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Trends in Australian home loan interest rates

May 17, 2016 10:18 pm / Leave a comment

The reserve bank of Australia’s decision to cut interest by 0.25% in May brings the cash rate to an all-time low. Three of the Big 4 followed by cutting their standard variable rate (SVR) by 0.25%. Only ANZ passed on 0.19% citing higher funding costs.
The RBA publishes a range of interest rate statistics including the mortgage standard variable rate and discounted mortgage rate, by both for major lenders and regional lenders. Here are some observations from a quick analysis of the RBA interest rate data.
For a number of years from the late 1990s to just before the GFC, banks moved their head line standard variable rate (SVR) lock step with the RBA cash rate. Following the GFC, banks did not pass on all the decreases to the cash rate as their funding spreads widened. The chart shows that the gap between the cash rate and the headline standard variable rate increased from around 175bps to over 350bps, particularly from around the GFC. With the banks following the RBA’s May lead, the headline SVR is also at its lowest.

graph1

Showing the headline standard variable rate however does not show the full picture. Some borrowers do not pay the full standard variable rate. For example simply taking up one of the banking packages e.g. CBA’s Wealth Package, will give a borrower a reasonable discount (around 0.7%).
The RBA also publishes a series of discounted variable rates offered. The chart below shows the discounted variable rate on owner occupied loans.

graph2

Since 2008, the level of discounts offered by banks to mortgage clients have increased by around 20bps. One factor could be selective pricing based on risk, rather than on overall reduction in the headline SVR.  However even spread on the discounted SVR over the cash rate has increased significantly, despite accounting for a greater level of discounting.

At least over the past 18 months, the NIM for most banks has been steady. I have had a look at the net interest margin of two big 4 banks (ANZ, CBA) and two majors (Suncorp, and Adelaide Bendigo) from their annual reports. ANZ did recently show a 3bps reduction in their NIM. Interestingly Westpac who also reported half year results recently showed a 3 bps increase in NIM, through better pricing on customer deposits.

graph3

At least for the time being it seems like the banks have been able to pass on lower interest rates while more or less maintaining margins.  For home owners, lower interest rates are bonus.  Whether the lower interest rates have the RBAs’ desired effect remains to be seen.

 

Source of data:

http://www.rba.gov.au/statistics/tables/#interest-rates

Stress testing and its Cold War genesis

February 16, 2016 11:41 pm / Leave a comment

From time to time, I came across the name Herman Kahn.  He was  mentioned in papers on stress testing or scenario planning.  Both of these are important tools in risk management for financial institutions.  My Google search of Herman Kahn uncovered a number of accounts.  The best and most entertaining piece on the man is by Menand in a piece for the New Yorker.   Kahn worked at RAND  formulating strategies and policies for countering the nuclear threat from the Soviet Union.    Kahn was known as “the heavyweight of the Megadeath Intellectuals”.  The term “Megadeath Intellectuals” comes from the fact that this group of scientists or strategist were at the forefront of considering the scenarios where the US and the USSR are tipped into all out nuclear war.  Here the cost can range from one or two million to hundreds of millions of lives lost depending on how the scenario plays out.
There are some parallels in stress testing for financial services.  The most value in these exercises comes from understanding how management can respond, what level of risk can be tolerated etc.  However financial services don’t need to deal with an adversary who is “bright, knowledgeable and malevolent”.  At most banks need to think about how they handle a market that suddenly refuses to provide the capital or liquidity they need.  In Kahn’s world, Game Theory was critical, while for financial institutions, the markets and the economy are usually a given.