Why Must Banks Lift Rates in Line with RBA?

[Oynas]

Many people say that the banks must lift their variable mortgage rates in line with the RBA's cash rate. But why?

The cash rate is the rate at which banks lend to each other overnight. The variable mortgage rate is the rate at which banks lend to those borrowing to buy homes. Home lending can lead to major losses if house prices fall or if the borrower defaults. Lending to banks overnight is far less risky. If lending involves much higher risk, why wouldn't interest rates be higher to compensate?

Banks are like any other business except instead of selling beer, cars, etc, they sell money. The cash rate is the price of one product. The mortgage rate is the price of a different product. The cash rate and the mortgage rate are different products. As with any different products, you would expect different prices and different price movements. The price of apples and the price of oranges are different and move differently. We can thus expect the cash rate and the mortgage rate to be different and to move differently. Even if the price of apples is regulated by the government, we cannot expect the price of oranges to move in line with the price of apples if the price of oranges is not regulated by government.

The RBA only regulates the cash rate. It does not regulate the mortgage rate, giving banks freedom to set their own mortgage rates. Why would it be a problem if the banks chose to set whatever mortgage rate they want?

This is not an attack on borrowers. I just don't understand why the cash rate and the mortgage rate must be perfectly correlated.

 

[r2d2]

Very simple answer, the bank is there to make money!

The cash rate represents bank's funding cost "floor" in the market, so for them to able to fund future loan originations, they have to pay at least this rate to get the funding. Variable rate on their mortgage book is the benefit they will receive from the origination of loans. The difference between the two rates is their profit margin.

Use a simple example, if a bank's variable mortgage book has a balance of 100 billion and the bank's average funding cost at 5% with average variable home rate at 6%. Therefore the bank's profit margin going forward (assume no change) is 1% <=> 1 billion dollars!

If RBA decided to up the rates by 25 bps, then the bank's new funding cost is going to be at least 5.25%. If the bank kept their variable mortgage interest at 6%, this represents a 250 million loss on their potential income going forward. Now do you think bank mustn't lift their rates?

Obviously if bank lift their rates too much - then they will **** off everybody and they will lose both new and existing business.

Who said the cash rate and mortgage rate are perfectly correlated?

 

[on the move]

So if RBA raises .25 where/who the extra money go to ?

 

[WillG]

Why aren't landlords allowed to raise rents whenever funding costs go up?

 

[Rolf Latham]

Why aren't landlords allowed to raise rents whenever funding costs go up?

Hi Will

A better direct comparison could be a week to week let with no lease. Thats a variable rate and you can increase pretty much as you want

A normal 6 or 12 mths lease is more closely allied to a fixed rate loan where the rate doesnt move when the variable goes up, that is, you have have a fixed term agreement

ta
rolf

 

[Corey Batt]

They raise 'em because us Bank share holders and evil blood sucking creatures trying to squeeze every cent from the working class proles.

 

[Peter_Tersteeg]

So if RBA raises .25 where/who the extra money go to ?

This statement assumes that all of the money a bank lends comes from the RBA. This is simply not true. A lot of the money comes from other sources such as super funds and other financial institutions both local and abroad. The cost of money for these sources varies and this also needs to be reflected in what the customer gets.

 

[NoCredit]

Banks will charge as much as they think they'll get away with!

Always have, always will.