Who gets all the money

[toony]

I am not sure if this has been mentioned before or not, but i am curious.

We pay interest of 7.5% on a $100k mortgage. The banks tell us, they need to borrow from overseas to finance Australian mortgages. In some countries they have central bank rates of close to 0%. Where does all the money go?

Bank of X in USA borrows from the US Fed Reserve at 2%, then borrows to Aust Bank at 5%. Does this mean 2% goes to US Fed Reserve, 3% to the Bank of X in USA and the Aust Bank makes 2.5%.

Am i missing something? How does the Reserve Bank here effect this transaction? Do the people of the US or whatever country take 5% out of 7.5% of my interest?

I am a little perplexed.

 

[Marty McDonald]

I am no expert on international high finance but its my understanding that banks dont borrow directly from the reserve bank or US fed. These org's act as clearing houses between banks when they settle their accounts each day. If a certain bank is owed more than it owes other banks at the end of the working day then the reserve or Fed will pay them interest overnight on those funds at what ever the cash rate is in that country. The rate paid by the reserve or Fed for overnight funds affects the money market rates as it sets the absolute risk free rate of return for cash / liquid investments. This is why the cash rate can be used to some degree to control market and ultimately home / business loan rates.

The money markets are where banks actually borrow money at the wholesale level both in Australia and OS, the other funding source is off course deposits. So the cash rate is just the benchmark for no risk returns for overnight funds. You here of the reserve buying securitized mortgages from the US banks but this is more to do with capital ratios and banks liquidity requirements not funding for lending I think.

Capital market / money market investors demand higher than the absolute minimum return, their required return is based on the credit worthiness of the borrowers and how long they want the loan for (the longer the more expensive). At present the Aussie banks are trying to borrow more longer term as they and every other bank got a fright with the Lehmans crash and the freezing of the money markets world wide.

So the cash rate of 0% in the US it doesn't mean that is what the Aussie banks are paying for their funds. They may want to borrow x amount over say 7 years and would have to pay investors say the overnight cash rate + 3% or 4% to attract those funds.

So while i think the banks may be gouging at the moment it is not to the tune of 7%

Cheers

 

[bluestorm]

toony, you are simply looking at the cash rate. Bank borrowing gets a lot more complex than that. Banks can source funds from a mixture of customer deposits, short term (Bank Bills, LIBOR indexes) and long term borrowing (bond market). Banks also hedge against risk with all sorts of mechanisms (swaps, etc), to hedge against currency movements, to hedge against loan defaults and loan prepayments.
Hedging against inflation (discount factors), so when an overseas bank lends $1b at today's dollars, in 10yrs that $1b is worth less, so the banks price in a factor when lending.

The following link only starts to get into the detail of it.
http://www.stubbornmule.net/2010/11/bank-funding-costs/

 

[alexlee]

More importantly, Australian banks hedge.

So they might borrow (hypothetically) 2% in the US (from US pension funds, etc, not from the Fed), but that's US dollars. They would have to swap it back into AUD, at a cost of, say, another 2%. So their total cost is 4% for Australian dollars. They then lend it to you at 7%, but have to pay all of their operating costs. Still profitable, of course, but it's not the 7% v 0% that the average person thinks it is.

Why hedge, you ask? Because if they didn't, they would be exposed to currency exposures. Given how much the aussie has been jumping around, that's too much risk for the banks.