It is not home owners who suffer when banks divert OCR cuts to protect their profit margins, it is small business and farmers who pay the costs. We describe bank funding motivations

It is not home owners who suffer when banks divert OCR cuts to protect their profit margins, it is small business and farmers who pay the costs. We describe bank funding motivations

By David Chaston

In Australia, there is fierce pushback against the banks' refusals to pass on all of their recent official cash rate cut.

This is something that has been happening in New Zealand for the past two rate cuts.

And those same banks here are softening us up for a similar response on Thursday if the RBNZ cuts the OCR. Most observers expect it to do that.

But things are different here.

In Australia, the withholding of the full rate cut there affects almost all mortgage borrowers. Most of them are on a floating rate.

But in New Zealand, most are not; most home loan borrowers here are on a fixed rate.

And banks here have already decided not to pass on the reductions that have flowed into wholesale rates, which are now all at record lows.

Risk premiums too are now at their lowest in years.

So banks are enjoying lower costs while they hold back on fixed mortgage rate reductions.

However, the public conversation about floating rate reductions following an OCR cut is not really about mortgage rates.

It is really all about borrowing costs for SMEs. And that includes farmers.

If banks don't pass an OCR cut on in full, it is small business and farmers who are being penalised with rates higher than the RBNZ would want them to pay.

The banks' floating rate is a benchmark used to set revolving credit arrangements (used by many micro businesses who offer up their home as security for a credit line they use to fund their business) and farmers whose borrowing is tied to the same or a similar benchmark.

We have shown that wholesale rates and risk premiums are at lowest ever levels, so what is the basis of banks claims that "margins are under pressure"?

Part of that is just because rates are generally low.

And part is highly technical and relates to changes in the wholesale funding markets in the huge American financial sector.

Some new regulations for the enormous US money market funds have made it relatively more expensive for banks to raise funding in those American money markets.​

These regulations take effect in October and will require money market funds that invest in short-term debt securities, such as bank bills, to publish their net asset values (NAV) daily, rather than maintaining a fixed NAV of $1 a share.

This means that a fund's price will fluctuate depending on market conditions.​ ​In addition, if a fund's assets that can be liquidated within a week drop below a certain level, the fund can impose a fee on redemptions, or even stop redemptions altogether for up to 10 days. But while these new rules affect both institutional and retail money market funds that invest in "prime" corporate debt, they don't apply to funds that invest solely in cash and US government bonds.

As a result, an increasing number of US managers are following the lead of Fidelity Investments, which converted some of its prime funds to government funds that invest in cash and US government securities.

This means there is lower demand for bank securities and this affects how our banks raise offshore money. Banks say that it now costs around 25 bps more to borrow than it did a year ago in those US money markets.

Of course, they have been well aware for some time of these changing US rules and that their funding costs would be going up as a consequence.

But 'going up' is only a relative term; they are 'going up' relative to falling rates.

All this is complicated, but it does make it easier for banks to talk about 'higher costs' and base it on something.

However, the US money markets are not the only source of funding. European covered bonds are still a huge and very cheap source of funds and most big banks have considerable capacity to access these markets. Banks won't actually go to the US if the EU is cheaper.

And we sometimes overlook that the domestic term deposit and retail savings account market is another source of funds. Not all of the previous OCR cuts have been passed on to the TD market, although at-call savings accounts have had the full reduction imposed on them. The sad fact is, these savers are very loyal and banks take advantage of that. They intensely analyse their 'replicating portfolio' - their base of lazy money - and know exactly how much they can extract out of these savers. There is nothing 'fair' in how they are treated for their loyalty. If term deposit savers start to shift funds in significant volumes, banks will respond with higher rates to keep them.

Term deposit savers should shop around.

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

We welcome your comments below. If you are not already registered, please register to comment.

Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current comment policy is here.

26 Comments

Comment Filter

Highlight new comments in the last hr(s).

