2013 Conference

Financial Services

Financial Services

The residential mortgage market is one of Australia’s most important retail financial markets for consumers. Since 1990, the Reserve Bank of Australia (RBA) has targeted the desired interest rate on overnight loans in the money market (or cash rate) as part of monetary policy. Importantly, consumers of residential mortgage loans have become increasingly mindful and well informed through the media and elsewhere of the impact of changes in the official cash rate on their own borrowing rate. While there is no regulatory requirement for lenders to pass on these rate cuts, consumers have then formed the expectation that rate cuts should instantaneously pass on in full, whereas lenders that pass on rate increases face the accusation of being predatory and insensitive to customer needs. Politicians of all types typically respond to the demands of consumers (read voters) in the same way. This paper analyses the behaviour of banks in response to changes in the cash rate, with a focus on the speed and accuracy with which rate cuts and increases are passed on to borrowers. Over the period 4 September 2000 to 5 March 2012, we regress the standard variable mortgage rate for each of Australia’s Big-4 banks against current and lagged cash rates along with a dummy variable indicating whether the change in the cash rate was positive (an increase) or negative (a decrease). Overall, we find that the Big-4 banks are slow to react to changes in the cash rate but typically adjust 75 percent of the lending rate with one month. This may sometimes benefit mortgage holders in that the banks are slow to pass on rate increases but sometimes not when they are slow to pass on rate decreases. However, we find evidence of asymmetry in that the banks more quickly pass on rate increases.