Interest Rate Margins
January 29th, 2009 at 9:00 pm by David Farrar
This graph used the Reserve Bank data and shows the difference between what banks are charging for floating mortgages and what they pay for six month term deposits.
The big spike at the end is the credit crisis at work, but also maybe showing that the banks are not doing too badly.
But what I found interesting is there has also been a gradual increase since 2000 in the margin.
Related posts:
- The culprit for interest rate rises
- Hickey on bank margins
- Talking down interest rates
- Guest Post: Our high exchange rate
January 29th, 2009 at 9:13 pm
I suspect the 2008 spike reflects political instability as well as it became clear that Labour really wasn’t rational, and the Nats were somewhat confusing.. as happens during an important election.
JC
Vote:January 29th, 2009 at 9:22 pm
My suspicion is that having less our mortgage lending tied up in fixed term plans would see margins stay more level. Something to do with banks having less day-one exposure when the OCR moves and they don’t match it. Gut instinct here.
Vote:January 29th, 2009 at 9:26 pm
Oh that, and knowthing that their debt risk has been increasing, the property bubble becoming too big etc. They’ve been saving up for a rainy day. Actually quite wise, just a pity it was with my money. It’s a shame the NZ Govt didn’t forsee the storm brewing. Instead they purchased a rusty train set and stuffed the public ‘service’ full of policy analysts etc.
Vote:January 29th, 2009 at 9:35 pm
Heard today on talk back (oh why do I listen) but it had an accountant ring in. His inside opinion is that they are padding up for the expected bad debts. As for the slow increase I assume as every company should do is try to increase profits more shows lack of competition.
Vote:January 29th, 2009 at 10:37 pm
I thought floating rate was linked to the 90 day bill market and if so linking it to the 6 month term deposit pay rates isn’t really the correct relationship to show. If the graph showed the 6 months mortgage rates and pay out rates discrepancies or the 90 day vs floating that would be more accurate – assuming I’m right about the link of course.
So ….. I used the same data you linked to from the reserve bank and graphed the interest rate differential between floating mortgage rate and the 90 day bill rate and saw some interesting results. I haven’t worked out how to stick the graph in my post so I’ll just summarise and hopefully you can repeat the exercise to confirm I’m not making it up.
Pre 2000 the differential was MUCH more variable (noisy if you like) but overall averaged 2%. Post 2000 – it has been VERY steady around 2% – a linear trend line shows a VERY slight downward trend since 1988. The trend since 97 has a definite upwards trend but not a big one. There HAS been a big jump since March 2007, which indicates that the banks started to become risk averse and/or profit taking.
Such a reduction in variability of profit margin between base costs and sales price indicates cartel like behaviour but does not necessarily indicate increased gouging. Competition tends to lead to more variability as different companies go for market share at different times, for instance.
However, if we look at the enormous increase in loans amounts over that period, the reduction in overheads the main banks have had (closing branches, internet banking, less staff, less staff per loan) this is strongly indicative of an environment where we do have cartel like behaviour. Margin per loan is probably increasing as other costs per loan are dropping.
I think even my analysis is a bit simplistic as I haven’t looked at return on capital, risk profiles and thus bad debt provisions (which have dropped enormously since the early 90s for instance) but once again a rough analysis indicates we are being asked to bend over without the benefit of a lubricant by the big 4 ozzie owned banks.
This type of cartel like behaviour does have regulations to address it but NZ is rather bad at picking on business when they do it.
Vote:January 29th, 2009 at 10:52 pm
It’s never failed to amaze me there are three industries where Joe public resent these industries making a profit. Banking, Insurance, and Pharmacys. These industries provide a service, they have shareholders or owners to pay a return on investment. I personally think its because a fair amount of what they do provide is free, the public want it all for free. Try getting an Accountant or Lawyer to do something for nothing. Yeah Right !!!
Vote:January 29th, 2009 at 11:20 pm
Seen your accountant increase rates by 50% since 2007?
The banks in NZ take the piss, alot.
In the same way the UK was called treasure isle during the 70/80′s by car companies, NZ is a cash box for AU banks.
Vote:January 29th, 2009 at 11:31 pm
Hi Murray
I think the point isn’t about making a profit but rather signals of cartel like behaviour, which is illegal. Capitalism is the bees knees but has some weaknesses, one of the biggest being cartels and monopolies, which is why we have laws against this type of stuff.
The indications are these guys could be breaking the law.
Vote:January 30th, 2009 at 12:20 am
Murray M – you forgot oil companies (and the free air)
Vote:January 30th, 2009 at 6:46 am
When I was trying to organise a deal with three NZbanks.
