Interest Rate Disparity between Reserve Bank of Australia and Major Australia Banks - Case Study Example

Heading: RBA Your name: Course name: Professors’ name: Date A letter of Transmittal (covering letter) Sender name Title/position Organization name Street address City, state, zip code Date Recipient name Title/position Organization name Street address City, state, zip code Dear The key purpose of this report is to explore the RBA’s decision and the reaction of other Australian banks. It also describes some of the factors that RBA considers when regulating interbank interest rates The report further lists and explains some of the reasons for banks defiance of the RBA. Lastly, the report explores the RBA’s situation with respect to other countries like Europe, China, and India. Thank you. Sincerely, (Name) Executive Summary In Australia, there is a disparity in the interest rates between Reserve Bank of Australia (RBA) and other banks in the country. The move by the RBA to lower and hike cash rates for interbank lending was based on a number of factors including weakening economy; increased unemployment rates; inflation; dollar, and international forces. Nevertheless, Australian banks do not comply with the RBA’s decision to cut lending interest rates, and instead hike their rates. The banks choice to increase their lending rates was due the high costs and the need to maintain profitability. The move by the RBA to cut rates can also be seen in many central banks in various parts of the world, such as Europe, China, and India. Therefore, this paper seeks to explore the issues described above. Table of contents Appendix B Introduction With rapid economic changes in the world, countries are continually devising ways of coping with them. They normally do this through their central banks that have a tremendous influence other financial banks’ activities. In Australia, RBA recently decided to make a decision to regulate its cash rates on interbank transactions. Some of the factors considered by the Reserve Bank include inflation rates, unemployment, dollar, international force, and federal government. Despite the decision, some banks like ANZ Bank, Bank of Queensland declined to comply with RBA’s move. Similar situations have also been experienced other countries like Europe, China, and India. Factors considered by RBA As RBA (2012) reports, the Reserve Bank of Australia, since 2011 to date, has expressed its intention to promote public confidence. The RBA attempts to impact the country’s economy by lowering and raising the cash rates with an aim of maintaining some economic parameters low, such as, inflation, and unemployment. Nevertheless, despite the reserve bank’s decision to lower interest rates by 25 basis points numerous times, commercial banks in Australia have refused to reduce their rates by the same amount. RBA (2012) says that in the RBA’s decision to regulate interbank interest rates, there are a number of factors that were put into consideration. To start with, RBA considered unemployment rates as one of the factors. According to the bank, the fast rising rates of unemployment in the country triggered the need to reduce its interest rates. In spite of riches that Australia possesses, it is explicit that the country currently experiences a substantial rise in unemployment rate; that is the country’s job markets are weak. Consequently, economists reported that the idea to minimize interest rates by the RBA is noble, as it helps in the maintenance of the balance. Following the Australian Bureau of Statistics (ABS), after a careful study, results demonstrate that the country’s unemployment rate has risen from 5.1% to 5.2%, whereas the country’s employment rate has sharply reduced from 15,400 to 11, 444 million within the same month (Immigrate Australia 2012). According to other market economists’ survey demonstrates that there is an increase in the unemployment in Australia by 5,000 with 5.2% unemployment rate. As per the National Australia Bank’s top economist, Spiros Papadopoulos, the latest information on employment would cause RBA to pursue the reduction of future, formal interest rate. The Australian market is projected to get dry, but Papadopoulos, says that the outcome displayed a softer and weaker economy than they expected (RBA 2012). This is said to be one of the factors affecting the RBA’s decision. Besides, the weak rate of employment is explicitly evident, for Australia’s unemployment rate failed to shift since mid-2011 displaying how unpredictable its job market’s course has gone through. It is clear that there has never been a change in the unemployment level since the June 2011. Additionally, RBA’s decision to regulate its interbank interest rates was triggered by inflation rates in the country. This implies that the Reserve Bank’s decision to minimize interbank interest rates is