Having a lend: does our money go straight to the banks when mortgage rates go up? (2024)

When indebted households send extra money to their lender to cover the latest increase in their fast-rising mortgage repayments, they could be forgiven for feeling a little bitter.

This week, two of Australia’s biggest lenders reported swelling margins on the back of rising rates.

But is there really a direct link between a customer’s increasing loan repayments and bank profitability? Or, like the financial sector itself, is the connection more opaque?

Bumper profits

Australia’s big banks are profiting from a rising interest rate environment, a point acknowledged by the Commonwealth Bank and National Australia Bank when reporting recent strong returns.

The profitability of Australia’s largest bank and biggest lender, CBA, is also evident in its share price, which had been hovering near record highs before a pullback over the past few trading sessions.

But banks don’t necessarily profit from receiving higher residential and business loan repayments – they are in the margin game.

Three-quarters of CBA’s funding is drawn from household and business deposits. This percentage represents a small increase in recent years but a dramatic shift from the time of the global financial crisis when deposits accounted for just 55% of funding.

Given Australia’s big banks have not been raising deposit rates at the same pace as interest rates since the central bank started lifting the official cash rate in May last year, bank margins have increased.

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NAB’s net interest margin, the main barometer of profitability, rose by 12 basis points in the December quarter to 1.79%.

CBA’s margin increased by 18 basis points to 2.1% in the six months to December.

On Friday, the Reserve Bank governor, Philip Lowe, chided banks for not passing on rate rises to savers fast enough, and he encouraged customers to look for a better deal.

“If Australians switch, then the banks have to respond. When there is competition, firms have to respond,” he said.

Banks also have access to some funding they pay little or no interest on, such as transaction accounts, and they also draw on wholesale funding that reflects demand and risk appetite from international investors.

Representative body Australian Banking Association (ABA) says expenses are on the rise.

“Like other businesses, banks borrow money to fund their operations. Like banks overseas, the cost of Australian banks’ borrowings has increased,” says the ABA, adding that there have also been increasing compliance and operational costs.

‘Curveballs’ for the banks

The past six months have proved to be a particularly difficult period for many households, with rising mortgage rates and rents as well as inflation-fuelled price rises for electricity and food.

At the same time, it’s been a highly profitable period for the banks due to the differential between the rate they pay to savers, and the interest they charge borrowers, even taking into account fixed loans.

While lending rates and funding costs drive profitability, there are also other factors at play, such as bad debts and the general health of the economy that will dictate how much business the bank is doing with customers.

“When interest rates go up, their lending rates tend to go up faster than their deposit rates – but that might change towards the end of the cycle,” says Shane Oliver, AMP Capital’s chief economist.

“As interest rates go higher, that leads to less sales by the banks and credit growth slows right down and eventually leads to losses on some of their loans.”

NAB recorded a jump in credit impairments – loans that might not be repaid in full – in the past quarter, while CBA’s results showed there could be trouble brewing in specific sectors, such as construction.

Meanwhile, NAB and ANZ announced large increases on some of their savings accounts, with the latter offering an additional one percentage point on its Progress Saver account, the equivalent of four 25 basis point rate rises in one hit.

This has occurred days after the competition watchdog announced it would investigate how banks set interest rates for savers, including differences in rate increases between home loans and bank deposits.

“The banks have had it good for a long time and now there are some curveballs they need to watch out for,” says Effie Zahos, money commentator at the financial comparison site Canstar.

“There is pressure here for the big banks to lift their game when it comes to savings deposits. Banks are in a good position, it just means their profits will be squeezed.”

Margin protection

This week, Lowe cited the need for resilient and profitable banks, even if that seems unpalatable at a time when many households are under financial stress.

But there’s no consensus on how profitable, or what sort of return on equity they should generate.

In 2017, the then prime minister, Scott Morrison, rightly claimed that Australian banks had a return on equity of about twice that of rivals in other parts of the world.

Past practices show the banking sector is willing to protect those margins, even if it means using highly unpopular out-of-cycle rate increases – whereby banks increase interest rates even if the central bank does not – as they have before.

This discussion will probably be put back on the table some time after the RBA halts its current series of increases, according to some in the banking sector.

NAB recently raised its expectation for the peak RBA cash rate to hit 4.1%, implying three more 25 basis-point increases to come. On Thursday, another of the Big Four, ANZ, followed suit, matching the prediction.

“Persistence in inflation pressures suggests that the cash rate will remain in restrictive territory for some time,” said ANZ economists, referring to a policy setting designed to cool the economy.

ANZ expects the RBA will add to its ninth consecutive rate increase in February with increases in March, April and May to follow. The rate would then hold at 4.1% and not start retreating until November 2024 – an 18-month pause.

One reason some in the banking sector expect out-of-cycle rate rises to be up for discussion in the near future is that the banks are losing access to a pandemic measure that allowed them to draw on cheap funding.

The idea behind that RBA term-funding facility was that it would encourage the financial industry to extend credit, and keep the economy moving, amid early pandemic fears it could crash.

The argument follows that banks will therefore consider out-of-cycle rises to restore the current margins they enjoy.

The brunt of the financial headwinds, however, will not fall on the banking sector that has previously navigated more troubling times than this, with the burden to fall on the young and the indebted.

While self-funded retirees aren’t happy about the speed rate rises are appearing in their savings accounts, ultimately they’ll receive higher savings rates.

“The winners tend to be people who have high savings, and obviously benefit from high interest rates,” Oliver says.

“The losers tend to be those with net debt. Those with more net debt tend to suffer because they pay more on interest rates servicing that debt. Those in debt tend to be younger.”

With Peter Hannam