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Banks Tell The Truth, For Once

By The Noble Contrarian on December 15, 2010 in Other

The latest in a painful series of ‘determined to be different’ advertisements claims Commonwealth Bank has “more satisfied customers than any other Australian Bank”. Given they have the most customers by a large margin, this is probably true. No doubt they also have more dissatisfied customers than any other Australian bank (Telstra will probably start using the same line on us soon).

Most of the messages we hear from the banks are like this. Drivel. On mortgages, though, they have a point. Home loan rates should rise by more than any increase in the Reserve Bank’s official rate.

Some countries, China and Japan, for example, generate excess savings. That means the money that people have to invest outweighs the money people want to borrow – all the Chinese banks need to do is get the money from one group and lend it to the other.

In Australia, our enthusiasm for credit far outweighs our propensity to save. Across the banking sector, when you compare the demand for loans and the supply of deposits, there is a massive deficit. This hole needs to be filled by foreigners (the excess savings in Japan and China eventually make their way around the world to plug the gap).

Three years ago these foreigners were prepared to lend to us at margins as small as 0.1% over the benchmark rate. Post GFC, they are not so generous. The equivalent margin is 0.8-1.0%.

The reason this is still impacting on the banks’ cost of funds today is that our banks had locked in the low borrowing costs for three, four and five years. As the old, cheap funding rolls off and is replaced by new, expensive funding, the average cost of funds continues to rise.

If I’ve lost you don’t worry, the point is that, for once, the banks are telling the truth. Their funding costs are rising. And, because home loans are such a politically sensitive area, they have not been able to pass the increase on to their customers. The banks are making less money on mortgages than they were three years ago.

Fear not if you are bank shareholder. The overall net interest margins for Australia’s big four have risen since the onset of the crisis. That’s possible because the lower margins on mortgages have been offset by charging through the nose for any loan that isn’t a home loan.

Small to medium businesses are paying margins 3-4% higher than they were before the crisis, compared with 0.2-0.4% extra for homeowners.

This is a bad outcome for the overall economy. Resources are being diverted from productive business assets to unproductive housing, and the banks, by charging below market rates on home loans, are making it almost impossible for anyone else to compete. All because of an unhealthy political obsession with mortgages.

The Australian banking sector is not competitive enough. It’s a cosy oligopoly where the profits made far exceed a reasonable return on capital. Contrary to popular opinion, Australia’s homeowners are the one group of borrowers that aren’t paying the price.