Term deposit rates: An unexpected positive for savers

23 Aug 2016

By Shadforth Financial Group

The Reserve Bank of Australia cut the official interest rate to a record low of 1.50%. Whilst such news would usually be greeted with dismay by savers, since many financial institutions would lower their deposit rates, the response from the banks regarding their term deposit (TD) rates was surprising. The major banks actually lifted their TD rates by between 0.45% and 0.85% on maturities of up to three years.

Reasons for increasing the TD rates

We believe there are a number of reasons the major banks have taken this course of action.

Following the global financial crisis in 2008, regulators in many countries sought to improve the financial stability of their banking systems. Whilst it was generally accepted that the Australian banking system fared well during the crisis, the Australian regulator, APRA, has implemented measures to further strengthen Australian banks.

A key measure has been for banks to increase the amount of capital they hold relative to their loan books. Many banks responded by issuing hybrids securities which many retail investors have subscribed to.

Furthermore from a regulatory perspective, increasing rates on TDs with periods longer than a year is necessary to meet net stable funding ratio requirements in 2018.

Banks have also sought to rebalance the source of their funding. As shown in the chart, in recent years banks have increasingly sought funding from the wholesale market. A significant proportion of this wholesale funding has been from overseas sources, in particular other banks.

Whilst this form of funding has come at a lower cost it does also increase the banks’ risk. If, for example, Australia lost its triple AAA credit rating, the cost of the banks’ wholesale funding is likely to rise, given the Federal Government’s bank guarantee. Thus to increase their deposit funding, relative to their wholesale funding, banks need to offer more attractive interest rate to savers.

Another factor in the bank’s decision appears to be political. The decision to raise TD rates accompanied their decision not to pass on the full 0.25% rate cut on many loans, including the politically sensitive mortgage rates. This could be seen as an attempt by the banks to appease their critics over their treatment of Australian consumers versus the banks’ shareholders.

This is particularly relevant given the Federal Opposition’s decision to continue to seek a Royal Commission into the banking sector. Given this position is supported by some members on the Government benches, the possibility of some form of banking review, initiated by the government, appears likely.

At an industry level, the banks may also be seeking to increase their market share with potential for a ‘war on deposits’ as a source of funds. However with many banks increasing their TD rates simultaneously, the impact here on any one bank’s market share may be muted.

Investment implications

This development is unquestionably a positive for savers particularly in an environment where interest rates have been pushed to record lows. The banks’ decision also makes TD’s more attractive relative to similar types of investments particularly given the bank’s strong financial position and APRA’s oversight of these institutions.

Whether the banks raise TD rates further in the future remains to be seen. However the issues identified will maintain pressure on banks to offer competitive rates.

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