The Global Financial Crisis (GFC) and the ensuing uncertainty it created has changed the face of home loans forever. Once, mortgage holders looked to the monthly decision of the Reserve Bank of Australia (RBA) as the sole influence on whether their rates would go up or down.
However, in the current climate homeowners have to learn to assume that if the RBA cuts rates, their lender is more than likely not to pass on the full amount.
That is due in most part to the fact that the official cash rate set by the RBA has very little to do with how the banks source and pay for their funds to lend to borrowers.
This may be a bitter pill for most homeowners to swallow, and fodder for the nation’s news outlets – but unfortunately it is the way we have to view the home loan market.
There are a number of key factors which influence the rate a bank or lender will set for their mortgages, and in turn effects what they pass on following the RBA’s monthly meetings.
Just as we borrow from the banks, they in turn borrow from each other as well in order to maintain capital. When there is a heightened risk of sovereign default (i.e. countries at risk of not meeting their own borrowing repayments such as the case at present with Greece and others) this increases the risk of a bank defaulting on its own borrowings. To compensate for this higher risk banks will increase the interest rate they charge to one another which therefore increases overall funding costs.
A major source of funds which Australian banks use to lend out comes from overseas investors in securitised loans (which means loans secured by a mortgage on a property). These investors purchase the debt from Australian lenders in order to earn the interest revenue from the loans. The Australian lenders use the proceeds of the sale to provide loans to more borrowers.
The sub-prime crisis which kicked off the GFC has meant that securitised lending is no longer viewed as such as safe investment, and as a result the funds available through these means are priced higher to offset the perceived risk. This means that lenders must charge a higher rate to borrowers in order to continue to access funds to continue lending.
The other primary source of funds for home loan lending comes from deposits such as term deposits, transaction accounts and savings accounts. As securitisation markets dried up, lenders turned to deposit holders to partly fill the gap in funding. This sparked a war for deposits and as a result increased interest rates being offered. The increased rates banks pay customers for their deposits means a higher rate of return is needed from home loans in order maintain an operating margin.
Aussie is not a deposit taking institution we partner with a number of providers, many of which use deposits as a source of raising funds to lend out.
Changes to Banking Regulations and Government Legislation
As a result of changes to international banking regulations (Basel III) financial institutions are required to maintain additional capital reserves (i.e. funds to offset the risk of money being loaned out). This means lenders have to have huge amounts of capital on its books to satisfy the new regulations. This has put increased strain on financial markets to raise the necessary capital which has in turn increased its costs.