Many home loan holders were shocked by Westpac’s move to raise its standard variable interest rate by .20 of a percent, as the move is independent of any Reserve Bank of Australia (RBA) decision. This move has also led to the other major banks also raising their variable interest rates, and to debate over whether or not the raising of interest rates will force the RBA to lower the cash rate further in order to compensate Australian households.
In order to understand why the Westpac and the other majors have raised their variable interest rates, we need to look at what prompted Westpac to take such a risky move in such a highly competitive mortgage market. Let’s examine the events that led up to the move.
At present, Westpac holds approximately $180 billion worth of variable rate loans on its books. In order to cover the risk associated with these loans and to ensure that the bank can meet its financial obligations, the bank needed to raise its capital holdings. This meant finding an additional $3.5 billion in funds.
The need for the Westpac to raise its capital holdings is attributed to the fact that the Australian Prudential Regulation Authority (APRA) have imposed a 25% risk-weighting from July 1st, 2016. Prior to this, the major Australian banks had an average risk-weighting where under the advanced approach’ each of the major Australian banks calculated their own risk-weights. In comparison, smaller, Australian banks use the standardised approach’ and have an average risk-weight of 39%.
APRA’s decision for imposing higher capital holdings on the majors was based on the need to reduce perceived credit risk that is created by the property market, as well as to level the playing field between the major banks and their smaller competitors. For instance, prior to APRA changes, the major banks could hold lower capital as smaller banks did, but due to the shear-size of their home loan portfolios, they were able to make higher returns on their capital.
By APRA forcing the majors to raise their capital holding, these banks will be amongst the largest capital holding banks in the world, giving them greater financial stability. But, in order to do this they have to increase home loan prices, otherwise, they’d have to accept lower returns. This is what Westpac has done by raising variable home loans by .20 of a%. This move will generate $3.5 billion in equity, which will return 7% after tax. Prior to this move, Westpac is said to be generating a 4% return. This being the case, then it seems that the bank’s shareholders are absorbing the weight of APRA’s new rulings, as returns are lower than previously experienced.
Collectively, Australia’s major banks have raised $20 billion in new equity. Thus, it can be said that APRA is having the desired impact.
The RBA have been concerned about the financial risk associated with the Australian property market also. If the state of the property market becomes unstable then this can have a profound effect on the financial system as a whole, and on the Australian economy.
By APRA imposing new risk-weights on the majors, they have reduced the appeal of these lenders to home owners and investors for home loans. Plus, this move may also take the heat out of the property market. Therefore, the move by the majors should give the RBA room to move, if needed. Though it’s highly likely the RBA will use the sit and wait’ approach to see how interest rate changes impact on household spending. Ideally, the rate changes will slow the rate of property price growth in overinflated markets, such as Sydney and Melbourne, without having an adverse effect on the broader economy.
If the move by the majors to raise interest rates has an impact on consumer confidence, then the RBA may lower the official cash rate. However, with the majors moving in November it’s probable that the official cash rate won’t be lowered until February of 2016 if it is going to be lowered.
Westpac, like the other major banks, has an advertised standard variable interest rate. This rate, for Westpac, currently sits at 5.48%, so a .20 of a% rise will take the bank’s interest rate to 5.68%. For investors, the standard variable rate will rise to 5.95%. Fixed rates will remain unchanged. Term deposit holders will also benefit as some new term deposits will have an increase of 25 basis points. Check Terms & Conditions for all rates listed.
However, in saying this, many home loan holders are not paying the standard variable rate. This is due to bank discounts and special rates that have been negotiated. Data suggests that some home loan holders have an existing rate that is as low as 4.5%, in some cases.
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