BANK FUNDING COSTS OF RBA BANK

QUESTION

 

You were recently appointed to a middle-management role in an Australian Bank. Recently, you read an article in the business news stating that the Reserve Bank of Australia had announced a decision to investigate Bank funding costs (refer to the attached article, ‘RBA investigates Bank Funding Costs’ ( Financial Review, 27 /02/12).

SOLUTION

Q. 1: Report Discussing Investigation of RBA into Bank Funding Costs

Introduction:

In an article published in the Australian Financial Review on 27 Feb, 2012, George Liondis reported that the Reserve Bank of Australia while conducting an investigation into the bank funding costs amid the ongoing debate that should be lenders lift the interest rates outside the official moves. The newspaper claimed that had information that Reserve Bank of Australia had conducted interviews with senior executive of several large banks prior the release of its report on funding costs released with its quarterly report in March 2012. The article claims that the decision to hike the cost of funds was attributed by the banks to their decision to hike home loan interest rates even though the official cash rate was kept steady by the RBA. The mortgage rates were increased by the leading banks of Australia after the benchmark rate was maintained that 4.25 percent by the RBA. This decision inviting criticism from several quarters including the Federal Treasurer who blamed that the banks were protecting their record profits while transferring the high costs on to the customers.

RBA Investigation:

The allegations were refuted by the Gov. of RBA who claimed that the funding costs have not come down in accordance with the cut in official rate announced in November and December last year. The reports of the ongoing investigation were confirmed by several banks when they acknowledge that RBA has sought detailed information from them regarding their costs involved in raising money. The major funding channel of the banks was raising money by issuing bonds which had become much more expensive owing to the debt crisis going on in Europe. Another key source of funding for the banks is customer deposits and the interest paid by banks on these deposits was also examined by the RBA in its investigation 1.

 

 

1. RBA Summary of Australian Financial Regulation, www.rba.gov.au/fin_stability/reg_framework/index.html.

 

 

1. (i) Influence of Funding Costs on Lending rates:

The lending rates set by Banks are influenced by a number of factors. The most important ones include the cost of funding. Other than this, factors like credit risk linked with the loan and liquidity risk that is involved in funding the long-term assets which have short term liabilities are also considered by the banks (Fabbro and Hack 2011). Australian banks have diverse funding bases and the most significant funding sources are deposits, long-term and short-term wholesale debt. There are significant changes in composition of funding and a visible shift has resulted in the increase of the use of deposits by major banks that have cut their use of that term debt. Regional banks have reduced the use of securitization and have also increased the use of their deposits 2. Similarly the foreign banks have also significantly reduced their use of short-term debt. The trend among the banks is shifting towards term deposits where higher interest rates are paid as compared to the other forms of deposits (Boge and Wilson, 2011).

1       (ii). Competition for Deposits:

The increase in the share of term deposits shows the presence of a number of interrelated factors like as the banks are offering better rates to the depositors and strong business profits and the caution in business has resulted in increased corporate cash holding which is increasingly being invested into term deposits rather than any other form of financial instruments 2. These term deposits provides the advantage of a stable funding source for the banks and although the average maturity period of these term deposits is relatively short, somewhere between four to seven months, typically these deposits are rolled over many times. There has been stiff competition going on between the various banks not only for term deposits but the banks are offering attractive rates of interest on savings and transaction accounts (Deans and Stewart, 2012). The competition for deposits between the banks which saw a somewhat decline during the early part of last year and we saw this competition intensified by the end of the last year.

 

 

1. ADI Authorisation Guidelines, April 2008, Paragraphs 15 and 16. The framework set out in the paper Basel II: International Convergence of Capital Measurement and Capital Standards: A Revised Framework – Comprehensive Version published by the Basel Committee on Banking Supervision in June 2006.

 

 

2       (i). Fall in Cash rate

As a result while the cash rate fell by 50 basic points since the middle of last year, the average cost of deposits for major banks was estimated to have the time by nearly 25 basic points. According to the report of the RBA, it is estimated that there is an overall change in the funding costs of the banks. When compared with 2007, the average funding cost of major banks is estimated to be nearly 120-130 basic points higher. Though most of the increase was witnessed during 2008 and the early part of 2009, when the financial crisis was most intense, there has been a further increase in the funding costs of the banks in the middle of the last year (RBA, 2011).

2       (ii) Sources Used by RBA in its Investigation:

A wide range of sources are used by the reserve Bank to derive its estimates of the funding cost of the bank. While it uses the data that is reported by the financial institutions to the APRA and also the regular profit statements issued by the banks, the prices offered by the banks of different types of deposit accounts are also taken into consideration. The reserve Bank maintains a database a wholesale funding and this database is regularly updated. All this information is also supplemented by holding comprehensive consultations with both big and small financial institutions (RBA Bulletin, 2012).

