How dare my bank increase my interest rate!!

Ok so I'm no lover of banks... don't get started about how the majors have sat back under tacit government protection based on the notion of 'too big to fail' since the 2008 GFC all the while systematically undermining equitable access to finance in regional areas, suffocating resources designed to provide service and quality advice, and finding ways to shake more and more dollars out of you through fees and the huge gulf between your loan interest and your deposit interest.

I'm not here to defend the rate they are charging on your home loan. But I will say this - they are not the reason why you're interest rates have increased. At least not directly. No no no! The outfit who is actually making your life harder is the Reserve Bank Australia (RBA), owned by our federal government!

But who is this RBA and why are they doing this to me!!?

It's not just about your loan

It might come as some surprise that while you are borrowing money from your bank, it is in fact borrowing that money from other sources in order to fund your loan. A major source of funding for Australian Banks is the RBA. Your loan and every other loan issued to Australian homes and businesses by any other Australian back, is funded in part by the RBA.

Your bank is a retailer of money, and like every retailer, they buy stock from a wholesaler, mark it up, and sell it to you via a retail front. The RBA is one of several wholesalers who sell money to your bank. Yep - your bank buys money, adds their margin, then re-sells it to you. The cost of purchasing money is the interest rate you pay.

Likewise the cost of your bank purchasing money is the interest rate it pays to the RBA. That rate is called the cash rate, and it is the price that all major banks in Australia pay when borrowing from the RBA. 

Every month the RBA decides whether to increase, decrease or keep steady its cash rate. If you have a variable loan then, usually, your bank will pass on some or all of that increase or decrease in cost from the RBA. While there are some variations in the amount and timing of this pass on between different banks, in general, a change in the cash rate will result in all banks changing the interest rates associated with all loans they have on issue. As a result, the cash rate influences just about every loan on issue in Australia, both to households and also small and large businesses.

When the cash rate changes, everyone feels it.

Ahem... well just about everyone. Sometimes you can avoid the pain of rising rates by choosing to fix your loan. We've covered the topic in more detail here. 

That's a lot of power

The RBA is indeed a very powerful organisation... When it changes the cash rate it can increase or decrease the cost of all debt in the country! And since debt is the grease that helps the wheels of commerce turn, well that impacts how the entire economy will perform.

If you increase the cost of all debt, people and businesses are less likely to not only spend for consumeristic purposes, but also less likely to invest. Increasing interest rates has the effect of curbing spending and investment levels and can even drive businesses and people alike to cut back. 

This is the darker side of economic management.

When considered at the macro, nationwide level, we talk of a rising cash rate reducing household spending, business investment and therefore lowering inflation. But as we look into the detail of that picture a little more closely we see households cancelling holidays, putting off renovations and switching to cheaper supermarket brands. We see people parking the car at home and opting to take public transport to work. Some may even sell their house and downsize because the cost of their existing home loan becomes unmanageable.

It really starts to hit home when you consider that businesses are taking these actions too. When holidays and construction projects are put off or cancelled, the businesses providing those services lose money. So they need to cut back too, and that can sometimes mean making staff redundant, cancelling pay rises and bonuses and crimping access to the company credit card for team coffees. Just about every business which makes money domestically (as opposed to making money from overseas customers) will feel compelled to respond to rising interest rates.

And so with just a 0.25% change, the RBA can set off a series of cascading responses by millions of individuals and businesses the true effect of which can be very difficult to predict.

Can we trust the RBA?

There's many that say we can't. I'm a little more optimistic...

Democracy and its institutions have developed over hundreds of years and a key principle built into the design of good democratic systems also applies to the RBA: checks and balances.

Checks and balances limit the potential for corruption, the influence of any one person in decision making, and also brings in accountability for poor decision making. Which is to say checks and balances are built in to address nefarious things like the concentration of power and corruption, but also to protect us against something as simple as incompetence.

Countries like Australia, which has 2 legislative bodies (Lower House and Senate) and where the reserve bank is implemented by an act of parliament, usually have competent, transparent and independent reserve banks, answerable to the government who is itself answerable to the people.

So, the government is checked by the people, the 2 houses is an internal check within the government, and the implementation of the reserve bank through an act of parliament is a check on the RBA, as our government can change the laws that govern that institution.

There's a great example of this accountability to the government in recent times, when the Federal Treasurer Jim Chalmers chose not to renew Phillip Lowe's tenure as RBA governor after public furore over his inaccurate commentary about future rate rises to be expected. 

It's a tough job - the RBA must seek to understand as much as possible about all of the country's economic indicators such as GDP growth, inflation rates, unemployment rates, and influences from the international economy, before making a call on the cash rate. Get that wrong, or indeed, make some loose commentary about rates in the media, and the government might call time on your employment! 

So is my bank innocent?

No, never ever! But you are not powerless either!

A bank is a business - a retailer of money. They want to make profit and they have shareholders to satisfy. Now, for the avoidance of doubt, read that to mean that the bank executives and board members want their shareholders to grant them large salary packages in recognition of the great job they have done in producing large profits.

The cost of the money they buy in order to re-sell to you is just one aspect of your loan interest rate. There are a variety of factors which weigh into it, including the bank's cost structure and how competitive the market it, just like any business. 

Businesses exist to make profit. I run a business, and I want to make a profit because that profit is what I use to pay bills, dress and feed my kids and enjoy the occasional holiday. I am not anti-profit, I love it!! There is a difference however in making profit because you are innovative, or because you are so absolutely loved by your customers, who willingly give you money because of your exceptional service and the benefits they get from using your products.

So does your bank do something special for you that should justify what they charge you? If the answer is no then you simply need to remember that you, as the customer, have the power. The power TO WALK.

Yes that's right. At the shopping centre, if a retailer doesn't impress you, you walk over to another shop. 

In the loan market, it is a bit more complicated due to various complex bank policies to navigate when seeking a loan, and the often laborious process of applying. So that's where a top notch lending advisor, like Mountway ;-) becomes so important. We help you walk away from banks which are bad for you and into banks which are good for you, avoiding wrong turns, wasted time and frustration along the way.