In a rather unusual move in October, the big banks began announcing increases to their home loan interest rates, even though there has been no change in official cash rates.
Why did they do it and what does it mean?
While Australia has a strong banking system, the regulator, the Australian Prudential Regulation Authority (APRA), has introduced rules to make it even stronger. One outcome is that the ‘big four’ banks (ANZ, CBA, NAB and Westpac) will need to hold more capital to help shield them from any potential increase in bad loans or other economic upheavals. Previously, for every dollar that one of these banks lends to its customers the bank would need to hold 16 cents in capital. APRA has increased this to 24 cents per dollar – and this comes at a cost.
In very simple terms, and all else being equal, if a bank can only lend 76 cents for each dollar it has, it is going to earn less interest than it would by lending 84 cents per dollar. On their own, higher capital reserves mean banks earn less interest on their loans, which in turn leads to a reduction in profits.
Profitability is an important measure of a bank’s strength, so to compensate for the reduction in interest income, at least in part, the major banks started raising interest rates.
The Big Four have a tendency to move together on interest rates. It happened when rates on investment loans were increased, so it’s no surprise others have followed Westpac’s lead. They all need to maintain profitability to keep their shares attractive to investors.
Interestingly, smaller banks are not affected by the higher capital requirements.
Winners and losers
While the focus had been on Westpac being the first to increase its mortgage rates, and by the highest amount, it should be noted that Westpac increased the interest paid on some new term deposits by 0.25%. For anyone relying on interest income that’s a plus. We are yet to see if the other banks will be as generous.
On the losing side are homeowners with a variable rate home loan with one of these banks. So too are property investors who will also pay this on top of the earlier increase to investment loan rates. If landlords seek to pass on their higher interest payments, renters may also feel it in the hip pocket. And depending on a complex interplay between depositors, borrowers, capital raisings and profits, bank shareholders may see a reduction in dividends.
But let’s keep things in perspective. The 0.2% Westpac rate rise will increase repayments on a $300,000 loan by $46 per month. Prudent homebuyers will have factored in significantly higher interest rates when calculating how much to borrow, and this modest increase will be something they can take in their stride.