The news came on Wednesday that Westpac was raising its standard variable home loan rate by 20 basis points. It had been expected and demonstrates yet again that when the choice comes between profits and customers, banks will always choose profits.
It takes a fair bit of gall for a bank to announce it will be forcing home owners to pay about $45 a month more on an average home loan of $350,000, at the same time it announces its profits rose 6% over the previous year.
But banks are not known for lacking gall.
On Wednesday, Westpac announced its standard variable home loan rate would rise from 5.48% to 5.68% and that its unaudited net profit for 2014-15 was $8,012m – up 6% on the previous year – and that cash earnings rose 3% to $7.82bn. It also announced that it was raising $3.5bn through a discounted share issue to shareholders, which was being done in order to boost its capital reserves.
Westpac’s reason for the increase in interest rates was put down to the increase in its capital reserves required under new regulations instituted by the financial regulator Apra. In July, Apra announced the banks needed to increase the amount of capital they held relative to their mortgage loans. The new regulations meant that “the average risk weight on Australian residential mortgage exposures will increase from approximately 16% to at least 25%”.
In effect this meant that banks need to hold more capital, which doesn’t bring in profit relative to loans, which do. The reason Apra brought in these new regulation is that loans are risky, and holding a higher ratio of capital in effect makes the banks safer should a housing collapse occur and suddenly they have a lot more dud loans on their books.
The recommendations for this came out of the Murray financial system inquiry and were first mooted late last year. And as soon as they were mooted, banks began saying it would lead to higher mortgage rates.
In November last year the former Westpac CEO, Gail Kelly, spoke to the cost of holding a greater share of capital that “either we price for that cost (ie take lower profits) or pass it on (ie to customers)”.
Well gee, what a tough choice for the bank. I am guessing they thought long and hard about what to do.
Westpac announced on Wednesday that that along with its 6% increase in profits, it was also passing on a final dividend of 94 cents a share – up 2 cents a share on last year. Thus rather than cut or keep dividends steady, it is passing the costs of the new regulations on to the customers through higher loan rates.
This is a big deal in the economy given Westpac is the second biggest home loan lender. And given the big four banks –Commonwealth, Westpac, ANZ and NAB – hold about 82% of all home loans held by banks, there is a very big chance the other three will follow:
One of the problems with our banking system is that the four very profitable banks absolutely dominate the market – and dominate it in a way they haven’t for a very long time:
The GFC saw the end of small lenders – destroyed by the massive explosion in short-term lending costs on overseas markets:
In the fallout, rather than support the small banks, the Rudd government allowed Westpac to buy St George, Bank of South Australia and RAMS; the Commonwealth Bank to buy BankWest and a third of Aussie Home Loans; and NAB to buy the mortgage broker Challenger.
It was a nice consolidation period for the big banks, and the government helpfully guaranteed deposits up to $1m for free and charged a sliding scale for deposits over that amount.
It made the banks a very safe place to keep your money during a pretty scary time.
Their funding costs certainly went up as the fight for banks to get the money via term deposits saw those interest rates rise well above the cash rate.
Before the GFC, banks got about 40% of their funding via domestic term deposits (ie Australians depositing money in banks which banks lent to other people), now it accounts for nearly 60%.
From 2010 through 2013 the cost of this funding was significantly higher than it had been prior to the GFC, but it has since fallen:
On the other side of the ledger, the sharp increase in funding costs during the GFC led to banks raising their mortgage rates by more than did the Reserve Bank, and then later not dropping them as much when the RBA began cutting:
Before the GFC the standard variable home loan was between 135 to 145 basis points higher than the cash rate. By the end of 2013 it was 305 basis points higher, and last month it was up to 325 points.
The rise by Westpac and the likely follow by other banks will widen this gap further.
And what this all means is that the gap between what banks give us for term deposits and what we pay them for a mortgage is now wider than it has been at any time this century:
Little wonder that despite the RBA cutting interest rates in the past year, Westpac was able to declare that its net interest margin was steady at 2.08%. It should be noted that Westpac also announced on Wednesday that it would raise the term deposit rate by 25 basis points.
But in the wash-up, what we have is banks passing on the costs of regulations to consumers – and blaming the government, even though the government has been extremely good for the banks over the past decade. The irony is that the new regulations will make the banks more secure and thus less of funding risk, which will in turn reduce their funding costs.
On a broader scale, the Westpac rate rise, plus other reductions in discount rates from other banks over the past few months, has in effect cancelled out the two RBA rate cuts. It has also increased the likelihood of the RBA cutting rates sooner should it believe the economy needs another push – Westpac’s move saw the likelihood of a rate cuts on Melbourne Cup day increase from 22% to 31%.
But regardless of rate cuts, be sure that the cost of any moves to make banks more secure – which will benefit not only them but the whole economy in the future – will be borne mostly by bank customers rather than bank shareholders.
