Quick To Respond, Slow To React: Banks’ Unconventional ‘Rate Tango’ Explained

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The banks have long adhered to the mantra of ‘give slowly, take away quickly.’ 

It has been so prevalent that Treasurer Jim Chalmers has commanded the Australian Competition and Consumer Commission (ACCC) to investigate why banking institutions historically drag their feet when it comes time to reward customers with rate hikes but are lightning fast at imposing these same increases.

An uncommon phenomenon has recently occurred: Commonwealth Bank declared that it would elevate interest rates for specific loans by 0.25% and various deposits by 0.75%, with the increase being immediate on deposits but delayed when it comes to loans.

Banks usually hurriedly apply it to home loan rates whenever the Reserve Bank of Australia (RBA) announces a rate hike. 

Deposit rates are often only used slowly. Now that 2023 has started, though, this is changing; and if you have money in the bank or own shares via your superannuation, then it pays to understand why this reversal is occurring.

To comprehend how banks earn money, we need to recognise the net interest margin – the variance between the revenue from lending and deposit costs. 

To illustrate this concept, if someone has a million-dollar mortgage with an annual 6% interest rate, that bank earns $60,000 in revenue yearly. It does not equate to profit since it must be taken elsewhere.

Banks need capital to fund their loans, attracting that money by enticing customers with interest payments. When you deposit a million dollars in the bank, expect an annual return of less than 7%. That is usually impossible – you might get 4%, amounting to $40,000 for the year instead.

Deposits are not the only method that banks use to raise capital – they can also issue bonds and borrow funds on wholesale markets. Such avenues are generally cheaper than deposits, so if banks shift more of their money from bonds to deposits, their operational costs will rise.

For bank CEOs, net interest margin is a cause of sleepless nights. As the chart below illustrates, this figure has steadily declined for years due to banks gradually shifting toward pricier deposit-funding methods.

The pandemic caused the net interest margin to plummet when rates were reduced to zero, yet it has recently increased. Commonwealth Bank announced its margin had elevated to 2.1% in the last two quarters of 2022 due to a higher rate environment and competition within pricing pressure.

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