Banks Quick On The Downtake As Battle For Borrowers Grows

Sydney Morning Herald

Saturday February 20, 1999

Ross Gittins Economics Editor

The banks' interest margin is shrinking as competition intensifies in lending to small business and remains as tough as ever in lending to home buyers.

That's the purport of the latest dispatch from the banking battlefield, included in the Reserve Bank's quarterly article on the state of the economy.

The Reserve monitors the way the banks respond to its cuts in the official interest rate. Their response to the latest cut, made in early December, was surprising.

By now it's well known that the banks drag their feet in passing on cuts to their existing customers, taking two or three times as long as they do when passing on an increase.

Not this time. This time the delay was much shorter and, for business borrowers, even shorter than for an increase.

Another funny thing was that the extent to which the banks passed on the 0.25 percentage point cut (25 "basis points") varied considerably, ranging from 30 basis points for home-equity loans to zero for credit cards.

This variation tells us a lot about the points on the battlefield where the competition is raging most fiercely.

In the area of personal lending, for instance, the banks are competing hard for home-equity loan business (a revolving line of credit secured by your home mortgage), but not for ordinary personal loans - and certainly not for credit cards.

And whereas the rates on most classes of small-business lending (loans of less than $500,000) were cut by at least 25 basis points, the average cut for variable-rate home loans was only 20 points.

So lending to small business is the banks' chief battleground at the moment.

Another consequence of the intensified competition is that the banks are now more inclined to vary the interest rate they charge according to the security you're prepared to put up.

So an unsecured personal loan will cost you 12.3 per cent, whereas a line of credit secured against your home will cost only 6.6 per cent.

And the indicator rate (that is, the advertised rate before they add a customer risk margin) for a small-business overdraft is 6.95 per cent if the loan's secured against the businessperson's home, but 7.55 per cent if it isn't.

Indeed, the banks have become so enamoured of the security provided by the borrower's home that, if you give them a mortgage over it, they don't much care what you do with the loan.

Consider this. The interest rate on a standard variable home loan is 6.5 per cent. For a home-equity loan it rises only to 6.6 per cent. And for a small-business fixed-term loan secured by the owner's home, the indicator rate is only 6.65 per cent.

By now, however, you may be wondering why those chiselling banks cut their home-loan rates by only 20 basis points, when the official rate was cut by 25.

Before you conclude that competition in the home-loans department must be going off the boil, there are a couple of points to remember.

The first is that the non-bank mortgage managers - Aussie Home Loans, et al - cut their rates by the full 25 points. The going rate from the mortgage managers is now 15 to 40 basis points below that of the major banks.

It's painless for the mortgage managers to follow the official rate down because they raise all the money they lend to home-buyers from the commercial market. And interest rates in the commercial market fall in line with the official rate almost automatically.

By contrast, the banks get some of their funds from the commercial market, but a lot of them from ordinary depositors like you and me.

And the sad fact is that the interest rates the banks pay on savings and cheque accounts were already negligible - 0.1 per cent in my case - before the cut in the official rate. So there was no way they could be cut any further.

In other words, the banks' average "cost of funds" fell by a lot less than the 25 basis point cut in the official rate - and, in all likelihood, by a lot less than the 20 points by which they cut home-loan rates.

So the fact that the banks cut by a fraction less than the fall in the official rate is not a sign that competition is lessening. Under the circumstances, it's a sign that competition is as intense as ever.

(By the way, the present, almost non-existent rate of interest on ordinary bank accounts is just one of several weaknesses in the Australian Bankers' Association's argument this week that we should stop complaining about bank fees and charges because the cost of holding an account is a mere 33c a day. To this should be added the hidden cost: the interest we're not being paid on our deposits. Bankers, it seems, have yet to learn about opportunity cost.)

But another point to remember is that the banks' response to the recent cut in the official rate is just the latest skirmish in a long campaign.

One reason the banks have taken to making odd-looking adjustments to their range of rates after a fall in the official rate is that they've also taken to cutting their rates in between falls in the official rate.

It's these uncalled-for cuts that are the true sign that competition has become more intense. The non-uniform response to movements in the official rate is just the banks fine-tuning their competitive strategies.

So, rather than focusing solely on the latest adjustment, we ought to work out the cumulative score - the body count, if you like - over a period long enough to encompass the outbreak of competition first in lending for housing and then in lending to small business.

The Reserve Bank notes that, at 4.75 per cent, the official cash rate is now back down to exactly where it was in June 1994.

Over the same period, however, the standard variable home-loan rate has fallen from 8.75 per cent to 6.5 per cent. So this fall of 2.25 percentage points has to be explained purely as the consequence of increased competition.

The corresponding drop for small-business loans is from 9.3 per cent to 7.55 per cent - a fall of 1.75 percentage points also attributable to greater competition.

These falls represent, of course, a narrowing in the banks' interest margin - the gap between the interest rate they charge their borrowers and the interest rate they pay their depositors and other lenders.

The Reserve publishes separate figures for the major banks' interest margin across all their lending and borrowing within Australia.

If you start back in the early 1980s before the advent of financial deregulation, the gap between the average rate they charged and the average rate they paid (their cost of funds) was more than 5 percentage points.

Between June 1994 and September 1998, it's fallen continuously from 4 percentage points to 3.2.

That squeeze is the ultimate proof that competition in banking has become more intense. Of course, it also explains why the banks are so keen to raise their fees and charges.

© 1999 Sydney Morning Herald

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