influenced by inflationary pressure that the country faces. Inflationary pressures impact interest rates since the rates paid on majority of loans are set in the loan agreement. A lender can be reluctant in lending money for certain duration if the buying power of the money will be lower than it is repaid. Thus, the lender will need a higher rate, which is an inflationary premium. Therefore, inflation forces interest rates to increase, while deflation makes interest rates to decline. With respect to RBA, the lowering and increase in the interbank interest rates would help in the controlling inflation in the country (Immigrate Australia 2012). What is more, the RBA’s decision to regulate interbank interest rates was based on the federal (commonwealth) government factor. Notably, actions of the commonwealth government have a considerable impact on the interest rates. This is because the federal government is always the country’s biggest borrower. Besides, the federal government has an initial claim on the existing funds in the money marketplace. Because of the immense taxing powers, and the country’s strong economy, the commonwealth government has the greatest credit rating, and thus, its preferred investment is in its debts. Therefore, RBA considered the federal government, as the main borrower, in its act of regulating the interbank interest rates. Furthermore, Immigrate Australia (2012) says that RBA’s initiative to lower and increase interbank interest rates was founded on international forces factor. Clearly, global forces affect interest rates in Australia. To the level that international investors are ready to lend money to the country, they complement local sources of money in marketplace; hence, lowering RBA’s interest rates. If such forces decide to lower or sell their holdings in the country, and reinvest somewhere else, more required funds would have to originate from local sources that would increase interest rates. Thus, RBA must have considered this factor in determining its regulation of interbank interest rates (RBA 2012). Further, RBA considered the dollar as one of the determining factors for regulating interbank cash rates. The dollar is the major currency in foreign trade and widely used in globe markets. Orderly changes of the dollar in international exchange markets are indispensable for foreign and local stability. Highly volatile or main exchange rate shifts can force the reserve bank to act and may also influence the country’s money policy interest rates. Additionally, alterations in the country’s financial system have considerable impact on interest rates. In case there is a threat of collapse by a big financial institution, it will not default on the money it owes it depositors. The commonwealth government would make favorable deposits, regardless of the influence of its budget deficit. Additionally, Immigrate Australia (2012) notes that Federal Reserve would establish bank reserves as essential; hence, raising the funds’ supply in the market, as well as lowering interest rates. Besides, Federal Reserve is another crucial factor that RBA considers in controlling interbank interests rates. This is because it is the one that regulates the credit availability; that is the amount of money available for lending. The reserve also maintains the interest rates levels at which the money are available. Why banks defied RBA’s decision Explicitly, many financial institutions in Australia have not complied with the RBA’s decision to regulate interbank interest rates. Some of these reasons include maintenance of profitability, coping with high costs; regain confidence, and strengthen the dollar (Hernandez 2012). To start with, Hernandez (2012) reports that the banks of Ban of Queensland (BoQ) has reportedly increased its domestic interest rates on loans in spite of the RBA’s decisions to maintain the overnight interest rate at 4.25%. With the BoQ increase in loan rates that took effect on March 2012, the bank’s interest rates went up from 7.36% to 7.46%. BoQ’s Chief Executive, Stuart Grimshaw said that the increased lending costs caused the increased interest rates on loans by the bank. In fact, BoQ’s rates are similar to the Westpac Bank, whose interest rates are the highest among the largest four. Soon after the BoQ made its decision, other big four and 45 banks in the country ignored the RBA’s decision, and increased their lending rates. Mortgage Choice, the leading independently run mortgage broker in the country, warned borrowers and buyers to get ready for future changes or unexpected alterations to their monetary circumstance, and encouraged them to consider a repayment shield of at least 1-2% (Hernandez 2012). The company stressed the government’s decision for borrowers to go for loans at lower rates as that would mean possible increased $10,000 average savings for five years. Because