Get the best rate on your term deposit

According to the statistics, the bulk of Australian investors’ deposits sit with the big four banks; we’ve driven up their share prices to near, or past, record highs; and we lap up their hybrid issues.

Our media and politicians may attack the ‘big bad banks’ but investors, it seems, love them. They even donate generously to the cause.

If you’ve got, say, $100,000 in a term deposit with a big four bank you’re paying about $500 per annum (or more) for the pleasure. Let’s explain why.

Background

Banks in Australia are governed by the Banking Act and regulated by APRA (Australian Prudential Regulation Authority). This applies to all banks – big or small, local or foreign owned. The complete list can be found on APRA’s website.

One of the key roles of the Banking Act and APRA is to protect depositors from loss. The present Government weakened the protection slightly in 2011 – by allowing banks to issue covered bonds – but deposits still get special treatment as ‘protected accounts’.

In essence this means that, except for covered bond investors, they’re repaid first if a bank strikes trouble.

They also get the Government Guarantee, introduced in 2008 and amended in 2012. The current basic rule is that each investor gets up to $250,000 guaranteed by the Federal Government at each institution (refer details here).

Whether your account is with good old CommBank, with its AA- credit rating, or Investec – the local subsidiary of a BBB- rated South African bank – the AAA rated Federal Government is on the hook^[i].

What does this mean for investors?

You need to be comfortable that a Hugo Chavez isn’t going to get control of the Australian parliament and negate the guarantee, or a similar left-field event – which we think is a reasonable assumption. Besides, even a CommBank deposit might not survive that type of event.

Since risk is a level playing field, your chief consideration should be price. Customer service matters a little, but remember we’re talking about banks!

On price, the big four consistently lag behind (leaving aside NAB’s online offshoot UBank). Table 1 compares the best rates shown on www.infochoice.com with those offered by the big four banks. Occasionally the big four offer up a generous special – for instance, Westpac’s 8% pa for 5 years, in 2009 – but they’re rarely at the top.

Why? Because it’s much easier for a CommBank or Westpac to raise wholesale funding than an Investec, or even Bank of Queensland. Plus the big four have got lots of customers and a whole lot of inertia on their side. Many investors just roll their term deposits into the best rate offered by the same bank, instead of looking outside it.

All of this means the big banks can raise deposit money without trying too hard. The Reserve Bank data shows this effect clearly.

Despite offering lower rates, the big four banks hold almost $500bn in household deposits. Rabo and ING – both highly rated global institutions – hold just over $20bn between them.

Astute investors should always be on the lookout for situations where the market has got it wrong. When ANZ can take 5-year term deposits at 4.55% pa at the same time Rabo Direct is offering 5% – a ten per cent difference – Mr Market has failed miserably.

Someone with $250,000 or less can make almost half a per cent per annum with no change in risk, and arguably a reduction of it. The Rabo group is rated AA- by Standard & Poors (the same as the big four) and provides some diversification to Australian investors already in the same boat as the Australian banks when it comes to overexposure to the residential property market.

We have a market where investors, in subordinated notes and convertible hybrids, regularly take a big step up in risk for a small pick-up in rates. In that context it is astonishing that term deposit investors can get half a per cent for free.

Rabo Direct and ING Direct often have the best rates on the longer terms but, when looking at shorter terms – one-month, three-month, 12-month term deposits – it is UBank (a NAB venture) that currently reigns supreme. Government Guaranteed NAB will pay you 4.1% on a six-month term deposit, Government Guaranteed, NAB backed, UBank will pay you 4.51% for the same term (4.61% if you get their loyalty bonus).

Money making opportunities don’t get any easier.

Other considerations

Price should be your primary concern but there are some other factors to take into account, especially as they may affect your price in the future:

1. Customer Service. Some banks are better than others on this front but we haven’t come across one whose customer service is so good it’s worth paying a lot of money for. Give us the extra half a per cent any day.
   
   One key factor with the online providers is that you need to be comfortable using a computer. If you are, Rabo Direct’s service is one of the best your author has used in recent years. It’s a bit of work to get it set up, but after that you can open term deposits and shift money to internal and external accounts with a few strokes of the keyboard. Many banks require a trip to the local branch, or at least a phone call, to get a term deposit set up.
    
2. Rules. Banks don’t take a uniform approach to term deposits. Despite it being economics 101, they don’t even have a consistent approach to calculating break costs (the penalty if they let you close your deposit early).
   
   If there is any chance an unexpected event will leave you needing your cash, make sure you ask the question in advance. In ING Direct Living Super: a middle ground for super investors we highlighted the ‘interest rate reduction’ formula. This approach makes a term deposit more expensive to break the longer it remains on foot.
   
   The other key rule is what happens at maturity. Some banks let you nominate in advance, others require you to give notice at the time (with an automatic renewal if you don’t). The latter approach increases the chance you’ll forget and roll your money into a term deposit which is sub-standard for you and an excellent result for the bank. If you’re the type of person who tends to miss notices in the mail, stick to those banks that automate the process.
    
3. Practicalities. It’s simply not practical for many people to chase the absolute best term deposit rate. If you’re rolling monthly or quarterly term deposits you’re likely to spend a lot of time opening up bank accounts and leaving money in lower rate bank accounts whilst you move money around.
   
   So it’s worth having accounts set up with banks that tend to be near the top when it comes to rates. On this front, the big banks again rate poorly. They have a habit of using ‘specials’ to ensure they can get away with very low rates on some of their term deposits.
   
   One automatic roll of a term deposit while you are away on holidays can cost you a significant amount since you don’t get rolled from special to special, but from, say, three-month term to three-month term. If the three-month term is no longer the ‘special’ then you get nailed.  Non-special rates are often 1% to 2% below where they should be.
   
   Again this is where the online outfits come to the rescue. Banks like Rabo Direct and ING Direct generally rate highly across the range of terms (UBank has only recently started offering SMSF term deposits so time will tell). So long as there’s no cost – which, for online services, generally there’s not – there’s no downside to having an account established.
   
   A final practical factor to note is that not all banks treat SMSFs equally. Some don’t serve them, others treat them as business customers (not retail) and serve up lower interest rates. If you’re comparing rates make sure you’re comparing SMSF rates.
    
4. Risk. A bank failure is unlikely, but it’s not impossible. Whilst deposits are Government guaranteed, if it was called upon you’re unlikely to have instant access to your money. If you’re concerned about this risk, spread your deposits over two or more banks.

You can’t bank at a branch but online outfits like Rabo Direct, ING Direct and UBank win hands down on price (and often service and consistency). It’s amazing they’ve only managed to take a tiny percentage of the term deposit market.

In a nutshell

The message is very simple. Since risk is largely taken out of the equation, term deposits are one area where you should chase yield.

Open up an account with those whose rates are consistently near the top and shift your cash whenever there’s a buck to be made.

^[i] The Government Guarantee only applies to APRA regulated subsidiaries of foreign banks. It doesn’t apply to foreign bank branches.