This is a question that is asked of us by every client. The answer – as of this moment – they already have. In case you’ve been incommunicado two of our major banks announced increases to their interest rates during the week. There is now acceptance the other two will follow.
Why? I hear you scream in your coffee. Sure, the banks in question have announced an increase in their funding costs – due mainly to them paying higher than the cash rates for term deposits as well as the increase in rates by the US Federal Reserve (all four of our major banks raise funds offshore) – but this isn’t the whole reason.
Usually, the best time for the banks to raise rates is when the RBA cuts rates. They usually choose not to pass on the entire rate cut. Our banks are now of a mind that the cutting cycle must have run its course so they’re getting ahead of the game by raising rates before the RBA does (oh, they’ll pass on those rate rises as well).
The reason banks do this is to improve something called their Net Interest Margin (or NIM). This is the difference between the interest rate banks borrow and lend. It is the starting point of calculating their profitability. It’s a biggie. So, if you’re a shareholder of bank shares you should be rejoicing. If you’re a borrower, not so much.
We’ve had a few inquiries from potential borrowers who’ve been so peeved that they want to change banks. We’ve asked them to hold off for now until the others also raise their rates and if they still feel the same way, we’re happy to help. Some customers are shocked – no, not by a broker knocking back business – but to be informed that the other banks may also be contemplating a similar move.
They kinda have to. They all borrow from similar markets and have to be competitive in paying term deposits. But they also compete for equity – from shareholders – you know, the guys they pay dividends to. Dividends are paid from profits and NIM (see above) is the biggest factor in a bank’s profitability. So, if two banks are able to pay higher dividends to attract equity guess what the other two are going to do?
There is a clear danger with out-of-cycle rate increases. The RBA is a government authority. When the RBA moves interest rates it is for the good of the economy. So, if the RBA decides to move rates to rein in an out of control economy (not a problem yet) it will do so to curb lending. This is the lifeblood of business. The RBA can quickly respond if/when the economy responds.
Banks are businesses. They have no such responsibility. In theory, they can raise rates until people go broke. The only thing that stops them doing so is competition. But when they all follow one another, it is the role of Government to ensure that there is no collusion or signaling going on.
My view is that our major banks are not stupid. They’ll know how far to push this particular envelope. Otherwise the Government may be forced to cap out-of-cycle rate rises. If you think a cap on rates is far-fetched, then you haven’t been around long enough. In fact, there is a school of thought that reckons the banks are being asked to raise rates by the regulator to control the housing markets of Sydney and Melbourne. I’m not too sure about this but it makes better sense than if the RBA raised rates across the board. It also takes the pressure off the RBA as it is targeted precisely at the segment of the economy that the RBA wants to target without it affecting other lending markets.
So, to answer the question in the title of the article. They have and will probably continue to do so. That’s what usually happens after they’ve fallen for so long. That is a good thing for all of us. It is usually the sign of a strengthening economy – so it probably means that wages may (at last) go up so you may actually be able to afford the rate rises.
Please note that the writer is not an economist and the information contained in this article is anecdotal gathered from newspaper articles, economists and our clients.