the analysts forecast that the RBA would maintain the interest rate, the decision never startled the banks in Australia. Immigrate Australia (2012) demonstrates that although businesses like and housing industry were displeased by the RBA’s decision, the treasurer, Wayne Swan came to the RBA’s defense. According to him, the present cash rate remains 250 basis points less than Liberals’ reign. The treasurer also claimed that the RBA is flexible to respond if the world condition further worsens. Besides, the treasurer said that the government will deliver a sensible fiscal strategy; that ensures that it is not increasing the price strains in the economy. Therefore, the treasurer’s defense on RBA’s decision is justified as the high currency is motivated by the high trade conditions, which are in turn, driven by international developments. The reduction of lending rates by banks will enable customers to save money; hence boosting their savings and country’s economy by the balancing inflation rates (RBA 2012). Another reason for the Australian banks non-compliance with the RBA’s decision to reduce interest rates was their need to safeguarding, rather than to enhance them. According to Guy Debelle, the RBA’s assistant governor, commercial banks in the country were not scoring higher profits by loaning domestic clients by increasing their interest rates autonomously of RBA. Further, he notes that despite the fall in costs from mid-2011 till February 2012, they did not fall like the cash rate. Banking institutions raised their loan rates during a rise in costs to uphold their net interest limits in the difference noted in the latest years. Therefore, the banks have done this in order to maintain their profitability (RBA 2012). Financial institutions Australia have rejected the RBA’s decision to lower lending rates because of the need to maintain their businesses safety. According to The Prince in Banks (2012), ANZ Bank autonomously increased its lending rates by 6 basis points; 0.06% demonstrating constant pressures on the whole funding and deposits costs. Consequently, this elevates the bank’s latest normal variable mortgage price to 7.42%; hence placing them below WBC (7.46%); but above CBA (7.41%); and NAB (7.31%) (The Prince in Banks 2012). Similar situations in other countries Reserve Bank of India According to Reuters (2012), India’s central bank, in March 2012, kept its interest rates on hold with a concern over the resurgent inflation threats. This was at time when the country’s economic growth dwindled. The reserve bank of India (RBI) held its monetary policy repo rate at 8.50 %, as had broadly been anticipated. It also maintained the cash reserve ratio unaltered at 4.75% upon cutting it by 75bp in a surprise out-of-cycle decision. According to the RBI’s policy statement, the inflation risks in India were brought about by the latest surge in fiscal slippage, rupee depreciation and oil prices. The central bank increased rates 13 times as from March 2010 to October 2011; hence making itself one of the globe’s top hawkish central banks (Reuters 2012). Currently, Reuters (2012) reports that RBI’s interest rates are on hold since December 2011. Despite deceleration in growth, inflation dangers would still affect both magnitude and timing of country’s future rate decisions. Moreover, the economic performance of India in the quarter fiscal year is anticipated to improve compared to the previous quarter. Interest and bond rates exchange markets were displeased when the RBI constantly focused on inflation threats. The ten-year benchmark bond level increased by 4bp to 8.34% instantly upon the policy statement, whereas the benchmark five-year exchange rate was 6bp greater at 7.55%, and the one-year rate was 7bp high at 8.12%. According to the Bank of Baroda’s top economist, Rupe Rege Nitsure, it would have been unreasonable for the RBI too lower rates prior to budget preparation, as that it would provide a financial consolidation’s roadmap. Additionally, Reuters (2012) says that RBI tightened a toll on the country’s economic development that slowed to 6.1% September 2011, the slowest economy in the past three years. The country’s inflation improved in February 2012 on hiked food costs, but another measure of price strains cooled, market speculation of unexpected rate this year. On average, economists approximates growth in the financial year ending March 2013 will be 7%, compared to 9% expansion pace, which Asian economist in 2011. Reserve Bank of China As Reuters (2012) reports, China central bank reduced the amount of money that the commercial lenders should maintain as reserves so as April 2012 for its second time in almost three months as the recent measure to restore the weakening economy. People’s Bank of China (PBOC) is on the direction of gentle plan that will help ease the second-top economy against