They all came back with the same answers, and it wasn’t pretty.
If there is no cartel, I would be amazed. The excuses for their stances were almost identical.
In the end, just paid cash. It was a lot easier, and cheaper, and with a lot less risk.
They wanted PG’s on our borrowing, but could only refer to Government guarantees for money held by them as an offset.
And they all wanted 700 basis points spread on the swap. That’s not banking. That is taking the mickey.
Vote:January 30th, 2009 at 6:56 am
Dealing with this issue involves recognising we’re entering a new paradigm. Lowering interest rates previously resulted in increased activity because there was no scarcity of people wanting loans and no scarcity of banks and other institutions willing to lend. The rules have changed, therefore we need new tactics.
The overseas banks that own every NZ bank bar one, all have significant balance sheet issues due to two issues. Firstly there are significant as-yet unrealised liabilities for toxic debt – CDOs and derivatives. Secondly their provisioning for bad debts due to future loan defaults is rising fast – this applies across the board, residential mortgages, commercial loans of all kinds (both on commercial property and commercial loans for capital investment), and lifestyle loans (new cars etc.). The collateral that backed those loans is dropping in value and the potential for default is rising. This second issue also applies to NZ-based banks but not the first.
Of course their cost of capital is rising at the same time because there is a global scarcity of money.
This triple whammy means banks are scrambling to find ways to (a) increase their income from all sources and (b) write-down their liabilities as rapidly and effectively as possible.
That’s why their margins are increasing and it will take regulatory intervention to prevent this. Talking it down won’t work because the market mechanisms that operate in normal times are not designed to deal with these conditions.
What should happen is that govts the world over should stand aside and let those banks fail. The three big US banks for example, Bank of America, Citigroup and JP Morgan; all have exposures that equate to 5-7 times their total asset value. They should all be allowed to fail, despite the pain that would cause. Instead, the US govt will probably step in and nationalise them, allowing the pain to continue and spread, as more and more albatrosses are hung around their necks.
This is what I mean by a paradigm shift. A year ago such thinking would have been well, unthinkable. Now, it’s the plain and simple reality. We need new thinking and new rules and relying on the old rules won’t work so there’s no point in blathering on about lower interest rates encouraging economic activity because it just won’t work. It’s like a cancer patient ignoring the cancer and continuing their normal fitness regime thinking their health will continue. You wouldn’t do that if it was you, so why are we tolerating that thinking from those people who have the power to change and implement the new rules that are necessary?
Vote:January 30th, 2009 at 10:31 am
I seriously doubt there is a cartel, or that the bank executives would expose themselves through anti-competitive agreements. But no cartel is needed. The banks can all work out for themselves what will happen if they are restrained in their competition. They can then act cautiously to maximise sector profits. They will be cautious to ensure the others play along, and they don’t expose themselves to a big loss of market share. So it takes time, but can happen.
The only restraint is new competitors. That is why we have seen the growth of regional banks and non-bank lenders. And why, reluctantly, I have come to the conclusion that Jim Anderton was right (you’ve no idea how hard it is to write those words), and Kiwibank was a good idea.
Vote:January 30th, 2009 at 10:32 am
Notice how Bollard the economists and the gumint have all gone quiet on how Kiwis should be saving more than spending.
After berating us for years to save save save those that do so like myself are now subsidising the spendthrifts and borrowers.
and dont moan at me about high interest rates. I paid 20% plus rates in the 1980s on a mortgage.
fact is as japand showed in the 1990s low zero rates dont work they dont fix the problem
The OCR is a crock of shit and show be scrapped We dont have an offical petrol rate milk rate bread rate so why should there be a cost of money rate.
Still waiting of rthe ecomonists to come up with an answer to this they cant because there isnt one
Vote:January 30th, 2009 at 10:52 am
reid
- I agree with you around I would expect banks to be looking to increase their margins as by a whole load of measures (bad debt, cost of money etc) their cost of business will be going up. However, the trend for increased margins has been ongoing for a while prior to the recent problems.
gd
I agree with you I doubt whether there is a cartel. Note I was careful to say “cartel like behaviour” not a cartel. Telecom and VF do the same with network termination charges. But they do not have a cartel. As per your comments cartel like behaviour is natural in small markets with a small number of dominant players and I thought was regulated against here in NZ.
david – any chance of showing the same graph but 90 day vs floating as that graph does not have the upward slope the one above has?
