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Murray’s bank capital proposal to impact mortgage pricing

The Financial System Inquiry’s (FSI's) recommendation that Australian banks hold additional capital would lead to a rise in borrowing costs, according to the FSI final report.

While the FSI expects the cost of increasing capital requirements would be small, it estimates that a one percentage point increase in capital requirements would increase the average interest rate on a loan by less than 10 basis points.

“This is the figure if the full cost is passed on to consumers with no offset in interest rates by the RBA,” according to the FSI final report.

“However, in a competitive market, the actual change in lending interest rates would be lower and the RBA may lower the cash rate if conditions warrant,” the report stated.

“The Inquiry asked APRA to review its approach to generating these estimates, and APRA confirmed this approach was reasonable and consistent with other studies.”

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The FSI estimated effect on loan interest rates is roughly in the middle of the range found in a number of studies.

The surveyed studies find increases in loan prices for a one percentage point increase in capital ratio are 1 to 22 basis points.

APRA’s regulatory impact statement for the introduction of Basel III estimates a 5 basis points interest rate increase on a loan with a 50 per cent risk weight.

A recent Bank for International Settlements (BIS) study on the impact of Basel III found there would be a 12 basis points increase in loan prices per percentage point increase in capital, falling to around 8 basis points if only the advanced countries are considered.

“This low cost reflects that changing capital requirements only affect a small portion of the funding of a loan,” the report stated.

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“For example, a one percentage point rise in capital requirements affects the funding cost of less than 0.5 per cent of the average loan,” it said.

“That is, the funding cost on 99.5 per cent of the loan does not increase, and the incremental cost of equity over debt is only felt on the remaining 0.5 per cent.

“Changing the cost of this small slice of a loan’s funding therefore has a correspondingly small effect on the average funding cost.”

RBA staff research suggests that an interest rate increase of this magnitude would reduce real GDP by less than 0.1 percentage points, while other studies suggest the effect could be even lower.

In addition, Murray’s final report remarks that the effect on growth would likely be taken into account in macro-economic policy settings since the RBA considers actual lending rates when determining the cash rate.

 

Murray’s bank capital proposal to impact mortgage pricing
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