The Professor v The Banks
Illustration: Karl Hilzinger
Last Monday, Milind Sathye, a former central banker in India and now Canberra University's Professor of Banking and Finance, put the case that bank margins had been rising.
In crying poor, blaming high funding costs and not passing through Reserve Bank official rate cuts, the banks were deceiving the public, he said.
Steve Munchenberg, chief executive of the Australian Bankers Association, countered the professor’s arguments on bank margins. Margins remained under pressure he said.
It doesn’t help the public debate on bank profitability that the bank lobby relies on research which is not public to argue its case.
The RBA effectively says here that it conducts extensive discussions with banks before making up its mind on funding costs. See Deans and Stewart article which states that funding cost calculations are done by RBA in detailed consultation with financial institutions.
This consultation with industry arguably provides scope for industry to influence central bank decisions outside the public arena.
If, as the ABA maintains, the RBA need not change the cash rate since the banks were already doing their job for them, the question lingers … who decides monetary policy in this country, the RBA or the ABA?
THE FOLLOWING IS A RESPONSE FROM ABA chief executive Steven Munchenberg to our story. In italics are the responses by Professor Milind Sathye to the ABA arguments.
Munchenberg: At the risk of whistling in the wind, my response to a few of the themes in Professor Sathye’s response.
Sathye: It was good to see a four page response to my one page note. I appreciate the painstaking effort made by ABA in the interests of greater transparency, which I am sure would ultimately benefit Australian society as a whole. But it left me a bit intrigued … was the purpose to obscure the issue or illumine it? The entire response can be summarised in one sentence, ‘Don’t ask us, ask the RBA’.
Munchenberg: In terms of the RBA’s analysis, I thought it was fairly widely known that the RBA does a detailed analysis of bank funding costs – it reports the results regularly. Most of the data used by the RBA I understand is reported, however, the banks also provide commercially sensitive price information to the RBA, especially on large amount deposit pricing.
The RBA undertakes a very detailed analysis, looking not only at marginal prices, but the impact of term funding (e.g. in deposits, wholesale funding).
Sathye: It is good on the part of ABA to acknowledge that there is some ‘invisible’ data (that is, not accessible to the public) that enters the computation of RBA funding cost analysis. As it pertains to large amount deposits as ABA says, it means it would have significant impact on the calculations of overall funding costs. So a significant factor that enters into RBA funding cost calculation is out of the public domain and known only to the banks/ABA/RBA. Also, since the interest rates available in the public domain tell a different story, would it be unreasonable to believe that any argument coming from ABA/RBA is basically flawed and the society has to rely solely on the word from ABA/RBA. It assumes the infallibility of both.
It is also a cause for worry given the recent LIBOR scandal where the big banks (Barclays for example) in the UK manipulated interest rates to their advantage and kept misleading financial markets and society as a whole, not only in the UK but globally, for years. The FSA and BoE appeared to be both oblivious and were also slow in responding as the source indicated in the footnote would show. Consequently, it may be wrong for society to pin its faith on regulators / the Governor alone. The fallibility of regulators has been demonstrated not only in the LIBOR scandal in the UK but also during the GFC in the USA.
On another note, I wonder why such information should be treated as commercially sensitive when RBA provides only aggregate data. It will not be possible for any person to know what the rate is paid /received on large deposits by individual banks. Consequently, I see no harm in the RBA releasing such aggregate data for public consumption.
Munchenberg: As I said, the RBA regularly reports its findings.
Most recently the Governor of the RBA, before the House of Representative Economics Committee (22 February), stated that when the banks say, 'The costs of all the funding we get relatively to the cash rate over a period of the last five years has gone up’, they are telling the truth. This appears to contradict Professor Sathye’s ‘debunking’ of bank claims that high funding costs are the reason they have held back rate cuts, as you reported yesterday.
Sathye: This doesn’t contradict but actually supports my claim. I have argued on the basis of absolute costs. But given that ‘relative to cash rate’ is being used by the Governor and by the ABA to justify their claim, I also provided a ‘relative to cash rate’ analysis as an illustration for three rates in my email to Michael [West] to which ABA has responded. The central premise that lending rates did not decline as sharply as the deposit rates is also vouched even when we use ‘relative to cash rates’ as the table prepared by me would have shown.
What matters to mums and dads is the absolute rate, what interest they receive on deposits and what they have to pay on mortgages or other loans. If the deposit interest rates decline, the inflow of money in their pockets declines. If loan cost doesn’t decline, small businesses and mortgage holders all pay more. The outflow of money from their pockets continues to be more. ‘Relative to cash rate’ is an interesting phrase which can be touted to make it complicated for people to understand what is going on and then believing that probably the financial gods (RBA/Governor) may be right. But putting such blind faith in any institution or person can be dangerous, for the reasons we have explained.