I think the time has come for people to look at the alternatives to these large financial institutions. This sort of behaviour must drive people to respond by moving away from supporting this sort of selfish aggression.

However, the US money markets are not the only source of funding. European covered bonds are still a huge and very cheap source of funds and most big banks have considerable capacity to access these markets. Banks won't actually go to the US if the EU is cheaper.

I believe there is an RBNZ cap imposed on this type of bank asset securitisation and hedging out of EUR to USD to NZD via cross currency basis swaps is prohibitively expensive at the moment.

Last month, yields on U.S. 10-year notes turned negative for Japanese buyers who pay to eliminate currency fluctuations from their returns, something that hasn’t happened since the financial crisis. It’s even worse for euro-based investors, who are locking in sub-zero returns on Treasuries for the first time in history. Read more

At the end of the article you linked Sachin Gupta is talking about potentially no more carry trade. It seems to be a indicator that the bond market is likely to change direction. I'm wondering how much is left in the global asset bubbles and at what rate they are going to unwind.

Banks are as secretive as the Mafia and will never expose their margin , but if you recall in the bad old days of inflation , the Reserve Bank would recognise that the Commercial banks needed a 3% margin over the rate they set at the time for lending to the banks , and the OCR (or whatever we called it) plus 3% was the " prime overdraft rate" for borrowers in good standing .

Over the years , the banks have succeeded in making their lending rates so opaque (supposedly in the name of pricing for risk) that its almost impossible to fathom their actual margins .

You can be sure of one thing these boys are making more money than anyone else in New Zealand

For example , 1 year TD rates at BNZ are around 0,75% ( LESS THAN 1%) and they lend it to you and me at anything from 5.5% upwards (on mortgages ) and up to 20% on credit cards .

Some would say that even drug cartels and the Mafia can't make that kind of money, and they are probably right

Like I have said before , nice work if you can get it !!

"For example , 1 year TD rates at BNZ are around 0,75% ( LESS THAN 1%) and they lend it to you and me at anything from 5.5% upwards (on mortgages ) and up to 20% on credit cards ."

That's rather selective and misleading. That 1 year TD rate is for a sum of less than $5000. More than that and it 3.25%. The only fixed rate mortgage is 5.15% for 5 years, A one year fix is 4.85%. The only rate they have at "5.5% upwards" is the floating one.

Yes, and the state imposed O/N cash rate is still 2.25%. And is it not the truth that most Kiwis cannot last two months on savings if unemployment visits them.

It depends on which survey you read. About 28% say they would burn through their savings within a month. Yet another survey says 22% are broke after paying bills and another 22% spend any left over money after bills. So 44% would be in trouble immediately, and a further 23% have a regular savings plan. So 77% of NZers would be in trouble within a month or two of no income.

Do you have any links to this research?

Sorry there are a lot of surveys that google brings up. They are limited surveys and how far you can trust them is questionable. Some of the questions are skewing the answers as some seem pretty badly formed. The 28% might be a 26% on the third link (to interest.co).

http://www.stuff.co.nz/business/money/9688947/Kiwis-remain-poor-savers
https://www.horizonpoll.co.nz/page/285/third-of-hou
http://www.interest.co.nz/kiwisaver/65569/quarter-new-zealanders-would-b...

In addition to the slightly misleading statements you make comparing 1Yr TDs with 1yr mortgages (most banks have advertised TD rates around 3.25% and advertised HL rates around 4.25%) I am not sure your comment around margins is correct.

I'm pretty sure that banks disclose margin (either directly or indirectly) in their General Disclosure Statements... so they seem pretty transparent.

No they don't disclose their margins in a way you or I could even remotely understand them , you take a look at their Disclosure Statements and see if you can give me a figure for their margin income as a percentage over cost of funds or WACC ?

Only their ALCO will have a very good understanding of this in real -time

We also don't know what the "balance" of their short -term and long-term deposits ( mix) are , the Banking regulator will know , but we don't

We have a reasonably good idea of their margin income by simply doing the sums at a high level , but we have no idea what the real cost of $1 is to them , only they do .

