Australian banks have been under pressure from many fronts to lower their mortgage rates in response to a possible interest rate cuts from the Reserve Bank of Australia (RBA). The government and opposition parties are demanding that the banks should do the ‘right’ thing by easing the strain of the working majority. The RBA added to the pressure by declaring that it sees no reason why mortgage rates should not lowered in response to monetary easing. The media poured fuel into the fire by accusing the banks of greed.

So far, none of the banks are committed to do so- none pledged to lower their lending rates to match the RBA’s cut in the cash rate. As we said before in Too eager for an interest rate cut?,

Fourth, an interest rate cut by the RBA need not necessary mean a cut in the mortgage rate. In fact, the opposite can occur.

Understandably, with Australian households under unprecedented debt stress, this has fuelled popular sentiments against the banks. They have become the new bogeyman to target. But as one of our readers said very well in Would the RBA?s rate cut do any good?,

It is not so much bank bashing (kind of pointless beyond the immediate feel good and but easy to slip into) but the realities do need to be looked at, and yes, I agree it may be far too late for the banks to do much else and are themselves to an extent pawns in the bigger global picture.

Here, we try not to pass moral judgements on banks. After all, banks are just impersonal profit-making institutions. Therefore, it is inappropriate to apply moral motives on non-person entities. What can expect from entities in which their clearly stated objectives is to make profits?

While it is true that the money market rates for the banks have fallen since the market’s expectation of an interest rate cuts has risen, does that automatically mean that this alone is a good reason to cut mortgage rates? Motives aside, what are the possible reasons why banks are not willing to lower mortgage rates? We can think of a few reasons here:

1. Mortgages are long-term debt (typically up to 30 years). Cash raised from money markets are short-term credit (which ranges from 1 month to 1 year). How can we expect the banks to lower their long-term lending rates just because the cost of their short-term credit has fallen? Indeed, as the situation for the non-bank lenders like RAMS had shown, borrowing short-term money to fund long-term lending is a good way to become bankrupt, thanks to the credit crunch. This flows on to the next point…
2. Because of the risk involved with funding long-term debt entirely with short-term credit, banks have to diversify their lending source. As this news article said,
   

   Our banks raise about half their cash from local deposits, a quarter from local bonds and the rest from the global market.

   While the RBA may have some influence on the domestic short-term money market rates, we can assure you that they have no influence on the global markets. Indeed, as we explained before in Can falling interest rates and rising mortgage rate come together?, there is insufficient savings domestically to fund all the loans. Therefore, the banks have to get the shortfall from overseas and submit themselves to the global credit conditions. The global credit conditions are far from settled and major eruptions can still occur any time. As we said before in The next financial time bomb- Credit Default Swaps, CDS is the next global time bomb to explode. Indeed as this news article reported,

   Most institutional investors expect another failure of a major financial services firm in the coming year and view credit default swaps as a serious threat to market stability, according to a survey by Greenwich Associates.

   Once the banks cut their mortgage rates, it will be very unpopular for them to raise them again in the event of further ructions in the global credit markets.

3. What if the banks expect more bad debts in the future? Lending rates are proportional to the risk of default of the loans. The banks’ unwillingness to lower mortgage rates could be a sign that they are pricing in more risks on their loans.
4. It is open knowledge that price inflation is still on the rise in Australia. In fact, the RBA expects price inflation to peak at around 5% before turning down again. For any given nominal rate, rising price inflation implies a lowering of real rate. As we explained before in Is property a good hedge against hyperinflation?, during times of hyperinflation,
   

   At the same time, you can expect bankers to raise borrowing rates very quickly to protect their profits.

   By not raising their lending rates when price inflation are trending upwards, banks are actually losing money in real terms.

Finally, we would like to point out that we are by no means defending the banks. Neither should this be construed as ‘predictions’ that banks will never lower their mortgage rates.