The trend of banks increasing their net interest margins and channeling their efforts into loan refinancing has raised concerns that it will reduce competition in the lending market.
This shift could have significant implications for borrowers and the broader economy, according to Peter James (pictured above), director of non-bank lender Mortgage Ezy.
“Banks are notorious for fattening their net interest margins (NIM) on loans whenever the cash rate scales higher,” James said. “While borrowers bear the brunt of RBA rate hikes instantly, banks conveniently sidestep depositors, short-changing them by passing on a fraction of the increase, if at all.”
“Regrettably, the past year has given rise to a two-speed highway.”
The rapid increase in the official cash rate, rising 12 times in 15 months, has left borrowers facing increased amounts of mortgage stress as a record number roll off low fixed rates.
However, Australia’s major banks delivered record half-year results and appear to be on track for a record full-year 2023 result, with cash earnings of $17.1 billion in the first half of 2023, according to a half-year PWC report.
This is on the back of the big banks raking in nearly $30bn in combined cash profit last year.
One reason for this difference is the banks’ NIM, which is the gap between the money they earn from loans and investments versus what they spend on deposits and interest-related costs.
In a Morgans report published in February 2023, it was noted that “CBA has maintained an optimistic outlook, aiming for a 4-basis point increase in NIM for every 25-basis point cash rate hike over time”, equating to 64 points in total of the rate hikes since May 2022.
Furthermore, NAB confirmed a “significant improvement” of 17 basis points in their NIM in their half year results report published on May 4.
For a broader perspective, the Reserve Bank offered insights into the funding dynamics of major banks.
It revealed that “deposits account for approximately two-thirds of major banks' non-equity funding, with this proportion remaining relatively stable over the past two years”.
While this is good for shareholders, it means that banks are passing on more of the rate increases to customers.
In contrast, non-banks largely rely on professional markets for their funding. Since the first cash rate increase in May 2022, bond market pricing has effectively doubled, adding approximately 1% to the funding costs of non-banks.
“Non-banks, hamstrung from raising money from the public have been at the mercy of the professional markets,” James said. “This stark disparity has smothered the fierce competition that once raged between non-banks and approved deposit-taking institutions (ADIs) with every twist and turn of the cash rate.”
The fallout, said James, is that banks have “indulged in unbridled price gouging”, a scenario that “unwittingly casts borrowers and the broader market as collateral damage”.
Historically, the situation hasn’t always been this way.
During periods of reduced loan volume, James said banks had often opted to “sacrifice NIM” to stimulate volume, which fostered healthy competition.
Over the past decade, meaningful competition for banks has come from non-bank institutions, as borrowers turn to non-banks in tight markets.
However, the landscape has evolved.
James said with non-banks now facing challenges in competing in the prime lending space, banks had “seized the opportunity” to target these loans to meet their volume requirements while simultaneously bolstering their profit margins.
“Non-banks are now finding it challenging to compete effectively, the lending market faces a new reality,” James said. “This situation raises concerns, as the absence of robust competition can lead to adverse consequences for borrowers and the overall economy.”
James said addressing these challenges required a multifaceted approach. One potential solution was to foster an environment that encouraged healthy competition among all players, including banks and non-banks.
“This may involve regulatory measures that promote fair lending practices and ensure that borrowers have access to competitive loan options,” James said. “Additionally, promoting transparency in the lending market can empower borrowers to make informed decisions and encourage lenders to offer competitive terms.”
“Ultimately, addressing these challenges calls for a concerted effort from regulatory authorities, financial institutions, and industry stakeholders to strike a balance between profitability and maintaining a competitive lending landscape that benefits borrowers and supports economic growth.”
