Puzzle Finance Blog

Banks prepared to face customer interest rate rage

A mortgage specialist is urging borrowers to hunt around for a better home loan deal if their lender does not pass on official interest rate cuts in full, as the banking industry tries to explain how rate decisions are made.

The Reserve Bank of Australia (RBA) holds its first board meeting of the year next Tuesday when a further cut in the central bank's 4.25 per cent cash rate is widely expected to be announced.

But the major banks have already warned that due to rising funding costs they may not be able to pass on any reduction in full.

"We understand that many people will be angry if banks do not pass on the full extent of RBA rate changes," the Australian Bankers' Association (ABA) chief executive Steven Munchenberg said in a statement on Thursday.

He said that for more than a decade the banks moved in step with the RBA, creating the reasonable expectation that cash rate changes were the only determining factor for lending rates, but the global financial crisis showed this was not the case.

"The RBA still influences short-term interest rates, but other factors, such as global uncertainty and strong demand for deposits, also affect what banks have to pay when they raise money," he said.

"For these reasons, the RBA cash rate is no longer an accurate indicator of banking funding costs."

He said of the three main sources of funds that are lent to customers, about 60 per cent are from bank deposits.

Twenty per cent comes from money borrowed by the bank for less than 12 months - from other banks, pension funds and Australian and overseas investors - and 20 per cent from money borrowed over a longer period, usually from foreign banks and investors.

"Australia's banks have to raise an important proportion of their funding from overseas," he said.

"The deep crisis in Europe means that the cost of borrowing money in those international markets has risen to levels seen during the global financial crisis. The RBA does not influence the price of money internationally."

Still, the more broader finance industry believes this will be a challenging time for borrowers, who face having to meet their current interest payments without any respite.

"This will please neither the Reserve Bank nor the federal government," Mortgage and Finance Association of Australia Phil Naylor said in a statement.

"The gauntlet will be thrown down to borrowers, who will need to assess their options and may be motivated to seek a better mortgage deal from another lender."

RateCity, a financial comparison website, said the good news was that many smaller lenders were more likely to pass on rate cuts and were already offering extremely attractive variable home loan rates.

"The savings required to offset any costs of switching are not great," RateCity CEO Damian Smith said.

He said a borrower paying the average mortgage rate of the big four banks - 7.3 per cent - would only have to achieve a new rate of 6.8 per cent to be better off inside eight months on a $400,000 loan - assuming switching costs of $1000.

Posted by Colin Brinsden- AAP Economics Correspondent (The Age) on 2nd February, 2012 | Comments | Trackbacks

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