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Banks' rates not determined solely by cash rate: RBA

Staff Reporter 4 minute read

Changes in risk premia in financial markets, following the credit crisis, have weakened the relationship between the cash rate and banks’ mortgage rates, with the cash rate no longer completely indicative of where home loan rates should be, the Reserve Bank has conceded.

In a research paper released yesterday, the RBA explained that for most of the past decade banks’ funding costs had tended to move in line with the cash rate, resulting in a market practice whereby small business and home loan variable rates closely tracked the cash rate.

But capital market instability has meant that banks’ funding costs have not fallen in line with the cash rate, the RBA said.

It is now estimated that banks’ outstanding funding liabilities have fallen by around 330 basis points since the first reduction to the cash rate in September, around 95 basis points less than the 425 basis point fall in the official cash rate.

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“The recent financial turbulence means that while the cash rate remains a key influence on banks’ funding costs, the costs of the various forms of banks’ funding have not fallen as much as the cash rate due to an increase in term premia and credit and liquidity spreads,” the RBA said.

Despite this, the RBA said the major banks had been able to slightly increase their net interest margins by offsetting lower margins on home loans with higher margins on business lending.

Since September small businesses have only enjoyed 230 basis points in interest rate cuts, the RBA said, but not only to recoup margins but increase their risk margins, it acknowledged.

Banks' rates not determined solely by cash rate: RBA
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