 

 

Conclusion:

The increase in the cost of funding, relative to the cash rate varies from institution to institution as there is considerable difference in funding compositions of these institutions and also in the pricing of various liabilities. Therefore the apprehension of the staff of the bank is not reasonable that the reserve Bank is on a bank bashing spree. The available evidence, for examples suggests that the increase in the funding cost of regional banks has been higher on an average as compared to the major banks since the onset of the financial crisis.

 

References:

 

Boge M and I Wilson (2011), ‘The Domestic Market for Short-term Debt Securities’, RBA Bulletin, September, pp 39–48.

 

Deans C and Stewart C (2012), ‘Banks’ Funding Costs and Lending Rates’, RBA Bulletin, March pp 37−43.

Fabbro D and M Hack (2011), ‘The Effects of Funding Costs and Risk on Banks’ Lending Rates’, RBA Bulletin, March, pp 35–41.

 

George Liondis, ‘RBA investigates Bank Funding Costs’ The Australian Financial Review, 27 02-2012.

RBA (Reserve Bank of Australia) (2011), ‘Submission to the Inquiry into Access for Small and Medium Business to Finance’, Submission to the Parliamentary Joint Committee on Corporations and Financial Services,

 

RBA Bulletin, March 2012. Available at: http://www.rba.gov.au/publications/bulletin/2012/mar/pdf/bu-0312.pdf.  Accessed on 8 April 2012

 

 

 

 

 

 

 

Question 2: Case Study:

(i)              The legal obligations of North Pacific in relations to its customers. Discuss if it has complied with its legal obligations in this case.

Introduction:

The overall regulation of finance and banking system is divided between Reserve Bank of Australia, APRA and Australian Securities and Investments Commission. The Reserve Bank of Australia acts as the central bank and holds the responsibility of the monetary policy and the stability of the financial system. Consumer protection in relation with financial and banking services is regulated by the Australian Securities and Investments Commissions Act, 2001¹. It covers misleading and deceptive conduct, unconscionable conduct and false or misleading representations. The new regulations provide that any unfair terms mentioned in the standard form contract will be void and also any term mentioned in a standard form contract which creates considerable imbalance in the rights and obligations of the parties under the contract. Similarly any condition which is not reasonably necessary for protecting the interests of any of the parties who gains an unfair advantage due to such a condition will also be void.

1. (i):  Legal Obligations of North Pacific.

In the given case Amanda and John were not given the details of the terms and conditions regarding the banking services by the manager of the branch, it could be termed as an unfair practice on part of the bank. They also signed standard form contracts without going into the details. As customers of the bank Amanda and John were promised that the terms of banking services will be e mailed to them later but despite several requests by them, these terms were not provided to them.

All persons carrying financial service business in Austria are required to hold the Australian financial services licenses (AFSL) which covers the provisions of financial services.

 

1. The sole regulator of Australian registered companies and a regulator of financial services.

Onerous requirements have been imposed by the Corporations Act² on banks and other financial institutions holding AFSL license in relation to the disclosures that have to be made to retail clients although some relief in relations with basic deposit products have been provided to the bank. In the given case the bank was under legal obligation to provide necessary information to Amanda and John which was not provided to them even after repeated requests. Several inadequacies have been pointed out in the present code for self regulation adopted by the banks but still the provisions of the code has many provisions to safe guard the interests of the consumers of the banks. For example clause 2.1 (5) presents an opportunity to the industry to provide information to the consumers including the details of the contract, complete details of the fees to be charged from the consumers and details of the terms and conditions of the contract. These details are required to be provided to all customers including existing and potential customers who are about to enter an agreement with the bank. In the present case the details were not provided to Amanda and John although they asked for the same many times. The industrial code of self regulation are required that the terms and conditions and other information regarding the contract should be provided to the customers in a way which is easily understood by the customers. Further more such information should be provided in a format which allows the consumers to easily make comparison between different banking products (APRA, 2009). In case of consumers with language barriers or disabilities, advice should be provided to them by the bank. It is advocating that disclosers on charges and fees levied by banks across all accounts should be improved especially in case of hidden costs and fee free transactions. The adoption of comprehensive and clear disclosure regime could help the customers by provided them information regarding the status of amounts charged and fees incurred. The provisions of the present code regarding the variation in terms and conditions of the contract are also alleged to be outdated. Adequate advance notice in writing should be given to the customers in case of any change in the terms and conditions of banking products and accounts. Among the other obligation of the North Pacific Bank Limited are the provisions regarding privacy of the customers. The bank is required to ensure compliance with the National Privacy Principles.

