Sir Humphrey Appleby of Yes Minister fame would have labelled ANZ boss Shayne Elliott’s call not to pass on the full RBA interest rate cut of 0.25% as “courageous”.
Predictably, the ANZ copped a berating from Treasurer Josh Frydenberg, RBA Governor Dr Phil, and most pundits, economists and commentators. The ANZ’s brand took a hit.
The ANZ wasn’t the only bank that failed to pass on the cut in full, but because it was first out of the blocks and a little more direct in its communication, it took most of the shellacking. Quite cleverly, Westpac bundled a cut of 0.20% to its main rates with a cut of 0.35% to a rate that no one really cares about too much (the interest only rate for property investors) and walked away from the controversy relatively damage free.
But I like “courageous” CEOs and I think Shayne Elliott is right to balance the interests of all stakeholders – borrowers, depositors and shareholders. The fact is that banks “lose” money (i.e. their profits get hit) when interest rates fall.
Let me demonstrate. Suppose that a bank has $100m of home loans earning interest at 4% pa. It is funded by $10m of capital, $50m of deposits that it pays interest at a rate of 1.5%, and $40m of deposits that it pays no interest on (cheque accounts, savings accounts etc). Revenue for the year is $4m, interest costs $0.75m, for a gross profit of $3.25m (this is before expenses and bad debts).
If interest rates are cut by 0.25%, revenue on the home loans reduces to $3.75m. If deposit rates are also cut by 0.25%, the interest cost reduces to $0.625m (note: there is no change to the $40m deposits earning 0%). Gross profit is now $3.125m, a reduction of $0.125m.
To help offset the impact of lower interest rates, particularly on their capital base, banks run what are called “replicating portfolios”. But even with these, falling interest rates negatively impact profits in the short term. Over the longer term, lower rates will help with “mortgage stress” and should keep bad debts down.
Post the Royal Commission, it is even more fashionable to bash the banks and that’s what made Shayne’s call so courageous. But he is right to consider the interests of shareholders, and will be even more right if ANZ continues to pay competitive rates to its depositors.
For every winner there is a loser, and depositors, particularly self-funded retirees and others living off the interest on their term deposits, are the real losers with this rate cut. And despite what the media likes to make out, there are many more depositors than home loan borrowers who will be impacted by the interest rate cut.
I continue to maintain that the RBA has got this rate cut wrong – it will have limited impact on economic activity and employment, and hurt many more than it will support (see http://www.switzer.com.au/the-experts/paul-rickard/rbas-dr-phil-gets-it-wrong-on-rates/. But if I am wrong and the economy needs the stimulus of a rate cut to boost employment and economic activity (yesterday’s growth reading was 1.8% rather than the RBA’s forecast of 2.75%) , why not go harder and cut rates now by 0.5%? As it stands, it looks like we will get another cut of 0.25% later this year and possibly one next year. This “drip feed” approach makes little sense.
Back to the ANZ, one area it should get a gold medal for is it will be the first bank to pass on the interest rate cut. It will be effective from Friday 14 June, whereas laggard Commonwealth Bank doesn’t pass on the cut until Tuesday 25 June.
New Standard Variable Home Loan Rates
The new standard variable rates start with a ‘5’ or in some cases a ‘6, a big difference to the rate new borrowers are paying which is often starting with a ‘3’. While many customers pay lower rates than the standard due to package discounts (typically up to 0.75%), the gap is still remarkable. Sure, customer inertia is a factor, but a more pressing issue is that it is really hard to get credit and many borrowers aren’t able to shop around to consider refinancing their loan. It is tough out there to get finance.
The RBA should be at the coalface with the major banks and regulator APRA to free up the market and get credit flowing again. Price is a factor, but availability is far more important.