Australian banks have traditionally offered cash rates of return that are well below the official Reserve Bank of Australia (RBA) ‘cash rate’. This has made it even less attractive for people with savings to keep those savings in a bank account. Even term deposits have struggled to offer much more than the cash rate.

The RBA’s latest bulletin (released today and available here) includes a few interesting figures on cash and deposit rates. This is best clarified by looking at the various rates from 2004 to now…

You can see that since the depths of the Global Financial Crisis (GFC), the banks have been offering very attractive rates in an effort to lure new customers. This is true both for new deposits (the top graph) as well as term deposits. The RBA commentary in the March Bulletin suggests that this new money may not be as ‘sticky’, and perhaps not that efficient in the long term as a source of funding for the banks.

“Who cares?”, i hear you say…. Well, it’d be great to be able to ignore this as irrelevant to our day-to-day but that would not be all that clever. This matters because the banks are using these funds as a source of funding to help them meet their capital and lending requirements. They need this because banks do not magically create money – they need to structure their businesses in the most cost efficient manner that is likely to allow them to continue to receive funds that they can lend out and earn their margin on… And just how are the margins looking?

Pretty good actually. Australian banks have managed to increase their margins since the depths of the GFC – which you could argue is a result of good management and stewardship or an inevitable result of the oligopoly that is Australia’s banking system. Regardless of the reason, it has placed Australian banks into a good position to maintain lending levels and hence help moderate the impact of the global downturn on Australia’s economy. The banks aren’t really suffering at all, which has boosted their standing on the international stage. Here is a look at bank interest margins (also from the March Bulletin) :

 Banks can therefore make more money if they keep a lid on other expenses and manage to maintain their lending. The key will be bad debt provisions. If all is good in Australia’s economic future (a concept i heard yesterday expressed as the “goldilocks outlook”) then bad debts should be relatively stable and these margins should be maintained.

Again, why care? It is because the additional interest being offered on term deposits has been caused by the desire of banks to secure more cash to reduce their reliance on borrowing overseas. If banks no longer feel a need to attract new deposits and accounts then there is less incentive for them to be so competitive on rates and it is reasonable to expect that the current premium over the cash rate will reduce back to its previous levels.

Since the GFC it has been the business sector that has seen its workload increase as banks increased business loan margins at a higher rate than the underlying cost of funds. To my way of thinking (which is not academic economics so can be taken with a grain of salt or used as a trigger for further reading by investment geeks or bored investors) businesses have paid for the higher deposit rates. This can only go on for so long before businesses start to lose some of their capacity to meet these higher costs, and eventually you see some of the good economic numbers begin to pale – such as employment and business profit.

The RBA finishes its March Bulletin with a comment that the official rate is lower than previous lows, which would suggest it needs to be higher but helps to clarify their hesitancy to increase rates by pointing out that the margin increases on funding costs and loans have been greater than previous low points – with the result that “monetary policy is now back in the normal range, though in the expansionary segment of that range.” (p 78 of the 80 page report).

My own take on this is that a portion of the RBA’s job has been taken over by the banks as they readjust to a post-GFC environment, with the result that the RBA’s job is made all the trickier as it attempts to bring official cash rates back into line with “normal” settings. None of this alters my impression that Australia’s continued reliance on overseas funding means we will participate in the scramble for capital that is accelerating globally as countries around the world seek more cash to finance their deficit shortfalls. Markets over-react and it is likely that the projected maximising of developed-nation calls on global capital supplies over the next few years will result in a spike in interest rates. Let’s see how correct i am on that one – personally, i hope that i am wrong and that Australia’s economy will continue to show steady growth over the coming years.

Either way, it is difficult to see the premium currently offered term deposits being maintained and so i see it as being a short-term benefit to those with capital, which will eventually recede bringing back the need to look at taking on more risk (than cash accounts) to keep ahead of inflation – in other words, a return to the long-term equity premium risk/return function.