RBA cash rate could have been around 5% if banks had passed on full rate cuts: Philip Lowe

Reserve Bank deputy governor Philip Lowe returned to theme of higher funding costs pushing up bank lending rates at a speech in Sydney today.

Lowe presented the following slide as part of a talk on the euro crisis at The Economist Bellwether Series showing that average bank lending rates have risen more or less in tune with increases in funding costs.

Yesterday, at an economist conference in Melbourne, Lowe said the Reserve Bank reduced the cash rate by around 150 basis points more than it would otherwise have done to compensate for the widening gap between the benchmark lending rate and interest rates set by the banks.

Speaking at an economists’ conference in Melbourne yesterday, Lowe said that due to both market and regulatory developments there had been an “increase in most interest rates in the economy relative to the cash rate”.

“This is something that the Reserve Bank has spoken about at length, and it has been an important factor in the setting of monetary policy over recent years.

“In particular, this increase in interest rates relative to the cash rate has been offset by the bank setting a lower cash rate than would otherwise have been the case. While it is difficult to be too precise, the cash rate today is in the order of 1.5 percentage points lower than it would have been in the absence of these developments,” said Lowe.

According to mortgage comparison website RateCity.com.au, the average standard variable rate stands at 6.38%, compared with a cash rate of 3.5% with banks passing on around 80% of cash rate cuts since November last year.

Westpac economist Bill Evans, who is tipping the cash rate to fall to 2.75% by year-end, said that following the 50-basis-point cash rate cut in May the average standard variable mortgage rate (SVMR) fell by 35 basis points, “blunting the potential impact”.

A week after the June decision to cut the cash rate by 25 basis points, Evans said just one major bank had announced that it would cut its standard variable mortgage rate by the full 25 basis points.

But Lowe also acknowledged the increasing costs that banks have had to bear since the GFC due to increasing regulation.

These include having to keep high reserves of cash, improving the quality of the capital held and holding more liquid assets.

“These changes are occurring not just because of new regulations, but also because they are being demanded by the marketplace,” he said.

“Together, these various changes are increasing the cost of financial intermediation conducted across the balance sheets of banks.

“In effect, the choice that our societies are making – partly through our regulators – is to pay more for financial intermediation and, perhaps, to have less of it.”

Lowe says the benefit of these changes and having to pay a higher price is “a safer and a more stable financial system”.

“As the world is being painfully reminded, the losses in output during a crisis and in subsequent years are substantial, and some of the losses may be permanent,” he said.

Lowe said Australia’s banks, alongside those in other countries, would continue to feel the impact of regulatory changes, as well as a “global loss of trust in financial institutions” that had led to all banks paying more for their funds in capital markets.

“These various changes are increasing the cost of financial intermediation conducted across the balance sheets of banks,” Lowe said.

“In effect, the choice that our societies are making – partly through our regulators – is to pay more for financial intermediation and, perhaps, to have less of it.

“The benefit that we hope to receive from paying this higher price is a safer and a more stable financial system.”