While I do respect the professionalism of the RBA/ governor, no one is infallible. At least what happened at the time of the Securency scandal in Australia should make us avoid that mistake. Kindly note just as I am not rubbishing everything that comes from RBA or the Governor, neither I am prepared to believe everything that comes from them to be the gospel truth. John Hewson also made similar point. It is often said public memory is short. I am just trying to refresh it.
For transparency, I have included the full quote below:
Sathye: As already stated, the entire response of the ABA can be summarised as ‘don’t ask us, ask the RBA’. This shifts the responsibility to the RBA which can now be seen as having a duty to explain why they are not making available in aggregate form ‘commercially sensitive information’, thereby compelling us to use only their word as evidence.
Thanks for copy pasting the conversation verbatim but even if ABA would have referenced it that would have helped and not obscured the real issue under discussion, that is, bank claims not only about funding costs but also about lending rates, net interest margins and profits. All these need to be studied at one go- not in isolation as I have been repeatedly saying through my opinion pieces and other contributions at the Senate Committee (available publicly).
- “Mr Buchholz: My first question goes to the spread between the cash rate and the standard variable. Our banking sector operates under the security of a four-pillar banking policy. When the dark clouds of global uncertainty came about they were able to cloak themselves in the security of bank guarantees. Admittedly they purchased those. When can Australian banking consumers expect a better deal?
- Mr Stevens: I hate to be a party pooper, here, Mr Buchholz, but I am afraid that banking customers—here we are talking about borrowers—have to pay the cost of funding both equity and debt that the banks face. There is a very intense debate over a few basis points in the movement in the gap between cash rate and borrowing rates. But in the broad when the banks say, 'The costs of all the funding we get relatively to the cash rate over a period of the last five years has gone up,'—I am not talking about whether it is going up or down a little bit right now; I am talking in net terms over that period—it has; that is true. The discussion is really over whether, in the net interest margins they are earning, they have kind of crimped a bit more or not. Really, those margins fluctuate a bit from quarter to quarter and year to year, but they have been in a reasonably narrow range for quite some years now. That is what has happened.
Sathye: This is an interesting statement. I wonder what the big revelation is here. If you do computation every fortnight or monthly then you can also find fluctuations ‘a bit’ at those intervals. Margins have been reasonably in narrow range? May be year on year but the KPMG figures as cited in Michael’s piece tell a different story between the GFC years and now.
Munchenberg: In response to the fact that the structure of banks' rates, both on the lending side and on what they borrow at, have all gone up relative to the rate we set—as I have said many times—we have set our rate lower, mostly to compensate for that. So, when you ask, 'When can people expect a better deal?' I think the borrowers are paying approximately what we feel is the appropriate rate for the economic circumstances.”
The Governor’s statement raises two other interesting points that go to claims in the article. The first claim is that by “refusing to pass on Reserve Bank interest rate cuts” banks have “hurt not only mortgage holders but savers, small businesses and other bank customers, according to research by Miland Sathye”. You will notice the Governor pointed out that:
- “borrowers are paying approximately what we feel is the appropriate rate for the economic circumstances”
- “In response to the fact that the structure of banks' rates, both on the lending side and on what they borrow at, have all gone up relative to the rate we set—as I have said many times—we have set our rate lower, mostly to compensate for that”
Sathye: Again the testimony of the Governor is being relied to support the position of ABA. I have already provided the relevant statistics of deposit rates, and lending rates. The margins and profit statistics is already there in Michael’s piece.
Munchenberg: What the Governor is explaining here, as he has many times before, is that rates today are actually not significantly different from what they would be if the banks had always passed on in full every movement of the cash rate. In other words, had banks always followed the RBA, the average mortgage rate would still be close to 6.42 per cent (to use your figure). This is how monetary policy works. The RBA is ultimately interested in what impact the cash rate is having on market rates, the rates borrowers’ experience. The cash rate is still an important influencer of market rates (just not the only one). If you want more on this see here.
The irony of this of course, is if banks start cutting rates unilaterally, that will reduce the chances of a cash rate cut and actually bring forward the time when the RBA starts raising rates.
Sathye: The SVR should be 6.05 in that case.
Munchenberg: The second point to highlight is the Governor’s statement about margins:
- “The discussion is really over whether, in the net interest margins they are earning, they have kind of crimped a bit more or not. Really, those margins fluctuate a bit from quarter to quarter and year to year, but they have been in a reasonably narrow range for quite some years now. That is what has happened.”
That is also what your own graphic showed yesterday. As I understand Professor Sathye’s position, from your report and previous statements by the Professor over the last three years or so, the Professor is arguing that banks have been under no real funding pressure for some years. Given that, why have our margins not been showing a steady march ever higher, rather than “fluctuate a bit from quarter to quarter and year to year…in a reasonably narrow range”?