Vote:January 30th, 2009 at 10:55 am
This isnt evidence of cartel behaviour. For one thing, the cartel was weakened at the start of the time period. The second thing is that this can be explained by a combination of credit spreads and time horizons.
gd you obviously ignore all the economists answers but there are dozens that are easily found through google. It would be a waste of time repeating those arguments here because you would just filter them out through the awesome power of cognitive dissonance.
Vote:January 30th, 2009 at 11:12 am
oops – should have said vibenna not gd in previous post.
Kimble
David’s put up the wrong graph – the real graph should be 90 day vs floating and that shows that the average difference between the two has remained at 2% for 20 years. despite david’s graph the banks are consitently (up until last year) charging the same difference between cost of money and loan rates for a long time.
However, the variation has dropped to b***er all (it barely moves off 2%) and their costs per loaned dollar have dropped. That’s at least indicative of an environment where there’s not a lot of real competition going on.
Vote:January 30th, 2009 at 12:26 pm
I think DPF put up the chart he wanted to put up: the difference between what the banks charge the public and what they pay the public.
Another chart that would be interesting is the banks changing source of funding over the years. I would expect the proportion coming from deposits to be dropping significantly in the last decade.
You are probably right that the differential between the 90 day and the floating rate has remained constant, so what has happened to the differential between the deposit rate and the 90 day?
Vote:January 30th, 2009 at 1:11 pm
Kimble/DPF,
90 Day bank-bill rate is here:
http://www.rbnz.govt.nz/statistics/exandint/b2/data.html
This only goes back to Dec-04, but shows the average cost of NZD funding (what the bank pays to get cash) vs NZD claims (what they recieve when they lend it out):
Vote:http://www.rbnz.govt.nz/statistics/monfin/c10/data.html
January 30th, 2009 at 2:42 pm
The banks need to screw every bit of profit they can get, to counter to some extent, the huge losses they will be racking up in the drops in value of collateral for their unwise lending, especially against property. Good luck to them.
Vote:January 30th, 2009 at 3:13 pm
Kimble the UK and USA economists are now saying that even zero % intererst rates may not fix the problem. So these idiots have embarcked on a process that they now say is a crock of shit.
Likei said Japan provided the illustration that low no interest rates arent the answer. they just lead to deflation and another set of problems.
the answer as in most things is moderation. Moderate interest rates say 5% 7% moderate growth 3.% 5% moderate inflation 3% 5%
Wild swings aint the solution IMHO
Vote:January 30th, 2009 at 4:18 pm
Beautiful send-up by Fred Thompson on video here; what a pity he didn’t become President………
http://blip.tv/file/1528079
Vote:January 30th, 2009 at 6:16 pm
Kimble
DPFs chart is comparing apples with oranges – floating rate mortgages are funded via the 90 day bill market not the 6 months deposit rates. As such it is misleading. For instance there has been no significant differential increase (between 90 bill rate and floating rates) since 2000 up until early 2007 after which it all changed. The chart above implies a level of profit gouging that has probably not occurred as the cost of money (the largest cost for banks – sort of) has followed the floating mortgage rate closely. Despite this there are other indications that the banks aren’t really competing – but they’ve not been usurious, which the graph above implied.
If I’ve got some time in the weekend I’ll try and collect more stats, do a bit more analysis and post something a bit more exhaustive as this is all a bit superficial.
Vote:January 31st, 2009 at 8:48 am
All jawboning to try and make the banks implement government policies. What’s changed to make a bank a less risky prospect to lend to? Is there lending being subsidised by the taxpayer?
Assuming that generally speaking it costs a fixed amount to run a bank, then surely as the the bank’s borrowing costs come down then either the spread has to increase or the volume of money has to increase. Since there is not a lot of evidence of increased lending by the banks then the spread will have to increase.
Vote:January 31st, 2009 at 9:26 am
Great link PhilBest
Pity it is so poignant – but then I am old enough to have grandkids so my ‘big’ worries include “who has flogged my stick!!”
Vote:January 31st, 2009 at 12:41 pm
Fred
A couple of points
- it looks like the banks have been creaming it prior to the current problems – well done banks – good on them and a sign of a more healthy economy
- I would expect the banks to do well in a growing economy and with our addiction to residential mortgage growth
- I would expect the banks to currently do exactly what they are doing which is increasing the spread between borrowing rate and lending rate as another major cost of doing business for them, bad debts, is likely to go through the roof and that has to be taken in to account
however
- their costs have gone down in terms of per dollar lent – they have less staff, branches, lend several times more on lesser overhead costs etc
- we aren’t seeing signs of competition ie margins dropping as scale goes up and profitibality increases corrrespondingly and so banks trying to win greater share – the reaal graph shows steadt and slightly increasing differences between floating rate and 90 day bill rate. in competitive environments it’s common to see margins move as circumstances change – someone tries to win extra market share or drops their cost in a smart manner – it just isn’t happening
- we ARE actually subsidising and reducing the banks borrowing costs via the government (our) RB guarantee – I’m with Gareth Morgan on this one – should never have been done
part of DPFs original point and one that I am banging on about is that we do not appear to have a banking system where they’re being competitive. Depending on one’s perspective it could be seen as rather cosy or cartel like.
