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

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.

By InvestSMART · 8 Dec 2011

By InvestSMART ·
8 Dec 2011

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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…

What happens if the big banks don’t pass on the full 25 basis point RBA interest rate cut to mortgage holders?

If banks withhold part of the 25 basis point official rate cut, analysts say the effect will be a transfer of wealth from mortgage holders to depositors — particularly retirees. Banks can use the withheld amount to help fund higher deposit rates or offset costly funding, protecting their margins rather than boosting profit, which means borrowers may see a smaller reduction in their mortgage rates than the RBA cut.

How does keeping part of a rate cut transfer money from homeowners to retirees and savers?

Banks that don’t pass on the full cut to home loan customers can retain that margin and use it to pay people who provide funding (depositors). Analysts in the article estimated that for every 5 basis points not passed on across about $1.2 trillion of mortgages, roughly $400 million would be shifted from home owners to holders of deposit accounts — a direct intergenerational transfer from borrowers to savers and retirees.

Why might banks decide not to pass the full rate cut on to borrowers right away?

The article explains that offshore credit markets are largely closed because of the European debt crisis, so Australian banks are relying more on domestic deposits for funding. To secure those funds and protect their interest margins against higher funding costs, banks may prefer to keep some of the rate cut rather than immediately lowering mortgage rates in full.

Does keeping part of the rate cut mean better returns for retirees and savers?

Potentially, yes. If banks hold deposit rates higher instead of cutting them in line with the RBA decision, savers and retirees could benefit in the short term. However, analysts note a coming trend of multiple rate cuts (markets were expecting up to 125 basis points over the year), so deposit rates are also likely to fall over time despite any short-term benefit.

How big is the effect on a bank if it withholds just a few basis points? Is there a real dollar example?

Analysts gave concrete estimates in the article: every 5 basis points not passed on across the $1.2 trillion mortgage book equates to about $400 million shifting to deposit holders. The article also noted a specific example where NAB’s decision not to pass 5 basis points after a prior cut was estimated to be worth about $100 million to the bank.

What do market commentators like AMP Capital say about whether banks will pass on the full rate cut?

Shane Oliver from AMP Capital described the likelihood of the big banks passing on the full 25 basis points as "a big if," suggesting analysts see it as uncertain that banks will immediately and fully pass the RBA’s cut to mortgage customers.

How did the Australian Bankers’ Association respond to the possibility of banks not passing on the full rate cut?

Australian Bankers Association CEO Steven Munchenberg said it wouldn’t surprise the RBA if one or more banks chose not to pass along the full rate cut, and he suggested the RBA would have taken that possibility into account when making its decision.

As an everyday investor, what should I watch for after an RBA rate cut and banks’ reactions to it?

Keep an eye on announcements from the big banks about how much of the RBA cut they will pass to variable mortgage rates and whether they adjust deposit rates. Watch commentary from analysts and industry bodies (for example NAB, AMP Capital and the Australian Bankers Association mentioned in the article), and monitor expectations for further RBA cuts — these factors will influence mortgage costs, deposit returns, and any potential wealth transfer between borrowers and savers.