources of funding: deposits, short-term funding, and long-term funding have all contributed to this pressure, although short-term funding is starting to ease.
Deposit rates are still high relative to their historical trend, and long-term funding is still very expensive. This is a problem because as cheaper long-term funding sources reach maturity, they need to be replaced. But the replacement funds are typically much more expensive. This is continually pressuring margins.
Consumer’s perspective
Home mortgage rates are the lowest they have been in 44 years. For those people who have outstanding loan commitments, the recent interest rate reductions have provided unprecedented financial support. Coupled with lower petrol prices and direct government payments, household disposable income continues to grow at a solid pace.
Businesses have also benefited, with rates on products such as three-year fixed interest loans at their lowest levels on record.
The flip-side to near record low housing rates and lower business rates is, of course, lower ‘at call’ and ‘term’ deposit rates. However, the data shows how much competition has worked to hold up term deposit rates – to the benefit of savers.
Indeed, when compared to the standard funding benchmark – e.g. the 90-day Bank Bill Rate – term deposit rates are near record highs. This is demonstrated from Graph 22. It shows that the average term deposit rate compared to the bill rate is close to zero.
Perhaps even more instructive is the fact that banks are offering special rates well above the bill rate (also above the Reserve Bank cash rate). It is a rare situation that term deposit holders can get better interest rates (i.e. almost 70-100 basis points greater) than banks can get on funds borrowed from the short-term money market.
n recent weeks, one bank has been advertising a deposit rate of 5%. This is 200 basis points above the official cash rate of 3%. The ABA is unaware of any period in which deposit rates have exceeded cash rates to this extent.
Adequate margins and banks’ security
Another important issue that needs to be publicly debated is whether bank interest margins are currently too low and, if so, how high should they go. The commercial case for increasing bank margins is to bolster the banks’ financial strength and security in order to better weather difficult times. In other words, by strengthening a bank’s balance sheet, a bank is effectively taking out insurance so they can continue to operate normally in tough times.
This is not a theoretical or academic exercise. The social dislocation caused in the US, UK and Europe from having weak banks has highlighted the critical role that banks play in providing economic and social security.
Increasing lending margins is one means of strengthening a bank’s balance sheet, although it comes at a potential cost – the loss of market share. Another means of strengthening a balance sheet is to cut share dividends. A number of banks have recently announced plans to cut their dividend payments.
Increasing margins and cutting dividends are commercial decisions for individual banks. What is clear from Australian history is that the private sector has been better at running banks than have Australian governments.
It’s essential for banks to be profitable and to maintain their high credit ratings otherwise; their costs of funding will rise even more.
For further information:
Heather Wellard
Director, Public Relations
Phone: 02 8298 0411
Mobile: 0409 830 439
[1] The margin has actually decreased from the beginning of the crisis, from 2.12% to 2.08%
[2] The graph is taken from page 31 of the Reserve Bank’s March 2009 Financial Stability Review.
By The Australian Bankers’ Association
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