How Do Banks Raise Rates Above RBA Rate?

[Spanning Tree]

RBA has set interest rates, but private banks like NAB have increased their own home loan rates above those set by the RBA. I would like to ask how is this possible? I know that the RBA sets interest rates by buying and selling bonds. Through arbitrage, bond interest rates affect other interest rates, such as home loan interest rates. Any difference can be arbitraged away. So then how is possible that private banks can raise rates above RBA rates? Can someone explain the economics behind this?

 

[prawn_86]

Ok my economics isnt really the best but i'll give it a crack:

There is no law in place saying that the banks must set their rates at what the RBA decides.

Oz has the Big 4, which is an oligopoly with huge market share between them. These 4 know that most people dont change banks often, and even when they do churn it is likely to be another big 4, so hence they are not in the business of price wars to gain market share. Cancellation fees just enhance this.

Hence why as soon as one bank raised rates independently the others followed, gotta keep the shareholders happy...

Some argue that the gov can apply pressure to the banks to not raise rates outside of the RBA, those same people would probably argue that in the last 10 or so years it hasnt happened so the new gov is weak. I know very little about politics, so cant comment, but i would like to know exactly how a gov can apply that sort of pressure.


Thats about it I think. Feel free to add more

 

[MRC & Co]

I imagine this is very complex with a lot of mathematics involved if you want to understand how it works exactly.

Would like to see somebody try and explain it though. Unfortunately, my economics did not go into the specifics behind monetary policy (only the broad basics). As I stated in another thread, the over night money market is a complex and confusing beast, it leaves my brain for dead! An area of which you would have to specialist in. I know an economist who contracts to the RBA (an absolute genius), so he would probably understand the specifics behind it these days. Will have to talk to him.

 

[dhukka]

RBA has set interest rates, but private banks like NAB have increased their own home loan rates above those set by the RBA. I would like to ask how is this possible? I know that the RBA sets interest rates by buying and selling bonds. Through arbitrage, bond interest rates affect other interest rates, such as home loan interest rates. Any difference can be arbitraged away. So then how is possible that private banks can raise rates above RBA rates? Can someone explain the economics behind this?

Firstly it should be pointed out that the RBA does NOT set interest rates. It sets the rate on the overnight cash rate. From the RBA website:

The cash rate is the rate charged on overnight loans between financial intermediaries. It has a powerful influence on other interest rates and forms the base on which the structure of interest rates in the economy is built.

In a normal environment Banks will pass on both interest cuts and hikes to customers. But we are not in an ordninary environment. The cost of funding for banks has risen significantly, the ddays of cheap credit are gone (at least for now) hence why the 30 yr mortgage rate in the US is basically unchanged from a year ago whilst the Fed funds rate has been slashed from 5.25% to 2.00%.

I suspect the banks will follow the first few moves down by the RBA but if the RBA gets aggressive don't expect mortgage rates to fall in line with the cash rate.

 

[Tysonboss1]

RBA has set interest rates, but private banks like NAB have increased their own home loan rates above those set by the RBA. I would like to ask how is this possible? I know that the RBA sets interest rates by buying and selling bonds. Through arbitrage, bond interest rates affect other interest rates, such as home loan interest rates. Any difference can be arbitraged away. So then how is possible that private banks can raise rates above RBA rates? Can someone explain the economics behind this?

Does any body Know what % of the funds bank's lend actually comes from the RBA,...

Banks like any business buy the funds at a wholesale rate and then lend them at a retail rate.

If the bulk of the Funds they are lending comes from sources more expensive than the RBA then they have to charge more.

In the banks defence alot of the banks are currently taking deposits on interest rates of over 8.25% ( which is higher than the RBA rate anyway) and the discounted variable rate is only 8.94% thats not an overly big margin.

__________________

 

[ROE]

According to RBA paper, only 20%-30% of their funds comes from over sea
but that doesnt really mean much as banking is all about risk

and if they start losing money made on bad decisions or low margin loan. They then need to source income from else where to maintain the margin or to off-set bad debts.

and one source of that income is loan book and maintaining high interest rate during bad times to offset bad debts is easy work or increase fees which I suspect they will in the next year is also high return with low risk

 

[pepperoni]

From my basic knowledge i understand its pretty simple.

The RBA sets a rate at which it will lend to banks.

Banks get some of their funds from the RBA which means their rates are to a degree influenced by the RBA rate.

But in reality banks will set rates as high as competitively possible to maximise profits.

Why people want to get into 30 year commitments where the price is totally at the banks discretion is beyond me!

Most unfair deal, and worst investment decision, ever IMO ... Ive taken 2 mortgages of less than 5 years each.

 

[gfresh]

Er, the banks difference between the overnight rate they borrow at, and what they charge customers is called PROFIT. So they will always charge above that rate. I don't think anybody has made this clear, but I thought this was the crux of it.

If all they did was borrow at the RBA target rate, and sold at the target rate, they wouldn't be making any money. Banks are in the business of making a profit.

If they need more profit (or to make up for losses in other areas), or to factor in risk, they will raise rates higher, which is what is happening at the moment.

There are no doubt less greedy and fairer systems which could work, but that is capitalism for you where the bankers and central bankers rule the land under the fractional reserve system. Each man for themselves, and if you aren't trying to get rich by borrowing, you aren't trying hard enough! Have to love it.

 

[Knobby22]

They do it like this:

First they decide they want to.
Second ; Signal to all the other banks in the ogliarchy we have in Australia that they want to do it. This needs to be done through the media to avoid them looking like they are forming a cartel.
Third: Get economists to argue their case for a rise to the public.
Fourth: Raise rates and watch the other banks do the same.
Five: At the Melbourne Club, ensure you tell which CEO of the another bank that it is their turn to do something to rip off the public next time e.g. fees/ another rise.

 

[Macquack]

They do it like this:

First they decide they want to.
Second ; Signal to all the other banks in the ogliarchy we have in Australia that they want to do it. This needs to be done through the media to avoid them looking like they are forming a cartel.
Third: Get economists to argue their case for a rise to the public.
Fourth: Raise rates and watch the other banks do the same.
Five: At the Melbourne Club, ensure you tell which CEO of the another bank that it is their turn to do something to rip off the public next time e.g. fees/ another rise.

Good stuff. I think you summed up the process nicely.

One question, in point Five, is it "At the Melbourne Club" or "At the Melbourne Cup."?

 

[HUGHIE]

Have seen a few statements recently made by Banks re Tax on savings – seems they want us to save more so as they can get their hands on our money at a cheaper rate. Having said this it is intriguing to note the rate of interest that is on offer from them, in particular the “On Line/on call” savings accounts, from 8.5% down to a lousy .05%. I would be interested to know what they are paying for their money given the RBA rate is 7.5%