And they are not telling , but you just have to look at the dividends paid to their Head Offices each year to know its a big number

refer : http://www.interest.co.nz/business/82926/after-their-australian-parents-... ... charts obviously sourced from publicly available data from GDS's

Ahh, check their financial statements..
Publically available data.

Okay nymad , you tell me what the best rate a firm in good standing is getting for an overdraft of say $50k from say ANZ vs BNZ ?

And one that does NOT have the business owners house tied up in it ?

You said "Banks are as secretive as the Mafia and will never expose their margin".
I just highlighted where you can find that general info.

Now you are asking for idiosyncratic information.
That's a lot different to thew general statement I rebutted for you.

However, the public conversation about floating rate reductions following an OCR cut is not really about mortgage rates.

It is really all about borrowing costs for SMEs. And that includes farmers.

Are the latter still locked into legacy IR swap deals where they pay fixed to receive floating against 3 month bank bill plus rates on rolling loan extensions?

There are still about $14.0 billion legacy Uridashi and $27.7 billion Kauri issues outstanding that demand banks pay fixed to a cross currency basis swap counterparty.

So what's more important to an economy? Home owners and their debts or.... Small and medium businesses and their debts? As for savers, no one seems to actually give a flying toss about them!

No one cares about savers because they shouldn't. 'Savers' don't exist, only investors.
What 'savers' never seem to understand is that they are competing with the Central Bank to lend money, whenever they 'save' it in a bank.
So, it is entirely the 'saves' fault that they choose to realise sub 3% returns. They are being efficiently remunerated, relative to the market and the level of risk they wish to hold.
If you want to be a saver, put your money under a bed or in a wardrobe. See how much return you get for that.

You are right - but I will demand gold or bank notes in exchange for the next residential property I choose to sell, rather than a faux bank credit in my digital account.

And that thing about the return of rather than return on your money
President of Property

Many will do exactly that if it the OCR drops further. So under your very narrow minded logic everyone who takes out a mortgage are ALSO 'investors" so they too can now start paying capital gains tax on their "investment" regardless of whether it's a family home or not. Nice one. thanks for clearing that up

Home owners and their debts are more important. Less money in home owners pockets = less money for local SME's.

Wrong, no business profit means no wages, means no wage/salary jobs for homeowners.
This is the fundamental problem with our ridiculous current 'too big too fail' banking system. It has highjacked productivity, creativity and innovation to the point that a huge majority of $$$ out there just goes to people trying to keep a roof over ones heads and the rest just flogging off homes or hoarding like its candy with only self indulgence being the harm. Well, its NOT! It harms everything.

What you as a Government and indeed anyone who cares about their job and income should regard as important is a healthy economy. So the answer is, SMEs the tradables sector IMHO.

If you collapse the economy into a depression by having too high an interest rate savers will a) take a huge hair cut and b) get nothing on what ever is left and c) get taxed as the Govn scramlbes to get enough $s to pay its bills. d) lose jobs in which case you cannot save.

Be careful what you wish for IMHO.

The banks will likely pass on the rates cuts eventually to borrowers, isn't the whole point of these rate cuts to stimulate the economy and not just to feed fat cat bankers.

Having lower mortgage rates will put more money in existing home owners pockets. We still have one of the highest mortgage rates in the western world.

I suspect the banks will pass on part of the cut, not all of it. Since the first quarter of the year the interest rates have gone up by around 0.1% which places the banks in a good position to cut by 0.1% if RBNZ announces a 0.25% cut.

The OCR cut is made out to be stimulus but it probably just turns into bank profits. Any cut will be slow to have any effect given the large number of 1-3 year fixed rate mortgages that people hold. In reality our central bank is mostly noise in the low interest rate environment so don't expect an economic effect of any merit.

Your access to our unique content is free - always has been. But ad revenues are diving so we need your direct support.

Become a supporter

Thanks, I'm already a supporter.