When an Australian economist’s piece on monetary transmission is discussed in Parliament..

It does not happen too often when Parliamentarians discuss an economist’s piece, even if the hearing is on economic matters.

So it is interesting when Prof. Abbas Valadkhani of Swinburne University of Technology writes this piece in Oct 2016 on how banks delay rate cuts following rate cut by central bank. He shows via research that these delayed rate cuts help these banks make money:

According to my analysis, the big four banks can make approximately $A8.6 million per day as a group if they do not fully pass onto borrowers a hypothetical 0.25% cut in the RBA’s cash rate.

More specifically, if ANZ, CBA, NAB and Westpac manage to postpone lowering their mortgage interest rates say by 10 days, they can potentially make an extra A$16, A$28, A$16 and $A26 million dollars in profits, respectively.

Previous studies on mortgages, small business loans and credit card interest rates have found significant evidence for the “rockets and feathers” hypothesis. That is, when the cash rate increases, various lending rates shoot up like rockets but when the opposite occurs they go down like feathers.

Rockets and feather mean a bank quickly passes rate hikes (like a rock) but the decline in rate cut is really slow like a falling feather .

Interestingly, the very day in a Parliament Standing Committee on Economics, this question was posed to a Aussie banker:

Mr THISTLETHWAITE: This is a hypothesis by economists which states that when central banks lift interest rates then big banks generally pass them on like rockets, straightaway; but when central banks reduce interest rates, they drop like a feather—in other words, it takes a lot of time.

Mr Elliott : Okay.

Mr THISTLETHWAITE: Mr Evans referred to this earlier. There is an economist, Professor Abbas Valadkhaniis, who has done an analysis about the latest rate cuts. It is true that, by delaying passing on the rate cuts to your customers, the bank makes a profit out of that, doesn’t it?

Mr Elliott : When you say ‘delaying’, as I said, there is no direct link between the RBA cash rate and what we charge customers. It influences some but not all of our cost of funds. As a broad question: if some of our cost of funds goes down, the longer we delay, clearly, that is to the advantage of the bank. That goes without saying; you are correct. It is our responsibility to pass those on as quickly as we can—yes. And we need to take into account the change in cost and what our competitive position is going to be. Remember, we are not just talking about passing on rate cuts to people who are already sitting with us; we are talking about our competitive position: what is the rate we are going to be competing with tomorrow morning at nine o’clock in our branch network? That is a really important consideration.

Mr THISTLETHWAITE: Mr Valadkhaniis’s analysis of the latest rate cut in August 2016 by the RBA says that your bank took nine days to pass on the actual cut from the date that it was announced by the RBA until it became effective with your mortgage holders and account holders. I will give you this: you are the best out of the big four. You took nine days; CBA,16 days; NAB, 16 days; and Westpac, 20 days. We will question them about this as well. His analysis is that, in doing so, you make $7 million. That is a profit for the bank of $7 million. That is true, isn’t it?

Mr Elliott : I do not know; I would have to look at the maths.

Mr THISTLETHWAITE: You do make money out of it, don’t you?

Mr Hodges : A point here which is probably not understood is that as we are looking at what we are going to do around these, it is really a competitive position, as Shayne said. We look to position ourselves in a favourable way with our customers. We do not want to make multiple changes, and we are trying to assess, ‘Where would we position ourselves, and where will the others position themselves, so that we can actually compete effectively in the market?’ So sometimes the delay is more around trying to work out what our best strategy is around being competitive and winning new customers in the marketplace, not because we are thinking we are going to profit by every day that goes by. That is a strategic competitive decision that we would make: do we want to be at the lowest rate? Do we want to be just one above the lowest rate, or do we want to be five basis points above? Everyone is trying to work out where their position is in the market. So I think there are some genuine competitive reasons why people might delay a little, to find out where we put our rate out there.

Much of this would apply to India and other economies as well.

The statement by Elliott of ANZ Bank just sums up the noise on monetary transmission:

Mr Elliott : When you say ‘delaying’, as I said, there is no direct link between the RBA cash rate and what we charge customers. It influences some but not all of our cost of funds.

Despite knowing this, so many bankers and economists continue to just talk about central bank interest rates. One can understand economics not knowing details but atleast bankers should educate people that policy rate cuts are hardly as important as they are made out to be..


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