When is an interest rate rise actually a cut? Craig Turnbull

GUEST OBSERVER

The question in the heading seems counter-intuitive – when is an interest rate rise actually a cut? The proper answer is – never.

But if you are Westpac bank and any of the other three on-looking major banks, your answer could be quite different.

Last week Westpac announced that interest rates for all loans will go up by 0.2% in November. This is despite the Reserve Bank continuing to hold the official interest rates at a steady 2% a few weeks ago at the October meeting and despite the billions of dollars of record profits our banks keep producing. This is not the first instance of banks making it up as they go along, moving rates as they see fit rather than as per economic policy.

The reason for the increase – the banks will tell you – is that the Australian Prudential Regulatory Authority (APRA), the body that regulates the banks, has imposed ever-tighter restrictions on the amounts banks can lend, by demanding an increase in the amount of capital that banks must hold as cash reserves. APRA has also placed limits on the amount of investor lending growth.

The banks have to have a certain percentage of capital on hand versus the amount of money they have loaned out, at all times. When The Reserve Bank and APRA want to speed up the economy and get “money” in to circulation, they will lower the percentage required to be held, which means more “money” can be loaned. Conversely, when they want to slow an economy or restrict the amount of lending, they will increase the amount of capital needed to be held in cash, so less “money” can be loaned.

It is a very fine line being walked here – APRA and The Reserve Bank want to slow the housing market in Australia (Sydney actually) but don’t want to further increase interest rates in to a slow post-mining boom economy. They need housing to generate jobs and growth – so lower interest rates is better, but they don’t want housing prices spiraling out of control. So their answer is to make it harder for banks to lend to housing, particularly for investors who are being blamed for the increasing prices. They have done this by effectively limiting the amount that banks can lend for investment housing and making the banks hold more capital in reserve.

In August, CBA and ANZ raised a total of $8 Billion in a week. NAB announced a rights issue for $5.5Billion, while Westpac has so far chosen to increase its reserves by using dividend reinvestment schemes.

So why did Westpac raise their rates for borrowers? Because at the same time they have increased the rates they will pay to depositors by 0.25%. The banks will assert that in doing so, their 0.2% interest rate rise to borrowers is actually a cut overall, because they will now pay savers more.

Westpac reasons that savers will flock to the higher deposit rates being paid for their cash and the result will be that Westpac will hold more capital in their vaults. Only they clearly think that the cost of this capital is less than the cost of alternate ways of raising capital.

And it clearly is. Why? Because Westpac’s borrowers are being forced to pay for the capital through an interest rate increase, which is otherwise unnecessary.  Westpac doesn’t need to pay interest on capital borrowed or dividends on new shares issued. Quite clever actually.

Though I wonder if Westpac’s customers will let them get away with it?

I suspect they will, but that is because I expect that the other major banks are carefully examining Westpac’s move to have the borrowers pay for the extra capital they need. And I believe that in the next few days or weeks we may well see more similar announcements as one big bank follows the other.

So what does this mean for you?

It is quite simple. I think we are going to see another 0.25% to 0.5% interest rate cut over the next few months. But real estate investors like you and me are not going to see those reductions. They won’t be passed on, with the banks citing higher costs of capital as the reason.

For that reason, I feel that this we are probably at the lowest point in the interest rate cycle for real estate investors. I intend to examine my loan portfolio and see where adjustments to fixed rates from variable can be made. Though I don’t think I will need to hurry on this as I can’t see rates rising over the next six to twelve months.

I suggest you have a conversation with your financial planner or finance broker for a review of your own loan portfolio. At some point (official) rates will rise again and clearly it would be better to have locked in lower rates for as long as is possible, before those rates begin to rise.

Timing is everything.

Craig Turnbull is an author, property developer and real estate investor. He can be contacted here.