In response to the RBA announcement three of the Big 4 banks, along with a number of smaller institutions, have increased one, two and three-year term deposit rates by up to 60 basis points, to rates that will now see savers ahead on their cash savings after tax and inflation.
To fund these increases, banks have passed on between 10 – 14 basis points of the cash rate cut to mortgage-holders.
While the decision of the Big 4 to restrict mortgage reductions and increase term deposit rates surprised many commentators, it is in retrospect not surprising at all given the pressures of regulatory reform and global funding markets, both now and coming soon. In fact the majority of New Zealand’s large banks have followed Australia’s strategic lead in the wake of their own cut in official cash rate.
Why are banks increasing term deposits?
Regulatory reform is perhaps the most significant pressure; the Basel 3 reforms are in the process of imposing stronger liquidity requirements (LCR) on lending institutions. Banks are required to hold highly liquid assets equal to or greater than net cash outflow over 30 days. The coverage ratio became effective 1st January 2015.
Because banks are required to hold low-yielding assets (e.g. government bonds) for deposits and wholesale funding that has a maturity of less than 30 days, it makes deposits with a maturity greater than 30 days more attractive. Hence the introduction (albeit slow) of notice accounts that require 31 days’ notice to withdraw, and the toughening up by the banks on allowing early breaks of a term deposit. Obviously as a result of these ratios, term deposits are becoming more attractive to the banks, leading to a re-pricing up by the Big 4.
Judging by the speed with which the majors announced their loan and deposit decisions after the RBA announcement, ANZ, Commonwealth Bank and Westpac had carefully planned and costed this strategy in advance. In not passing on the full 25 basis point loan reduction the banks are obviously protecting margins and establishing a funding mechanism for competitive 2 and 3-year fixed loans that are quarantined from the variable rate book. The same can be said on the funding side: the banks in passing on increased rates on term deposits are not passing them through to their whole deposit base (for example existing term deposits until maturity, at-call bonus and online savers, and shorter-term term deposits). Analysis of more than 100,000 visitors to the CANSTAR term deposit comparison tables so far this year finds that the significant majority of investors are looking for an investment term of 12 months or less. This latest move is likely to change this behaviour as investors chase the higher return. Another good reason for consumers not to opt for the lazy rollover option!
Table 1: Big 4 term deposit rates
Source: canstar.com.au. Interest rates at maturity, based on a $25,000 deposit. CommBank interest rates above are not effective until 19th August
There are a number of reasons why term deposits are an attractive way to manage both liquidity requirements and profit margins:
Competition will significantly increase
The actions of the large banks to increase their domestic deposit reserves puts significant pressure on the smaller banking players, which are all far more reliant on term deposits to fund their home loan bases.
Canstar marketshare analysis shows that the top and second tier of banks’ term deposit aggregate is less than 16% of their aggregate home loans. Smaller institutions’ reliance on term deposits to fund their balance sheet is, in most cases, double that and more. The smaller institutions therefore have much to lose and will be obliged to stay competitive in this space and raise their 1, 2 and 3 year term deposit rates accordingly. Indeed this is already happening, with more than a dozen smaller players matching or exceeding the 12 month term deposit rates of the Big 4; currently a smaller number have moved on 2 and 3-year rates.
The big banks can afford to pay a bit to grow the term deposit base and it falls so neatly in line with the Basel 3 reforms that it is attractive for them. Tellingly of the 54 financial institutions that CANSTAR has noted as reducing standard variable home loan rates so far since the August RBA rate announcement, only six have passed the full 25 basis points through to borrowers. Protecting deposit market share appears to be the primary focus right now.
Keep an eye out for possible out of cycle home loan increases by the smaller institutions over the next 6 – 12 months as margin pressures bite. This will be aggravated by maturities in the existing book rolling into higher rates.
Overall, the cash rate is simply a signalling mechanism that flows through to other rates in the economy. This time it has not flowed through fully on the housing front, which both the RBA and APRA may quietly welcome and instead, for the first time in many years, has provided welcome relief for savers.
Stephen Mickenbecker is the Group Executive Ratings and Financial Services of CANSTAR.