What do the banks mean when they complain about the cost of funding?

Recently our banks began raising interest rates out of step with the RBA and they blame this on their increased cost of funding.

So what does this really mean? In a recent article finance strategist Rolf Schafer explains how this works….

Why aren’t the banks following the RBA?

Obviously, every mortgage holder has an interest (no pun intended) to see rates lowered. However, the banks have not obligation to follow the Reserve Bank of Australia

Banks have always been independent of the RBA when setting their interest rates.

So, why is this big news at the moment?

Because the banks are complaining that their cost of funding has increased.

In short, ‘cost of funding’ is the amount of interest cost paid by a financial institution for the money they have acquired from various sources (in Australia’s case, mainly from overseas).

According to an article on the Reserve Bank of Australia’s website” the banks have increased their equity funding, which is more costly than debt finance. Second, risk margins on loans have risen to account for higher expected losses.”

Banks take a number of factors into account when setting interest rates. Over the past few years, the cost of funding debts for Australian banks has significantly increased. Banks also need to take into account their expected losses.

The European Debt crisis has also increased bank cost of funding, although with easing pressure thanks to the bailout of Greece, these should begin to fall.

What most people are upset about is the fact that the banks aren’t keeping in line with the rates set by the RBA.

However, even Governor Glenn Stevens admitted in an interview on ABC Radio that, while the cash rate has fallen around 50% over the past year, the bank’s cost of funding hasn’t come down that much. So, it would make good business sense that for the banks to support a health economy, they, in turn, need to be strong.

In short, while bank profits continue to rise, so do costs.

Sometimes our politicians might find it popular to publicly criticise the so-called “greed” of our top four banks, but they would also recognise that there are often good reasons for their actions beyond a desire to please their shareholders.

A strong economy

With an economy that is the envy of the world, all Australians should be relieved that our banks continue to remain strong. However, it’s not entirely true that RBA has no effect on what actions the banks take.

For example, the recent actions of all 4 banks to raise their rates could likely force the RBA to lower rates in the future. This will put added pressure on all of the banks to follow suit.

However, whatever the RBA does is in the interest of every Australian. Their outlined task is to set the monetary policy for Australia, in order to achieve low and stable inflation in the medium term. Other important responsibilities of the RBA are:

  • to maintain financial stability and the stability of the Australian dollar;
  • to maintain full employment;
  • to contribute to the economic development and wealth of the inhabitants ofAustralia;
  • to act as banker for the Australian government;
  • to issue Australian currency;
  • to manageAustralia’s foreign currency reserves.

So, who’s in charge of interest rates?

In a recent article in the Financial Review, Steven Munchenberg, chief executive of the Australian Bankers Association, said that despite recent activity, the RBA is still firmly in control.

“The RBA takes into account bank funding costs, and their likely rate movements, in its decision making so that any rate changes remain within the framework of monetary policy.” he wrote. “Borrowers pay what the RBA, in effect, wants them to pay.”

It will be interesting to see what happens to interest rates in the coming months.


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