Of course we’ve now experienced the US sub prime credit crisis and the colapse of securitisation markets which is where non-bank lenders go to get the money they lend us. But the non-banks aren’t the only ones who raise funds through securitisation, the major banks (NAB, ANZ CBA Westpac, St George) have all used securitisation as a way to meet increased demand for credit.
The cost of funds in these types of markets has become much more expensive as investors seek higher returns because of the risk now associated with mortgage backed securities as a result of the sub prime fall out. This higher cost of funding is not just evident in the increase in our interest rates but also in the exit of lenders like Macquarie Mortages and the demise of RAMS.
Its for this reason that the banks have been saying they have to put their rates up independent of what the RBA is doing. Instead of moving in lock-step with the RBA as they have for years, a 25 basis point increase is passed on to customers as a 30 or 35 point increase and we all know that when the RBA has decided to sit tight, the banks have gone ahead with a 10 of 15 point increase of their own. They have done this for several months now. Overall the banks have rasied their rates by around a full one per cent (100 basis point) more than the RBA since August 2007.
Its been tough for some months and a long time since any of us enjoyed long term stability in interest rates let alone a cut. You may not remember but it was a way back in December 2001 when, as home owners with a mortgage, we were last able to celebrate a fall in interest rates. Back then the RBA cut rates by 25 basis points. This cut was more or less quickly passed on to customers by the banks and other lenders.
But now the mood is different – something has changed. The chief of the Reserve Bank has restated his optimism that Australia is winning the battle against inflation. Mr Stevens confirmed the view in the RBA's board minutes, released on Tuesday, that a slowdown had precluded the need for a further interest rate hike in the near term and, in response to this statement – “you shouldn't be waiting until it's really obvious that inflation has gone all the way back down…before you can conclude you've got to start doing something,'' – some commentators are even saying that rates will soon be falling.
"a slowing global economy will put a brake on inflation and usher in a 12-month period of cash rate reductions from 7.25 per cent to 6 per cent."
ANZ is about to undertake a review of its interest rate forecasts in response to Mr Stevens' comments and the growing signs of an economic slowdown. A spokesman for ANZ admitted there was now only "a slim chance" of its previous forecast of two more interest rate rises this year being proved correct. Of more interest is NAB’s assesment, forecasting an abrupt end to a six-year cycle of official rate increases in the first quarter of next year, when, it says, a slowing global economy will put a brake on inflation and usher in a 12-month period of cash rate reductions from the current 7.25 per cent to 6 per cent.
In this scenario will the banks pass on the lower rates and how quickly?
Speaking in Adelaide, CBA chief executive Ralph Norris has refused to rule out more rate hikes, independent of any Reserve Bank action. "Basically it depends on where pricing goes internationally. If rates continue to remain high, or increase, there is always a risk there will be further out-of-sequence increases."
This was the experience in the UK, where banks failed to ease the burden on borrowers despite official rates falling 75 basis points over six months. However, according to a NAB spokesman, the reason it occurred there was to offset higher credit costs, adding "it could happen here if the market continues to deteriorate". In Australia, though, the starting point is different. The banks have been pricing loans to reflect their higher cost of funds whereas the UK banks had no such opportunity to reprice their loans prior to the UK Central Bank lowering official rates in an attempt to stimulate a stagnant economy.
My view? In the absence of substantial competition, Australian banks will reluctantly pass on future cuts by the RBA as they attempt to re-establish the margins on home loans they enjoyed prior to the competition from non-banks. By this I mean they might pass on a 20 basis point reduction when the RBA cuts official rates by 25 points.
(References: The Australian, 17 July 2008; The Herald-Sun, 17 July 2008; Sydney Morning Herald, 17 July 2008)