Edition 2: December 2012
Banking isn’t always the easiest subject to get your head around. That's why bankmecu is endeavoring to make the task just that little bit simpler for its customers.
Today, we will publish the first of a series of articles explaining an aspect of banking that is both topical and relevant.
bankmecu has a responsibility to help its customers make more informed decisions about how they bank, and we trust these articles will equip you with the knowledge needed to do just that.
We encourage you to get involved and send us any feedback or comments you have on these issues. We would also like to hear your suggestions for upcoming topics. After all, as a customer owned bank we strongly encourage your participation in the decisions we make.
The topic for the first edition is bank funding and interest rates.
bank funding and interest rates
You may be aware that in recent months some banks, credit unions and building societies have lifted interest rates on some of their home loan products despite the Reserve Bank of Australia (RBA) maintaining its official cash rate.
To date, bankmecu has not increased interest rates on its home loans, but that’s not to say we won’t need to do so at some future point in time. We think it’s important that we explain to you what has brought about this change in the way home loan interest rates are being set.
RBA official cash rate and home loan interest rates
Recent history shows that banks, credit unions and building societies moved their home loan interest rates in line with the RBA. By doing so, financial institutions created a sense that movements in the RBA’s official cash rate directly influenced the cost of funding home loans and therefore how home loan interest rates were set. This was not the case.
The cost of funding home loans
The key influence over how home loan interest rates are set is the cost of funding these loans. The major listed banks source around 60% of their home loan funding from customers’ deposits and the remainder is borrowed from other Australian and overseas banks, investors, and superannuation funds. In contrast to these banks, bankmecu funds 100% of the home loans we make to our customers from the savings other customers deposit with the bank.
In recent times the major banks have experienced an increase in the cost of sourcing funds to finance home loans. As a result of the cost of overseas funds increasing, competition for domestic deposits has also increased. This has occurred because the major banks have turned their attention to funding more of their loans from domestic markets, and in particular from retail consumers. This increased competition for deposits has seen all banks, credit unions and building societies paying higher interest rates. Of course this is welcome news for depositors whose interests are largely forgotten as the media and governments generally appear more interested in home loan interest rates and their impact on borrowers.
At the same time, market forces including low demand for loans has sent home loan interest rates lower.
When considered together, you can understand that the increased cost of deposits and lower home loan interest rates has the effect of squeezing interest rate margins and when this occurs, profits will decline if the financial institutions cannot find other cost savings across their businesses.
High funding costs can impact profit and the value of bank shares
In the case of an investor owned bank, declining profits inevitably lead to a drop in the value of a bank’s share. Therefore the majority ofAustralia’s investor owned banks have increased home loan interest rates in order to protect shareholder value. Many have also moved to reduce staffing costs by reducing staff resources and off-shoring jobs to countries where labour costs are lower. The need for these banks to increase home loan interest rates, maintain profitability, and meet the needs of their investors is completely understandable; indeed the investor owned bank model demands these banks do so.
So what does this situation mean for bankmecu and our customers?
In the case of bankmecu, it is the customers rather than external investors who own the bank. At the same time our customer ownership or cooperative banking model dictates we must create value for all our customers whether they borrow, save, invest or simply transact. We do this by pricing all of our loan and deposit products, both in terms of interest rates and fees, so that when considered as an overall package, banking with bankmecu represents a more competitive way to bank when compared to Australia’s four major banks. We aim to ensure our customers collectively benefit by at least $30m each year, or 10% of our customer owned reserves, which are the profits bankmecu has made and retained since it was established in 1957. Canstar – a financial services firm - independently assesses this benefit each year by comparing bankmecu interest rates and fees against the four major banks. Additional intangible benefits we offer customers are a unique personal service experience and a more responsible approach to everyday banking and investing customers’ money.
bankmecu customer owned profits underpin our strength and our future
At the same time bankmecu must also make a profit. Indeed making a profit is critically important for a customer owned bank just as it is for an investor owned bank. The key difference is that in the case of a customer owned bank, profits are reinvested back into the bank ensuring it remains strong and can develop new products and services for the benefit of its customers. These profits form the cornerstone of the bankmecu’s tier one Capital. This Capital enables bankmecu to facilitate future growth, absorb unexpected losses (if this was to ever occur) and meet and exceed the strict prudential capital requirements determined by the banking regulator, APRA (Australian Prudential Regulation Authority). Making a profit is critical as customer owned banks cannot readily access debt/equity markets in order to raise external Capital.
Consider it this way. A customer owned bank is a closed loop. Customer generated profits are reinvested back into the bank for the benefit of the customers. Profits are not paid to external shareholders who as investors are seeking a risk related return. bankmecu is not owned by external investors, only customers which means the profits our customers make are retained by our customers for their benefit and their benefit alone.
Understanding this point is essential in understanding the key difference that exists between an investor owned bank and a customer owned bank like bankmecu.
Balancing customer needs and benefits
Now that you know how a customer owned bank works means that it should come as no surprise to you that bankmecu has a responsibility to balance the competing needs of all customers, whilst at the same time generating sufficient profit to invest back into the bank itself. We take this responsibility very seriously. Indeed the long-term sustainability of our bank demands that we maintain this balanced approach to creating customer value.
Interest margins tighten
For some years now we have experienced a narrowing of the gap between interest earned on loans and interest paid on deposits. Between December 2010 and October 2012 the Bank's net interest margin fell from 2.77% to 2.45%.
As a result of some very careful management of costs we have so far been able to absorb this fall whilst still achieving our profit target. However we are very mindful that at some future point in time we may also need to adjust interest rates on loans and deposits in line with changes in the market and independently of the RBA in order to maintain this essential customer benefit balance.
Tell us what you think
We are interested in hearing your thoughts on this issue. Please feel free to send us your comments and questions on this or other banking issues of interest to you via email to: email@example.com