On July 2nd the RBA followed up on its 0.25% cut to the cash rate in the June meeting with a further 0.25% cut, taking the cash rate to 1.00%. At both cash rate announcements, the Aussie 4 major banks were quick to respond, all announcing decreases to their mortgage rates. However, across the two cash rate cuts, the major banks did not pass on all the benefits of these rate cuts.
Total P&I owner-occupier mortgage rate cuts from the major banks following the last two RBA meetings are summarised in the table below:
So why are the banks not passing on rate cuts in full?
The answer is both simple and complex - the Overnight Cash Rate (OCR) that the RBA is effectively influencing through its monetary policy decisions is no longer a dominant component of a bank's overall funding.
The OCR is the rate that banks lend and borrow to and from one another, on an overnight basis.
It is estimated that the average daily inter-bank funding at OCR is approximately AUD4-5billion, only a fraction of the total funding that is undertaken by Australia's financial institutions.
Composition of bank funding:
In the last twenty years, bank funding has seen a shift from short-term wholesale funding, to longer-term and 'stickier' domestic deposit taking from retail and commercial sources.
This has been brought about by a need for stability of funding, as well as various regulations that have the same goal in mind. Examples being high capital adequacy, higher liquidity (LCR), stronger net stable funding (NSFR) and other regulatory requirements.
All of this was prioritised by global banking syndicates to ensure a more robust banking system.
As this shift happened, less and less transactions were contracted daily at the cash rate as liabilities were extended along the yield curve to smooth funding profiles.
For those that bought term deposits in 2009-2011, you would've noticed banks went from issuing TDs at +0.30%-0.40% over the cash rate, to +3.00%-3.50% over. This premium was due to a rush by banks to fulfil regulatory ratios and stabilise their funding bases.
The reducing relevance of the cash rate:
This funding shift has had implications for monetary policy.
The OCR, the benchmark rate that the RBA manipulates, has become increasingly less relevant as banks have diversified their funding sources and out of necessity become more reliant on longer-dated bank bills (6 to 12 months), secured funding (repurchase agreements or FX swaps), term deposits and notice accounts.
As recently experienced, banks are increasingly willing to move their own loan/deposit rates "out-of-cycle" to RBA cash rate moves.
There was much political fanfare when CBA and ANZ hiked rates out of cycle in September 2018 after the bank bill swap rate (BBSW) remained elevated for a prolonged period.
BBSW constitutes ~30% of bank funding at present and is a much larger influence on their overall funding costs than the RBA cash rate.
RBA cash rate = yellow line
3 month BBSW = white line
Ignoring the noise from both politicians and news outlets - bank funding costs have become increasingly detached from the RBA's tool for monetary policy - which reduces the efficacy of monetary policy.
If interest rates drop further and approach zero, there is a natural sticking point at 0%, where further monetary easing will lead to negative interest rates - where a depositor would pay interest to the banking institution to hold their money. This has social implications for a country such as Australia, where individuals are net savers thanks to compulsory superannuation.
As such, the banks can only pass on so much if the RBA cuts rates further, to achieve and maintain their own profitability and margins.
At present, the market is still pricing in another RBA rate cut for Feb 2020 - so only time will tell if RBA monetary policy is still an effective mechanism to promote growth and economic stability