Why banks are splitting the difference on rates

The big four’s response on interest rates reflects the tide of extra regulation flowing towards them.

The alacrity with which Commonwealth Bank responded to the Reserve Bank’s latest rate cut, and the nature of the response, underscores the tensions generated by the interactions between the new framework for bank prudential regulation and monetary policy.

The RBA cut the cash rate by 25 basis points to 1.50 per cent. CBA responded by cutting the pricing of its standard variable rate mortgages by 13 basis points, to 5.22 per cent. National Australia Bank followed soon after with a 10 basis point reduction in its standard home loan rate, to 5.25 per cent.

CBA, however, also announced that it was lifting two and three-year term deposit rates by 55 basis points, to 3 per cent, and both two and three-year rates by 50 basis points to 3.1 per cent and 3.2 per cent respectively. NAB lifted the rate on its eight month term deposits by 85 basis points to 2.9 per cent. ANZ followed later in the day, dropping its home loan rate 12 basis points while raising its term deposit rates to levels comparable with CBA. Westpac likewise has lifted its one-year and three-year deposit rates by 0.55 per cent and its two-year by 0.45 per cent.

While movements in official interest rates always tend to be seen through the lens of homeowners or aspiring buyers, the other affected parties — savers — tend to be overlooked. As rates have been progressively lowered to record low levels in the post-crisis era, borrowers have been rewarded and savers punished.

The standard variable rates CBA and NAB and their peers are reducing in response to the RBA decision are, of course, “rack’’ rates and competition for new loans tends (or to retain customers) tends to be at levels below the standard products advertised. Thus, the extent to which the banks might appear to be holding back, or passing on to depositors, some of the RBA reduction could be exaggerated.

While it is tempting to see rate movements and the way banks apportion them between borrowers and savers as a binary issue it isn’t, however, that straightforward.

There little doubt that in deciding to split the benefit of the rate cut between borrowers and depositors, the banks are reflecting the impact of the tide of regulation flowing towards them in the post-crisis era. Among them are a net stable funding ratio (NSFR) and a liquidity coverage ratio.

The NSFR requires them to hold a minimum level of stable funding in the form of customer deposits; the liquidity coverage ratio forces them to hold more and higher-quality liquidity.

A major challenge for the banks is to attract and retain customer deposits in an environment where the effective after-tax rates on offer are negligible.

There is a point, which we have just have reached, where they have to ensure their pricing doesn’t force those with their savings in term deposits to accept more risk for more return elsewhere.

The liquidity coverage ratio and the impact of the dramatic fall in rates on the banks’ holdings of high-quality liquidity and of non-interest-bearing liabilities — the cash sitting in what used to be called cheque accounts — means they are also trying to manage quite material amounts of liabilities that generate very low returns in the current environment.

Within the way the banks are pricing the RBA’s latest cut and apportioning benefit to both borrowers and savers, there might be a few basis points left over for their net interest margins and therefore for their shareholders to marginally offset the impact of the wider rate and economic environment.

It has been very evident in the performance of European and Japanese banks that low-rate policies (in their cases negative official rates) suck profitability from the banks and undermine their ability and willingness to lend and help generate economic growth. It doesn’t do much for their ability to raise capital under pressure either.

Mind you, with domestic business credit growth negative in June and relatively modest growth in lending for housing, there is an emerging weakness in demand for credit anyway.

The RBA is unlikely to be fussed about the way the banks are apportioning the rate cut, given that the only pause for thought the central bank might have had would have been its potential to reignite a housing market where, largely due to a tightening of prudential standards, the rate of lending growth is tapering and prices are growing more slowly.

If some of the benefit of lower rates were directed towards an already competitive market for business lending, helping SME cash flows, it would probably be delighted.

CBA said today it would shave 13 basis points off business customers’ variable rate cash products but there is a pre-existing battle going on between the majors for business customers and whatever growth in business lending there might be.

The obvious target of the latest (and previous) cuts is the Australian dollar, which has remained (from the RBA’s perspective) stubbornly high and was threatening to rise further as the prospect of a US rate rise this year has kept receding.

The low inflation number last week — the lowest since 1999 — would have been the final green light the RBA was looking for before pressing ahead with the latest cut.