Tuesday, 7 February 2012

Deposits, Bank Funding Costs and Bank Bashing

That $400,000 you were just loaned by your friendly bank to buy that new house didn’t come out of thin air.

The bank had to raise the capital to lend to you and since the GFC, about half of these funds come from deposits, about 40% from wholesale funding with the other 10% from odds and sods.

For this note, I will focus on deposits.

Prior to the GFC, deposits rates paid by the banks to savers were around 100 to 200 basis point BELOW the official cash rate (using 6 and 12 month term deposits as the benchmark).  The banks were stingy and miserable in their deposit interest rates because they were raising plenty of capital in the wholesale market cheaply and easily so they didn’t need to be too aggressive in bidding for funds from depositors.

Now, in the post-GFC environment, things are very different.  Deposit interest rates range from being around the cash rate to around 100 basis points ABOVE it.  Banks are obviously trying to get capital to lend to you and me buy paying more to get their funding from deposits.  They are not doing this to be good corporate citizens.  They are doing it because the cost of raising funds in the wholesale market has risen and it pays them to pay up for deposits.  It's great news for savers and may well explain the drop in money being put into the stock market is recent times.

The bottom line of all this is to show that the cost of being a bank that lends money to consumers and small business has gone up.  It’s why the margin between the cash rate and retail interest rates has changed so much in the last 4 or 5 years.

And it’s why we are likely to see one or more banks hiking lending rates in the next few weeks.  

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