Aussie banks are all-right

There’s a lot of talk about what a rough deal the Australian banks are giving the household sector just now. From this debate has flowed a number of suggestions that purport to increase competition in the banking sector.

Careful, reader: it’s not clear that there has been any reduction in competition (which is not the same thing as concentration).

The measure of competition that ought to matter most to Aussie households is the difference between deposit and lending rates – and this has narrowed. That means that, from the perspecitive of Aussie households, we are getting a better deal than before the GFC. At least on this measure, Aussie banks are now more competitive than before the GFC.

Also, beware, one of the proposals to ‘improve’ things may hurt Aussie households by lowering these deposit rates.

The argument against Aussie banks goes something like this: Aussie banks have widened the spread between the RBA’s cash rate and their variable mortgage rates. They are able to do this because the Australian banking system is uncompetitive. Therefore, the Government must intervene.

This argument is not supported by the facts. While it’s true that prices generally increase in uncompetitive sectors, rising prices do not themselves prove that a sector is uncompetitive.

We can better measure how competitive a sector is by looking at the difference between costs and prices. For banks, this is known as the net-interest-margin – or NIM.

For Aussie banks, the NIM is around the level of 2004, and a little above the level that prevailed in 2007, just before the GFC hit. The NIM went down in the GFC as the cost of wholesale money got very high. It has now returned to ‘normal’.

Much of the recent widening of the spread between mortgage rates and the RBA’s base rate reflects bank’s passing on increased wholesale funding costs. On this measure, there has been pretty much no change in the competitiveness of the banking sector.

You wouldn’t guess it from what you read in the paper, but the big winners out of all of this have been Aussie households. They have gained as the difference between the interest they earn of their deposits and the interest they pay on their loans has narrowed considerably.

What’s going on here? The GFC increased the cost of wholesale money, and therefore bank’s were willing to pay a higher price for any money – either in wholesale markets (so-called ‘term liabilities’) or retail markets (for our deposits).

An increase in competition in the global money market led to an increase in competition for Australian deposits – and this has made retail banking more competitive when measured by the spread betwen costs (the yield on retail deposits) and prices (the yield on loans).

Households ought to view the competitiveness of their banking sector through this lens. If banks are ripping off Aussie households, the spread widens and banks get more profitable. If they are competitive they will bid up the price of their inputs, and compress their margin over those costs.

Thus far households have been winners out of the GFC shake-up – Aussie banks have been forced to pay up for deposits.

As a result, the difference between standard mortgage and average deposit rates is now 320bps, or 25bps below the 2004/07 (pre-GFC) median. The difference between discounted mortgage rates and deposit specials is now ~90bps, or 60bps below the pre-GFC median.

It’s important to keep this in mind when considering so-called reform measures. One of the big ticket items on the agenda is covered bonds – these are funding alternative that will decrease bank demand for deposits, and hence lower the price they pay for them.

Will they also cut the mortgage rate? Perhaps  … but I doubt it.

Finally, don’t make the mistake of thinking that means you’ll save on your mortgage – you won’t. The RBA aim at the lending rates we pay at retail banks when they set monetary policy; so if the major banks tighten the spread between their retail lending rates and the RBA’s policy rate, the RBA will increase their policy rate to offset this.