RBA says bank funding costs to rise for another year
Australian banks have increased their net interest margins by an average of 15 basis points since hitting historical lows in 2008, a Reserve Bank assessment published in the quarterly RBA Bulletin yesterday shows.
Since mid-2007, the major banks' average interest rate on residential mortgage lending has increased by about 120 basis points, relative to the cash rate.
The average cost of the major banks' funding is 90 to 100 basis points higher, relative to the cash rate, over the same period.
Expected losses from mortgage lending rose by five basis points over the period, and the equity cost of funding these loans increased by an estimated 10 basis points.
The average spread in the cash rate on new term-loans to large businesses increased by 200 basis points, from 150 to 350 points, between mid-2007 and mid-2009. Since then, spreads on new loans have stabilised.
Expected losses from business lending rose by an estimated 30 basis points over the period. And the equity cost of funding business loans increased by an estimated 40 basis points.
When the RBA reported on bank funding costs 12 months ago, it said the average cost of the major banks' funding was about 130 to 140 basis points higher relative to the cash rate than it was in mid-2007.
Marginal costs are coming down, but, the RBA says, overall, bank funding costs will rise for another year.
The latest figures show that, although increased debt funding costs have been the most important determinant of the increase in lending rates relative to the cash rate, lenders have also priced in increases in equity capital and expected losses.
This is particularly the case for lending to businesses, as both the share of equity capital used to fund business loans and banks' perceptions of the risks associated with this form of lending have increased noticeably.
Major banks have increased the share of equity used to fund liabilities by around one per cent to 7.5 per cent since mid-2007. The RBA has assumed a target return on equity of 20 per cent pre-tax.
While it assumes a constant rate of return on equity, it recognises that variations in the share of equity used to fund different types of loans will be a factor in different lending rates. It estimates that two per cent of the value of residential mortgages is now funded from equity, compared with 0.5 per cent in 2008.
This would increase the equity cost of funding these loans by as much as 10 basis points.
Equity funding for business loans has risen from an estimated six to eight per cent, increasing the equity cost of funding business loans by 40 basis points.
The average cost of deposits is slightly below the cash rate. Before the financial crisis it was 150 basis points below the cash rate. The average cost for regional banks is slightly higher than for major banks, reflecting their greater reliance on higher-cost term deposits.
Since mid-2007, the higher cost of deposits has made the largest contribution to the overall increase in debt funding costs, reflecting their large weight in total funding and the 130 basis point rise in average deposit rates relative to the cash rate.
The cost of long-term wholesale funding, which is currently around 100 basis points over government securities, continues to place upward pressure on banks' funding costs
Nearly 20 per cent of outstanding term-funding was issued at lower spreads prior to mid-2008.
As the repricing of maturing bonds continues, the average spread of banks' outstanding long-term debt will increase by about 15 basis points over the next year. If the share of long-term debt in overall funding were to remain at its current share, of around 25 per cent, and spreads on new issuance remain steady, this would imply an increase in total funding costs from this source of just under five basis points over the next year.