Vote:January 31st, 2009 at 4:48 pm
Slij
“it looks like the banks have been creaming it prior to the current problems – well done banks – good on them and a sign of a more healthy economy”
The banks were handed a “print money for free” card as a result of a high OCR rate and overseas lenders keen to see us take on more debt.
“I would expect the banks to do well in a growing economy and with our addiction to residential mortgage growth.” Who was more addicted? the homeowner cashing equity, or the bank “marketing mortgages” via a proliferation of brokers.
“I would expect the banks to currently do exactly what they are doing which is increasing the spread between borrowing rate and lending rate as another major cost of doing business for them, bad debts, is likely to go through the roof and that has to be taken in to account”. I just don’t see how they can work out on a month by month basis on what the spread “should” be at any one time. Surely that happens on an annual basis, oe even longer term.
“their costs have gone down in terms of per dollar lent – they have less staff, branches, lend several times more on lesser overhead costs etc” Only because we have been swamped by credit dragged into the country by the high OCR.
“we aren’t seeing signs of competition” – Yep the banks have been socialised.
“we ARE actually subsidising and reducing the banks borrowing costs via the government (our) RB guarantee”. Yes but. . . they get “charged” for it. Which increases the cost of borrowing which doesn’t seem to be mentioned.
Vote:February 1st, 2009 at 1:14 pm
mistake [dd ]
Vote:February 1st, 2009 at 1:17 pm
Hi Fred
I did my comments in square brackets as I’ve not worked out this formatting thing yet.
“I would expect the banks to currently do exactly what they are doing which is increasing the spread between borrowing rate and lending rate as another major cost of doing business for them, bad debts, is likely to go through the roof and that has to be taken in to account”. I just don’t see how they can work out on a month by month basis on what the spread “should” be at any one time. Surely that happens on an annual basis, oe even longer term.
[ If banks worked this stuff out annually then they would soon be out of business -Banks know their position daily – the bank I was involved in had a rates board that set rates at the beginning of the week and would change it daily if necessary – they know precisely what the spread is between 90 day bill rate and floating rate but more importantly, the “actual” costs of borrowing – there are reports showing precisely the position and measuring against targets – all very professional ]
“their costs have gone down in terms of per dollar lent – they have less staff, branches, lend several times more on lesser overhead costs etc” Only because we have been swamped by credit dragged into the country by the high OCR.
[ The cause of cost reduction is irrelevant – the issue is their costs have gone down, which in a competitive environment typically results in reduction in price, which hasn’t happened ]
“we aren’t seeing signs of competition” – Yep the banks have been socialised.
[ I don’t think so – I just think they’ve decided that not competing aggressively is easier if everybody does it ]
“we ARE actually subsidising and reducing the banks borrowing costs via the government (our) RB guarantee”. Yes but. . . they get “charged” for it. Which increases the cost of borrowing which doesn’t seem to be mentioned.
[ The cost for the guarantee is nowhere near the true cost such an insurance policy would normally require – the true cost is the one set by the market i.e. what rates institutions were willing to lend the banks included the assessed risk. What the RB charges the banks is substantially less than the market risk premium. This is a subsidy ]
[ As an aside – I am not a closet socialist – I don’t think banks should allow customers to break contracts – I think they must do what they are currently doing and make sure they take in to account projected increase in bad debts etc I am just aware from my own business dealings that NZ is more vulnerable than most to one of the major failings of capitalism – monopoly or cartel like behaviour. We are a small economy with many small numbers of companies (e.g. 4 banks) with effective control of specific markets.
Indications are that banks are indulging in “cosy” competitive behaviour.
Interestingly; The rate for floating mortgages should be set from the 90 day bill market, which typically follows the OCR, and the banks have normally already sourced 80+% of their floating money at any point in time. Thus when the RB drops the OCR we really should expect the floating rates to move several weeks later not the same day. The banks move them pretty much immediately as it’s swings and roundabouts – they gain on the way up and lose on the way down. ]
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