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.
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.