 

2.   Corporations Act 2001

 

1(ii): The Code of Banking Practice volunteer adopted by the Banks in Australia set the standards for good banking practices which all banks are require to follow while dealing with their customers. The provisions of the code are in addition to the rights conferred by the federal laws especially the Australian Securities and Investments Commission Act 2001, Corporations Act 2001 and the Trade Practices Act 1974. The code of Banking Practice specifically required the Banks to provide the terms and condition of the current banking services and also provide complete details of standard fees and charges payable for the services offered by banks when requested by a customer. It also requires that the terms and conditions of the banking services should be distinguishable from promotional for marketing material. It also mentions that the details regarding terms and conditions should be provided before or at the time of making the contract for banking services. An exception is made in case where it is impracticable to do so and in such cases the details regarding terms and conditions should be provided as soon as practicable (Code of Banking Practice, 2003). In the present case these conditions were clearly violated by the bank manager Yvonne when he told Amanda and John that the terms and conditions would be sent to them through e-mail some time after the contract has been finalized. The bank manager was required to provide the details regarding the terms and conditions of the contract before or at the time of the making of the contract.  Under the code it is also the duty of the bank to draw the attention of the customers towards the availability of general descriptive information. The banks are required to specifically mention that information is available about the obligations of the bank regarding privacy of the information of its customers. It should also be specifically mentioned to the customers that information regarding the account opening procedures and bank cheques is available to the customers. The bank is also required to inform the customer about the standard fees and charges applicable to the customers and also tell them about the method of calculation of interest if any and the manner in which the customers will be notified regarding any changes in the terms and conditions, fees and charges and the interests rate. Any restriction on withdrawing or depositing money from an account or any minimum balance requirements should be conveyed to the customer before or add the time of the contract (Australian Government Treasury paper, 2008).

In case of credit cards the terms and conditions will include general information on the chargeback rights and the customers should be informed about the timeframe within which they are required to report a disputed transaction. A clear warning should be given to credit card holders that they can lose to their ability to dispute a transaction if they do not report it within the timeframe specified by the bank.

In case a customer requests for a copy of any document there are certain rights conferred upon the customer making such requests under the Corporations Act 2001 and Uniform Consumer Credit Code which are greater than the rights provided under the Code of Banking Practice. The banks are required to comply with the law where it applies and in case the above mentioned legislations do not apply the Code of Banking Practice will be applicable in such a case, the bank is required to provide a copy of the following documents if requested by any customer. These include the copy of a contract in which standard fees and charges, interest rates and other terms and conditions should be mentioned. In the present case the North Specific Banks has failed to discharge its obligation by not providing the terms of their banking services to Amanda and John.

2(i): Guarantee of deposits:

After the global financial crisis that hit the world in 2008-9, the Australian government also launched two schemes to guarantee the deposits made with the banks³. The first was the Financial Claims Scheme (FCS) which applies only to the Australian ADIs and the large deposits and wholesale funding guarantee scheme (Australian Government Guarantee Scheme, 2010). APRA has been appointed as the administrator for the FCS which was launched to provide some support to account holders having some ‘protected accounts’ up to the sum of AUD $ 1 million in Australian EDI against losses that may be incurred in case the ADI becomes a declared ADI. An ADI becomes a declared ADI if the APRA applies to the Federal Court of Australia or winding up the ADI and a declaration under section 16 AD of the banking act had been made by the Minister (Fitz-Gibbon and Gizycki, 2001).
2 (b): Administration of the scheme:

Similarly the guarantee scheme is under the administration of RBA and it was designed to promote the financial stability and also to ensure a continuous flow of credit during the time of high turbulence in the global capital markets. Under this scheme the customers who have deposits of more than A$1 million with a single Australian EDI was provided the benefit of guaranteed by the government 3. In the present case the deposit of Amanda and John is covered under the financial claims scheme which provides some supports to account holders of some “protected accounts” up to the some of AUD $1 million.

“Banks may play role as pillars of the community” Australian Financial Review 27 October 1999

References

APRA, Discussion Paper: Enhancements to the Basel II Framework in Australia, 21 December 2009 www.apra.gov.au/Policy/Proposed-Basel-II-Enhancements-2009.cfm,  accessed  9 April 2012.

 

Australian Government Guarantee Scheme for Large Deposits and Wholesale Funding website, at www.guaranteescheme.gov.au. accessed 24 March, 2012

 

Australian Government Treasury paper, ‘Australian Government’s 2008 Deposit and Wholesale Funding Guarantees – Design and Operational Parameters’,  at

www. treasury.gov.au/documents/1431 /PDF/Design_and_operational_parameters_281008.pdf. accessed 29 March 2010.

 

Australian Prudential Regulation Authority, Reporting forms and instructions at www.apra.gov.au/Statistics/Reporting-forms-and-instructions-exclude-Basel-II.cfm. Accessed      9 April 2012.

Bryan Fitz-Gibbon & Marianne Gizycki, ‘A History of Last Resort Lending and Other Support for Troubled Financial Institutions in Australia’ Research Discussion Paper 2001-07, System Stability Department Reserve Bank of Australia, 2001.

Code of Banking Practice published by the Australian Bankers’ Association, 2003

JF57

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