Banks have no justification for withholding rate cuts: Academic

Banks have no excuse in not passing on full RBA rate cuts, argues University of Canberra social researcher Josh Fear, who says the government should legislate to prevent “gouging”.

Fear says borrowers should expect banks to use a lot of complicated “jargon” to justify not passing on interest rate cuts in full. Earlier this month, ANZ said it would no longer make interest rate decision following RBA monetary policy announcement, the first bank to break with the timing of the central bank.

Writing for academic opinion site The Conversation, Fear reminded borrowers of “Westpac’s facile banana smoothie video” where it tried unsuccessfully to explain how the increase cost of wholesale funding (bananas) was pushing up the price of mortgages (banana smoothies) after the bank raised mortgage rates by 45 basis points in December 2009 following an RBA increase of just 25 basis points.

“When interest rates are going down, the world is suddenly a much more complicated place where simple explanations do not apply. Watch out for all sorts of jargon as banks try to obscure the real reason they do not pass on rate cuts in full,” he says.

According to Fear, the only way to stop banks using “cash rate movements as an excuse to gouge customers” would be for the government to step in and “stipulate that the interest rate margin is to remain constant over the life of the loan.

“[Banks] would need to make future expectations about interest rates clear at the outset – which would deliver greater competition in the mortgage market, which everyone (perhaps apart from the big four) agrees is a good thing.”

But Kevin Davis, research director for the Australian Centre for Financial Studies and professor of finance at the University of Melbourne disagrees, arguing that banks’ cost of funding isn’t directly related the level of the Reserve Bank’s cash rate because they get a fairly large proportion of their funding from international wholesale capital markets.

“They borrow for terms such as three years, which involves locking in a credit spread above risk-free rates. The interest rates they pay depends on what the market is willing to provide that funding at,” he says.

“At the moment European capital markets seem to have frozen, so to raise funding from those markets is going to involve quite a significant credit spread.”