Effect of Low Interest Rates

June 2, 2020

Outcomes for Australia:

Several of the banks across Germany and Japan have sought to diversify their revenue streams across geographies, increasing their product offering around the world and gain exposure to higher interest rates – in countries such as Malaysia, China, Hungary, Poland.

Also, many of the banks offer corporate bank accounts with negative interest rates – something that Australian banks have yet to do.

Customers are in effect charged for their deposit.

For example: with the European Central Bank deposit rate at -0.4%, a business deposit’s interest rate could be -0.8%.

The interest rate differential is used as part of the bank’s net interest margin.

In Commerzbank’s case, the bank has reduced headcount slightly whilst still growing revenue. They have achieved gains through utilising technology to cut cost, with over 80% of all processes to be carried out digitally by the end of 2019.

Margin Pressure:

In Australia, CBA has over $100bio AUD of deposits yielding at or near zero% at present.

The other three major banks, ANZ, NAB and WBC, all have similar liability profiles – though differ in the amounts.

The bank’s margin pressure is easily explainable:

If the RBA cash rate is 1% and short-term funding rates (overnight to 12 months) are near 1%, and customer deposits are at or around 0%, then banks are making ~1% margin on their liabilities (deposits).

If the RBA cuts rates to 0.5% from 1% in the next 6-12 months and customer deposits are still at or around 0%, then the bank’s margin on liabilities has contracted by 0.5% – all things remaining equal.

Shareholders can either accept the lower profitability of the banks or can seek the bank to recuperate the lower interest rate revenue from elsewhere – usually through bank fees.

Banks in Australia have made efforts to create “fee free accounts”, where customers aren’t charged transaction fees or account-keeping fees. Domestic ATM withdrawal fees have been removed and international transaction fees have been reduced.

This reduction in fees may need to be reversed if the above hypothetical comes to pass. ATM fees may be re-instated and other fees may be introduced (or reintroduced) to boost bank profitability.