The choice was simple - either stop lending, or raise interest rates.
ALL those contributing to the current mania around increasing mortgage rates would benefit from a history lesson.
Until the early 1980s, banks in Australia operated in an environment subject to government-imposed interest rates. This regulation, unfortunately, often had the impact of restricting credit, stifling the growth of banks and the economy, and preventing innovation that could assist consumers and business.
To its credit, the Hawke-Keating government adopted a floating exchange rate, the entrance of foreign banks and the dismantling of regulated interest rates. The results of deregulation have benefited the community. Australia has a banking system that is safe, sophisticated and convenient. If one uses interest margins earned by banks as a proxy for cost, there has been improvement. In 1980, the average interest margin earned by banks was 5 per cent, today it sits around 2.2 per cent.
Fees have increased, but so have the number of services that banks offer, with the exception of banking for rural and regional communities. If deregulation has delivered all that, why are many voices railing against one of its core tenets - allowing banks to set interest rates on loans? To some degree it is an accident of history driven by the emergence of the securitisation market and non-bank providers of home loans. Because these providers were free of the cross-subsidisation that banks had embedded in their businesses, they could charge a lower margin. Banks were forced to drop loan rates to meet this challenge.
Additionally, the bonds issued by non-bank lenders priced at a margin (or risk premium) above the 30-day bank bill rate. That risk premium was around 30 basis points so their funding rate was never going to be very different from the RBA official cash rate. Subsequently, the market moved to changing home loan rates as the RBA rate changed and a false nexus was established between cash and home loan rates.
Liquidity is the key to the solvency of any organisation that lends. To ensure liquidity, an organisation must have more assets (loans and investments) available for sale than it has liabilities (wholesale bonds and deposits) maturing. Banks deal with this by holding liquidity portfolios and operating funding programs that see liabilities maturing over long timeframes.
The latter point means that the cost of funds for banks is different to the RBA cash rate. This is true for two reasons:
?The natural structure of interest rates in a growing economy means risk-free rates are higher for longer maturities.
?Depositors and bond holders require a higher risk premium the longer the term of their investment.
For my bank, the premium we pay to raise term deposits has gone from about 0.5 per cent below the bank bill rate pre-GFC to as much as 1.3 per cent above today. We have already told the market that our first-half profit for this year will be flat as a result. A bank's role can be distilled down to standing between those who have more money than opportunities to invest, and those with more opportunity than money. Banks take on the credit risk of the borrower and manage the maturity mismatch between investors and borrowers.
To do this, banks require capital and, to get capital, banks must be profitable. With housing loan rates priced where they were before last Friday, banks were making no money from those loans, bringing into question the sustainability of the role. Banks faced a choice: increase rates or stop lending, and the second option would be far worse for all.
Rates have been increased - ours by 15 basis points - to reflect the true cost of funds for banks. It makes sense for the banks, for their stakeholders (customers, partners, staff and shareholders) but, most importantly, it makes sense for the economy as a whole. Underpricing risk was the principal cause of the GFC and the effects of that, as seen in countries with weak banking systems, are dire.
So why the outcry? Everyone can understand why borrowers are upset, and fair enough. They now must pay a little extra - but, in the main, they are still being charged less than when they took their loan out. And the media? I am seeing a little more balance in their reporting, led by those journalists who understand what makes economies strong.
There are, of course, the usual emotive commentaries on all this. It needs to be more balanced in my view. And finally, what about politicians? They are all well educated, and smart enough to understand the veracity of what I have outlined. Understandably, though, they see no votes in supporting increases in the home loan rates of their constituents. Their depositor and superannuant electors would have a different view I'm guessing.
Mike Hirst is managing director of Bendigo and Adelaide Bank.