Lest I be accused of basing my case on one answer from the RBA Governor before a Parliamentary Committee, I would point out that the RBA regularly reports the situation with bank funding costs:
Statement of Monetary Policy (7 February 2013):
“Relative to the cash rate, banks’ outstanding funding costs are estimated to have been broadly unchanged over the past three months. The relative cost of banks’ outstanding long-term wholesale debt remained stable over the period, with the large reduction in spreads for new bond issuance having only a minimal effect on banks’ outstanding wholesale funding costs at this stage. It will take some time for the reduction in spreads to flow through to overall bank funding costs owing to the relatively subdued growth in credit and the slow run-off of wholesale debt issued previously at higher spreads.”
Statement of Monetary Policy (8 November 2012):
“Bank funding costs – relative to the cash rate – have risen by about 50 basis points over the past year, but are estimated to have been broadly unchanged since the previous Statement. In absolute terms, interest paid by banks is declining (as is interest received). The rise in bank funding costs relative to the cash rate over the past year largely reflects the increased cost of deposits. The interest in deposits is largely in response to pressure from banks, investors and regulators globally to secure notionally more stable funding sources.
A number of banks have recently reported profit results for their 2012 financial years. Higher funding costs contributed to a small decline in net interest margins. Over the past few years, the major banks’ average net interest margin has fluctuated in a relatively narrow range”
Note that at the stage when the RBA said funding costs were up 50 basis points, banks had only held back 30 – 35 basis points on most home and small business loans, i.e. they were absorbing some of those higher costs.
One potential area of confusion is between absolute bank funding costs and costs relative to the cash rate. In absolute terms, for example, the price banks are paying for deposits has come down. Using the figures for term deposits in your article, in absolute terms interest rates on terms deposits have come down, from 7.95per cent to 4.25per cent, ie a fall of 3.70per cent. However, over the period of that fall, the cash rate dropped from 7.25per cent to 3.00per cent, a fall of 4.25per cent. Therefore, while interest rates have fallen in absolute terms, they have gone up relative to the cash rate (by 55 basis points). As the great debate is always about mortgage or small business rates relative to the cash rate, we always talk about funding costs relative to the cash rate.
Sathye: The example of term deposit has been cited in defence but what about online savings account and lending rates? All this needs to be considered at the same time to know the whole picture, not a picture in isolation.
Munchenberg: On some of the other points raised by Professor Sathye:
The Professor’s analysis is based on the stated assumption:
“Let us assume that all home loans were made out of online savings deposits”
This is a totally invalid assumption. Apart from anything else, the amount in online savings accounts amounts to less than 10per cent of the amount lent out in home loans. Banks do not fund mortgages that way and it would be impossible for them to do so.
Sathye: If ABA reads the table and comments thereunder, they would understand that they were to clarify a point in layman’s terms. The point being explained was the difference that arises due to not slashing lending rates as much as deposit rates. I cannot fathom that ABA thought I was suggesting all home loans are actually made out of online savings!!! The word ‘let us assume’ indicates it was a hypothetical example just to explain a point about share decline.
Munchenberg: It’s not all bad news though. I do have to make a correction to one of the figures I sent yesterday (the figures all come from the RBA by the way).
Yesterday I said online savings accounts have fallen by 95 bps. This is actually the figure for banks bonus savings accounts. Online accounts have fallen by 180 bps (no wonder Professor Sathye wants to assume we do a loaves and fishes trick and fund mortgages out of these). Given balances in online accounts are $110 billion and TDs are $275 billion, a weighted average for these two products shows that banks have reduced these deposits (combined) by about 100 bps against 175 bps in the official cash rate. These deposits make up about 65per cent of all personal deposits.
Sathye: Any particular reason why ABA is silent about the other rates and the source thereof? Why is there so much divergence? Also ABA missed the central point – the decline in deposit rates was sharper, as compared to lending rates, whether compared in absolute terms or relative to the cash rate. In the table I have indicated this as 155 bps. Where has this 180 bps come from? Which two dates are being used here? Would help if ABA was consistent in doing comparisons.
Munchenberg: Finally, on profits, banks report regularly on where their profits come from. Perhaps you could suggest to Professor Sathye that he look carefully at the detailed presentations from each bank on their website or on the ASX site. Bank profitability (as measured in terms of Return of Equity) has of course been falling and is broadly comparable with countries such as Canada and Singapore that avoided the full force of the GFC. Countries where banks have notably lower ROE tend to also have their names coupled with the word ‘crisis’.
Sathye: It is important that ABA does analysis consistently between dates. For example in the paragraph above on TD it uses Michael’s figures July 2008 and Jan 2013, while here for ROE it uses 2012 over 2011. I provide below a table showing ROE of the majors over the last four years (source: KPMG Financial Institutions Performance Survey of 2012 and 2010). It has been rising till 2011 except for WBC which marginally declined in 2011.