Reserve reports on lower margins

The Reserve Bank released its bi-monthly bulletin this week, and probably the most interesting article was a discussion of bank margins and the effect on these of competition.

Margins are the extra costs that lenders place on loans, over the cost of obtaining the funds, that allow them to pay costs and make profit. The Reserve Bank report studies the decline in the level of margins over the last three years.

The greatest decrease in margins has been found in housing interest rates, due to an influx of mortgage originators such as Aussie, RAMS, and Wizard. Consequently, over the last three years, while the Reserve Bank’s cash rate has fallen 2.75 per cent, the average standard variable rate has fallen by 4 per cent. Notably, in June 1996, the banks dropped their standard variable by about 75 basis points, independently of any action by the Reserve Bank. The same occurred in February 1997, with the banks cutting their standard variable rate by a further 70 basis points.

These reductions have seen the average margin on housing rates fall from around 4.75 per cent in 1993, to 1.75 per cent presently. Interestingly, this is the average margin that has existed in the United Kingdom, New Zealand and Canada for at least the last ten years.

Another factor that has lead to an overall reduction in lending rates, specifically in the area of personal and small business lending, has been the lenders change of focus in pricing, from the purpose of the loan, to the security underwriting the loan. Lenders have recognised that the if the security used is the same as in home loan, then the cost should be close to that of a home loan. In personal lending, the rise in popularity in the home equity (or line of credit) product, has been a result of steep drop in the charge for these types of loans. The average drop for these products has been 4.90 per cent, 215 basis points more than the cash rate has fallen in the same time. This has also been reflected in the fall in price for loans for small business, where a residential property is used as security. As well as a reduction in the overall margin, risk margins basically ceased to apply to residentially secured business loans.

The Reserve Bank concludes the report with the belief that these reductions are a one-off result of competition, rather than a result of cyclical movements in the market. As such, while the Reserve doubts that these events will be repeated, it also believes that such are the competitive features of the Australian financial system, that these reductions are here to stay.