stiff world headwinds, even though it has been growing weak. Reuters (2012) also notes that the PBOC set a 50bp cut in Chinese banks’ Reserve Requirement Ratio (RRR), upon constantly resisting market anticipations for such a decision. It would lower the RRR for the largest banks to 20.5% from 21%, introducing an approximately $ 63.5 billion (400 million yuan) into the banking system, which could be essential for lending. Even though the Chinese leaders emphasize on policy stability, reducing RRR is highly indispensable. According to a Huachuang securities’ economist, Hua Zhongwei, monetary and trade information in January 2012 attributed to certain downhill strain on the country’s economy. As per the recent Reuters poll policy lessening will be slow as the central bank warned about inflation in its 4th quarter financial policy statement. China’s turbo-charged economy is probable to slow to 8.2% within the 1st quarter from 8.9% in the past quarter. The PBOC announced its initial reduction in RRR in three years on November, 2011, a decision that took down from 21.5% (Reuters 2012). Reserve Bank of Europe According to Montevideo (2012), the European central bank reduced its major interest rates and made other main steps made to ease the accessibility if credit to promote the 16-nation euro economic zone. The broadly anticipated rate reduction, back to 1%, emerged hours prior to a high-stakes European Union summit, which would aim to consent on a strategy to defuse economic crisis, with Germany and France advocating for rule amendment to more stringent budget order in the union. Furthermore, Montevideo (2012) notes that the ECB that has been closely engaged in the drafting of plans for tighter monetary incorporation in the union has pushed governments to tighten their budget standards and indicated that it could do more to handle the disaster in case they deliver. The rate reduction was intended to buoy the Euro Zone economy that economists project to fall into depression by the start of 2012. The ECB has restored some of its top powerful crisis counteractive tools in the latest months in an attempt to calm increasing pressures in interbank lending markets. Conclusion RBA decided to regulate its interbank lending rates in order to address economic issues like inflation rates, unemployment, dollar, international force, and federal government. In spite of the move, several banks like ANZ Bank, Bank of Queensland declined the command to lower their lending rates. Some of the reasons that the banks gave for their decline were to cope with high costs, and to safeguard their profitability. Similar situations have also been experienced other countries like Europe, China, and India. References Hernandez, V 2012, Bank of Queensland Hikes Interest Rate despite RBA Decision, International Business Times Australia, retrieved on April 13 2012, from http://au.ibtimes.com/articles/310217/20120307/bank-queensland-hikes-interest-rate-despite-rba.htm Immigrate Australia, 2012, The Rising Unemployment Rate Causes a Cut in Interest Rates, retrieved on April 13 2012, from: http://www.imigrate.com.au/blog/migration/the-rising-unemployment-rate-causes-a-cut- in-interest-rates/ Montevideo, 2012, European Central bank cuts rate to record low 1% to fight recession and deflation, Mercopress, South Atlantic News Agency, Retrieved on April 13, 2012 from: http://en.mercopress.com/2011/12/09/european-central-bank-cuts-rate-to-record-low-1- to-fight-recession-and-deflation Reuters, 2012, China Cuts Banks' Reserve Requirement Ratios, Retrieved on April 13, 2012. http://www.cnbc.com/id/46438510/China_Cuts_Banks_Reserve_Requirement_Ratios Reuters, 2012, India Central Bank Holds Rates, Flags Inflation Risks, retrieved April, 2012 from: http://www.cnbc.com/id/46742847/India_Central_Bank_Holds_Rates_Flags_Inflation_R isks RBA, April 3, 2012, RBA statement on interest rates, Retrieved in April 13, 2012, from: http://www.theage.com.au/business/rba-statement-on-interest-rates-20120403- 1wa5x.html The Prince in Banks, 2012, Reserve Bank of ANZ raises rates, Retrieved on April 13, 2012 from: http://www.macrobusiness.com.au/2012/04/reserve-bank-of-anz-raises-rates/ Appendices Appendix A RBA’s move to maintain interest rate on hold satisfied the anticipation of fiscal markets: The view for the worldwide economy is unclear compared to last year country’s terms of trade remain extremely high and national revenue has strongly grown The upcoming growth outlook is weaker than was anticipated some months ago Employment growth has fared over last months, while unemployment rate has decreased by almost 5%. there is a decline in credit growth over a few months Year-ended Consumer Price Index (CPI) inflation must begin to turn down to the end of the year, as impermanent weather-related influences overturn. Appendix B RBA’s financial system Lenders/Savers Read More