The Reserve Bank of Australia: Controlling the Interest Rates Argumentative Essay

I agree with the treasurer that banks should pass the rate cuts on to the public.

The Reserve Bank of Australia (RBA) is tasked with the responsibility of managing Australian economy to keep employment rate, interest rate, and other macroeconomic variables stable. Doing this makes the economy stable and encouraging investments and general confidence in the economy.

One way the RBA manages Australian economy is by controlling the interest rates banks charges its customers (Adelaide Now, 2012). It does this by reducing its own lending rates to banks. In the past few months, RBA has lowered the interest rates by 25 basis points many times, but the commercial banks have not reduced their interest rates to match rates cuts.

Ideally, banks should follow cue and reduce interest rates they charge customers. The idea behind the RBA action is to lower the cost of credit. A low cost of credit regime is conducive for investment, low inflation, and general economic well being. By refusing to lower the interest rates despite RBA rate cuts, the banks are defeating the purpose of RBA action in lowering interest rate.

The banks have supported their decision not to lower interest rates by citing two major reasons: high cost of funding and the effects of 2007 credit crisis. Australian banks source part of their funds from overseas markets (Verrender, 2012).

The current debt crisis in Europe has made credit scarce for banks relying on overseas funds. Banks have stated clearly that domestic Australian financial market is partly influenced by what is happening in the rest of the world.

Banks have said that they are yet to recover from the 2007 financial crisis. This credit crisis dried up funds, and banks had no choice but to hike interest rate. Since 2008, banks have steadily increased interest rates, or refused to pass on interest rates cuts by the RBA to the consumer.

Banking is inherently risky business. Banks in Australia still depend on offshore lending on the short-term basis of 3 to 5 years, and then advance loans to their customers for a longer period of up to 30 years (Adelaide Now, 2012).

This difference in time creates the risk. Hence, shock in the global financial markets leaves Australian banks in a precarious position where they have to hike interest rates despite domestic policies by RBA.

Despite what banks are saying, their arguments do not seem to stand in the face of facts. Before bank deregulation of 1983, Australian banks relied on deposits from Australians to give out loans. After the 1983 reforms, banks started to rely on cheap offshore financing. This money was largely invested in the mortgage market. As a result, real estate market in Australia boomed from 1983 onwards.

Sourcing for offshore finance was not left to the big financial institutions alone; smaller banks and non-bank financiers also started doing the same. The financial crisis froze offshore credit markets. This led to crippling of institutions such as Rams, a non-bank lender.

Banks do not now rely on offshore market in the scale they were doing in 2008. Their focus is on the domestic market and long-term debt. This reduces their vulnerability to credit crisis in Europe and elsewhere. Therefore, the bank’s argument about the cost of funding being high is false.

Currently, banks hold a lot less debt sourced from overseas markets to warrant continual refusal to lower interest rates in tandem with RBA reduction of the same to banks.

The argument that the banks have not recovered is also not true. According to statistics from the Reserve Bank of Australia, all the key indicators show that banks are in a healthy financial position. Profits after tax have increased steadily from 2009.

Bad and doubtful loans have also decreased over time in post financial crisis period. Return on equity by major banks has risen sharply to stand at almost 18% as at 2011 (Reserve Bank of Australia, 2012).

On bank funding, domestic deposits have increased since 2008. Current deposits surpass pre-2007 levels. Banks are obviously encouraging depositors to save more money unlike in the past. Short-term debts consist of 20% of total debts (Reserve Bank of Australia, 2012).

Before 2007, the percentage was close to 40%. This shows that the banks have reduced their reliance of offshore financing. Long-term debt has increased during the period.

As the above statistics shows, Australian banks have recovered significantly, and they are in a good financial position. They have also insulated themselves from any external credit crunch or debt crisis.

Recently, the Commonwealth Bank and Westpac raised around $6.5 billion from the domestic market in longer-term funding, as most of the banks are doing. The amount the bank has given out that is outstanding is $1000.

This bank rationalized its high interest by saying that its raisings from the domestic market was expensive, yet only a fraction of money its loan portfolio ($6.5 billion) was raised from the domestic market; hence, the argument about the cost of funding is not convincing (Zappone, 2012).

Australian economy has improved tremendously, and that is why the big banks are reporting huge profits and registering a decline in non-performing loans. They have also adopted prudent policies. To further boost the economy, it is imperative that the banks charge customers low interest on loans. For these reasons, the treasurer believes that banks should pass rate cuts on to the public.

References

Adelaide Now 2012, “Reserve Bank of Australia leaves interest rates on hold,” Adelaide Now. Web.

Reserve Bank of Australia 2012, The Australian Economy and Financial Markets. Web.

Verrender, I. 2012, “Protecting the profit margins,” Business Daily. Web.

Zappone. C. 2012, “Banks lifted rates to protect profits: RBA,” Business Day. Web.