Why bank loans are so high despite the cash rate being so low

Having said that, the relationship between banks and government is much cosier — so, any complaints made by politicians when banks deviate from its pronouncements are purely theatrical.

The reality is that the price of bank loans and the interest on deposits are determined by an array of factors.

As the commercial banks in Australia are privately owned, they are free to set the price of interest they pay on deposits and charge on loan products. As such, there’s regularly a disparity between the rates charged by the banks versus the actions of the RBA.

When it comes to real property-secured mortgage products, banks are restricted in the amount of leverage they can use in the form of borrowings to on-lend by a factor known as “capital adequacy”. Banks do use monies held as deposits in their mix of treasury funds for mortgage lending, but these are a liability as they can be withdrawn at any time.

Loans are assets to the banks, but the maturity cycle of loans is counted in many years, which means that the maturity mismatch between assets (loans) and liabilities (deposits) presents an accounting problem.

Banks use a number of ways to re-align this mismatch including the packaged sale of loans, a process known as securitisation. In Australia, this is usually set up in five-year maturity cycles, or by moving similar type loans into off balance sheet Special Purpose Vehicles and selling them as Covered Bonds. Alternatively, they may borrow longer-term funds from other banks via the money market here and overseas.

To make banks’ lives a bit easier, the RBA can also buy assets from a bank under a “Repurchase Agreement” or “repo”, which is a form of non-deposit debt where the RBA buys a pool of assets at one price and sells them back at an agreed time and price in the future. As “repos” may be transferred back at a lower or higher price, they have the effect of both temporarily relieving the bank of liabilities (making it more liquid) while also affecting the bank’s treatment of interest rates in the intervening period.

Put simply, if the price is lower, the bank can figure this reduction “benefit” into a reduction in lending rates and vice versa. This mechanism allows the RBA to influence bank lending rates without any change to the RBA cash rate.

In recent years, Covered Bonds were introduced. These can account for no more than 15 per cent of the banks’ total capital raisings. However, it is important to understand that, regardless of how the banks raise capital, it all flows to the rate they pay on deposits and charge on loans.

The upshot is that the general public is right to question why bank loans are so expensive when the RBA cash rate is so low. But they should also question why it is necessary for banks to raise funding overseas at all when there is such high liquidity in Australian dollar-denominated super funds (many of whom are willing and able to buy long-term, AUD-denominated debt instruments).

It is a confusing situation but one that is allowing the entry of new players and new more flexible income investments and loan products.

We expect the divide between the RBA cash rate and lending rates to widen over the next several years, as local banks continue to look to overseas markets for funding at the same time as the RBA struggles to “normalise” its rates in the face of difficult economic inflation and growth indicators.

This margin gap will see depositors demanding higher yields as borrowers face higher interest costs, which will be used to maintain shareholder returns.

It clearly represents opportunity for alternate lenders (such as Semper) who are well progressed in creating alternate funding structures that are geared to provide borrowers more flexible and better-priced loan structures. These provide investors diversified, transparent, risk-priced liquid investments with yields that are better than those offered by their bank without compromising asset coverage.

We encourage brokers to watch this space and, in the process, ensure they’re staying across the industry movements that will progressively change the shape of financing in Australia.

Andrew Way is the director of Semper Capital and is credit, investor relations, corporate strategy and responsible lending lobbyist.

Andrew has worked in banking and finance for 30 years, specialising in risk management. Originally from the UK, he worked in Hong Kong and Singapore for 12 years before moving to Australia in 1999 as CEO International Ratings for Ernst & Young. He has also worked in the private sector and as a consultant and advisor to governments and non-governmental organisations.

Andrew is one of the founders of Semper and remains an advocate of regulatory reform in the (currently non-regulated) commercial finance sector and a proponent of responsible lending practices.