Tuesday, January 26, 2010

How much should Banks give back??

It's good news for home owners, but, how much margin should banks give back in the coming years?

In November 2009, John Rolf wrote an article for the Telegraph stating that it would take a number of years before banks reduce their margins. Last week, however, he changed his tune, suggesting that competition between banks would reduce the margin over the next twelve months.

I wonder how much the Banks should give back?

In November 2007 margin (the gap between the Reserve Bank benchmark rate and the rates offered by banks) was about 1.8 per cent. As of November 2009, it was more than 2.7 per cent.

This was caused by banks raising rates without the RBA moving rates, tacking on extra when the RBA was increasing in then cutting by less when the RBA was lowering.

Given what we now know about that Australian economy, one some level you would think that Australia should be able to function with a significantly lower margin, as the risk levels for banks are inherently lower. Banks in Australia typically face lower risks because of the regulatory system they work within. The regulatory system in Australia requires relatively high equity/deposit requirements and does not have the 'key in the door' option like in the USA.

As such, surely, the big banks should be able to reduce their margins.

But, by the same argument, the higher regulatory burden (in the form of higher deposit requirements) mean that, in order to compete with international banks in terms of profits, they need to get higher returns on each dollar lent/deposited.

Furthermore, while Australia (has) faired relatively well (so far) in the GFC, the whole reason we got into this mess was that banks we re lendign money our to people who coudln't afford it at margins that were unsustainably low for the banks.

maybe the banks should hold on to at least a portion of the margin they have gained over the last few years (at least then I might get some decent dividends on my stock).

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