Banks telling the truth on funding costs, study claims

Adam Smith 27 October 2016

Banks have long claimed that their funding costs aren’t affected by the RBA cash rate, and a new study has backed them up.

A five-year study by Simon Cottrell, a senior lecturer at the Australian Institute of Business in Adelaide, found that the official Reserve Bank cash rate does not drive bank funding costs, the Australian Financial Review has reported. The findings cut against recent commentary by the RBA and the Australian Securities and Investments Commission (ASIC) that bank funding costs are closely correlated with the cash rate.

Cottrell, a former banker, claims in his paper that factors beyond the cash rate have a greater influence on bank funding costs, the AFR reported

“The RBA's cash rate displayed no statistical significance as a driver of wholesale funding spreads and it is these findings that are particularly intriguing given the contrasting views of the Reserve Bank of Australia. Statistical evidence suggests the key drivers of Australian bank wholesale funding spreads are the VIX [a volatility index], the 10-year bond yield, the bank bill rate [BBSW] and the exchange rate,” the paper says.

Cottrell has claimed that the RBA’s statement that “the level of the cash rate set by the Reserve Bank is a primary determinant of the level of intermediaries funding costs and hence the level of lending rates” is incorrect. He also rubbished statements by ASIC chairman Greg Medcraft, who last week told the Senate estimates committee that bank funding costs were closely correlated to the cash rate.

"He is completely arguing against what I have found after researching this for the last five years. I have found in favour of the arguments being made by the banks, which is great for them but not so good for authorities."

The findings echo arguments from the Australian Bankers Association, which has claimed that bank funding costs had diverged from the official cash rate.

The RBA will make its next cash rate announcement next Tuesday (1 November).

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