Borrowers lose to retirees if banks don't pass on fall

Retirees stand to benefit if banks do not pass on the interest rate cut to mortgagees.

By InvestSMART · 8 Dec 2011

By InvestSMART ·
8 Dec 2011

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Retirees stand to benefit if banks do not pass on the interest rate cut to mortgagees.

RETIREES and savers with bank deposits stand to be surprise beneficiaries from any move by the big four banks not to pass on in full this week's 25 basis point cut in official interest rates to home mortgage holders.

As the banks continued their game of chicken last night, refusing to blink and reveal how much of the Reserve Bank's rate cut they would pass on to borrowers, analysts said one consequence of a reduced cut would be a transfer of wealth from mortgagees to retirees.

With offshore credit markets effectively shut due to the European debt crisis, home-grown deposits are becoming increasingly important to local banks as a source of funding. And to ensure access to the funds, banks will consider keeping some of the cut to borrowers to pay those with money to lend, analysts said.

''You're subsidising your grandparents' retirement,'' one analyst said. ''The banks aren't making any more money on their spread.

''All that's happening is if you're a borrower and want to borrow money, you've go to pay the people who have money. And the people who have the money are the retirees and the people who don't are the first home owners. It's nothing more than an intergenerational transfer.'' Analysts argue that the money raised by the banks from withholding some of the rate cut will not be going to their bottom line - but note that in using the money to offset the higher cost of funding it will protect their margins from contracting.

Another analyst said a deposit rate battle between the banks was on the cards, but noted that it might be relative given markets were expecting up to 125 basis points in rate cuts in the next year, meaning deposit rates would also tumble.

One analyst calculated that for every five basis points banks did not pass on to home owners from the rate cut, $400 million of the $1.2 trillion in mortgages in the banking system would be transferred from home owners via the banks to the providers of funds, increasingly deposit account holders.

Another calculated the five basis points that NAB did not pass on from the Melbourne Cup day rate cut were worth about $100 million to the bank.

Banks normally rush to cut interest rates on deposit accounts after a cut to official rates, but analysts expect to see a game of cat and mouse as they assess the value in keeping deposit rates higher.

Shane Oliver from AMP Capital called chances of the big banks passing on the full 25 basis points ''a big if''.

Australian Bankers Association chief executive Steven Munchenberg said: "It's not going to be a surprise to the RBA should one or more banks decide not to pass along the full rate cut. The RBA would have factored that in to their decision."

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Frequently Asked Questions about this Article…

Who benefits if banks don't pass on the RBA's 25 basis point interest rate cut in full?

According to analysts in the article, retirees and savers with bank deposit accounts stand to benefit if banks withhold part of the RBA's 25 basis point cut. By keeping deposit rates relatively higher while not fully reducing mortgage rates, banks effectively transfer income from mortgage borrowers to deposit holders.

Why might Australian banks choose not to pass the full interest rate cut to mortgage holders?

The article explains that with offshore credit markets constrained by the European debt crisis, Australian banks are relying more on domestic deposits for funding. Analysts say banks may keep some of the cut to pay depositors and protect their lending margins from contracting, rather than immediately passing the full reduction on to borrowers.

How does withholding part of a rate cut cause a transfer of wealth between borrowers and retirees?

Analysts described it as an intergenerational transfer: if banks do not pass on some of the interest rate cut to mortgage customers, the saved interest cost is effectively used to pay higher rates to depositors (often retirees). The article quotes an analyst saying 'You're subsidising your grandparents' retirement' to illustrate this shift.

How much money could be transferred if banks hold back small portions of a rate cut?

The article cites an analyst calculation that for every five basis points banks do not pass on to homeowners, about $400 million of the $1.2 trillion in mortgages in the banking system would be transferred from home owners to providers of funds (deposit account holders).

Are there real examples of banks keeping part of a rate cut? What happened with NAB?

Yes. The article notes one calculation that the five basis points NAB did not pass on after a previous rate move (Melbourne Cup day) were worth about $100 million to the bank, illustrating how even small gaps can add up.

Will deposit rates fall quickly after an official RBA rate cut?

Historically banks often rush to cut deposit rates after an official rate cut, but the article says analysts expect a 'game of cat and mouse' — banks may assess the value of keeping deposit rates higher to secure domestic funding. Also, markets expect multiple future rate cuts (up to 125 basis points over a year), which would put downward pressure on deposit rates over time.

What do major industry voices say about banks not passing on the rate cut?

Shane Oliver from AMP Capital called the chances of big banks passing on the full 25 basis points 'a big if.' Australian Bankers Association CEO Steven Munchenberg said it wouldn't surprise the RBA if one or more banks decided not to pass the full cut, and that the RBA would likely have factored that possibility into its decision.

As an everyday investor or saver, what should I watch for after an RBA rate cut?

Keep an eye on announcements from the big banks about how much of the official RBA cut they pass on to mortgage customers and what they do with deposit rates. Watch for changes in mortgage pricing, advertised term deposit and savings rates, and commentary from banks and analysts — small gaps (even a few basis points) can result in meaningful transfers between borrowers and savers.