The crisis-like spike in Australian bank funding costs has forced more lenders to slug borrowers with “out of cycle” mortgage rate rises, heightening speculation all borrowers will have to pay more on their home loans within months.
On Friday, $5.5 billion regional bank Bendigo and Adelaide Bank said repayments for owner-occupied borrowers with interest-only loans would rise by 16 basis points while other rates would increase 10 basis points.
It follows rate increases earlier this week by major bank competitors Macquarie Bank and AMP. On Thursday AMP said mortgage rates would be raised by 17 basis points,
equivalent to almost three quarters of a typical 25-basis-point Reserve Bank of Australia interest rate hike.
The moves flow from a rise in short-term money market rates, which make it more expensive for banks to get the money they use for loans and other ongoing business.
Bendigo and Adelaide Bank managing director Marnie Baker said its rate increases would “assist in balancing the increase in funding costs”.
“Funding costs have been steadily increasing this year, and we’ve absorbed this cost impact to date,” she said in a statement.
On Friday, Australia’s banks and other lenders were still paying above 2per cent to borrow money for three months as measured by the 90-day bank bill swap rate. That represents a 50 basis point premium to the overnight Reserve Bank cash rate setting of 1.5 per cent, a difference not seen since the global financial crisis.
The rate spike is a problem for the banks because their short-term borrowing costs increase, eating into their profit margins if lending rates remain unchanged.
The funding blowout, initially expected to be shortlived, has already prompted lenders such as Macquarie, Bank of Queensland, Suncorp and Pepper to enact ‘out of cycle’ rate increases to counter the immediate hit to their lending margins.
The hikes have also led to concerns the cost increase will leak into the real economy.
Geoff Wood, the head of macro and risk at Sydney based hedge fund Morphic Asset Management, said the market now thought the funding costs could remain elevated.
He said the major banks faced a choice – “they either reprice their loans or their profits fall.”
The elevated funding costs also has the potential to become a monetary policy factor, particularly if the major banks increase lending rates as a result.
“If the fund levels do stay elevated, the market has done a quasi hike for the RBA. It means the RBA is on hold longer and the currency is potentially weaker,” Mr Wood said.
However, analysts are split as to whether the major banks will risk a political backlash and increase mortgage rates to protect profit margins.
“The conclusion we have made from a policy perspective is that it depends on how persistent this is and the Reserve Bank has used the same language in its statement,” said National Australia Bank chief markets economist Ivan Colhoun.
“If the developments were big enough to impact growth, inflation and unemployment forecasts the bank may question whether policy rates are at the right setting. It would depend on the persistence of the event – and on whether other policy options might be available.”
While there are concerns in some quarters that interest rates in the real economy may increase significantly, the Reserve Bank pointed out that until now average mortgage rates had actually been falling for some time.
Official data shows that while banks’ lending standards are tightening, banks have also been competing aggressively to attract new borrowers.
Mr Colhoun said Reserve Bank governor Philip Lowe had recently shown “greater concern about financial stability than about the speed at which inflation returns to its target band”.
“So it would likely have to be a big deviation in [lending] rates and so far we haven’t seen anything significant enough.”
The funding cost spike has created a dilemma for the major banks that are under intense public scrutiny in the wake of the Hayne royal commission. They must choose between avoiding a political backlash from an out of cycle interest rate hike or defending profits.
Morgan Stanley banking analyst Richard Wiles said the response of the smaller lenders to mortgage rate hikes had led to “an expectation that the majors are on the verge of announcing a new round of repricing but said they would be reluctant to do so because of regulatory scrutiny.
“While banks can point to funding cost pressures, we believe the potential for adverse outcomes from the Productivity Commission and Australian Competition and Consumer Commission inquiries still make it difficult for the majors to contemplate repricing in the near term.”
But Mr Wiles told clients the major banks would move to raise rates if the margin pressures are worse than expected and political and regulatory pressures abate.
He said that a 15 basis points repricing was required to justify the current valuation of Commonwealth Bank, the nation’s largest lender.
But Mr Wiles said the banks would have to increase investor and interest-only loans by 25 basis points if they increased owner-occupied loans, a sector where competition has intensified, by 5 basis points.
“In our view, CBA and the other majors are unlikely to increase rates this much.”
Catherine Allfrey of Sydney-based fund Wavestone Capital said last month that the banks would be forced to respond to the increase in funding costs. That would shave a ‘meaningful’ 5 to 10 basis points off their net interest margins of between 1.7 to 2 per cent over the next 12 months.
The major banks had previously informed analysts about the impact of the funding cost spike in May market updates, although the elevated levels have persisted for longer than expected.
“The banks told you the earnings sensitivity so it’s in the numbers,” CLSA banking analyst Brian Johnson said.
Other analysts have pointed out that the funding cost pressures are more acute for the non-major banks that are relatively more reliant on funding tied to money market rates. The spike in rates may therefore improve the competitive position of the big banks.
UBS analyst Jonathan Mott said the major banks could respond to higher funding costs by repricing their mortgage books, but that smaller banks and the shadow lenders would “need to reprice substantially more to stabilise their net interest margins”.
“As a result, we believe higher funding costs may lead some of the smaller banks to reduce their application volumes and slow balance sheet growth.”