Despite failing to pass on the interest rate increase to depositors, bank’s continue to make the argument that higher funding costs are the reason behind higher interest rates which have been passed onto borrowers in excess of official rate hikes by the central bank.

Most of Australia’s online banks have declined to pass on the 25 basis point rate hike to their customers, with some of them even doing the opposite and cutting their promotional rates.

Virgin Money cut its promotional rate by 24 basis points for its online savings account at the start of the week, when this cut is bundled together with the 25 basis point rate hike enacted by the central bank, the effective rate cut equates to 49 basis points.

Bankwest continues to offer the highest promotional online interest rate of 7 per cent despite failing to pass on the interest rate increase to its customers.

ANZ did pass on the rate hike to its customers and currently offers a 6.25 per cent interest rate to all its savings accounts, whilst Westpac and CBA did so only for their highest interest accounts.

Since the financial crisis in 2008, a dramatic battle for deposits erupted between Australian banks, as they sought to diversify away from wholesale international funding markets which are volatile and froze during the crisis, to a more stable depositor based funding.

The latest moves by lenders not to pass on rate hikes to their depositors implies that the intensity of competition between lenders is levelling off.

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National income accounts data which was released on Wednesday shows that growth of the Australian economy slowed down during the September, expanding by a moribund 0.2 per cent, the slowest recorded level since the end of 2008, when the financial crisis was at its greatest, and the fifth slowest recorded growth rate since 2000.

Consensus growth forecasts by a majority of economists had been 0.5 per cent, and the sluggish result is likely to compel the central bank to hold interest rates steady until well into 2011.

The GDP data and the prospect of steady interest rates resulted in a sharp fall in the value of the Australian dollar against the US dollar, with the futures markets pricing in a 3 per cent probability of the Reserve Bank of Australia cutting interest rates during its final board meeting of the year scheduled next week.

Australian households however seem to be saving more, with the savings rate the highest it has been since 1987 excluding the period of last year’s fiscal stimulus.

The Australian household savings rate touched 10.2 per cent during the September quarter, sharply higher than the 8.2 per cent recorded during the previous quarter.
Savanth Sebastian an economist with CommSec Securities was quoted in The Australian as saying that the reason behind the higher savings rate was an increased level of national income as a result of the resource boom.

“The extra dollars coming in aren’t being spent. Consumers and business are holding on to the cash until the economic recovery gains traction. The double-digit household savings ratio and weak private sector investment outside the mining sector adds weight to this argument.” Mr. Sebastian said.

Australian Prudential Regulation Authority (APRA) data released this week echoed the view that the savings rate had reached its highest level in two decades.

According to APRA household deposits placed with the big four banking groups rose by an annualized 8 per cent in October. Term deposits grew even faster, by 21 per cent over the last year according to the Reserve Bank of Australia.

The RBA figures show $422.4 billion was held in term deposits in October compared with $348bn last year.

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The investment bank Macquarie conducted an analysis of the online savings market which found that the big four Australian lenders, as well as some international rivals were offering introductory rates that were as much as 200 basis points higher than the 4.5 per cent official cash rate.

The study found however that those rates were aggressively cut back within four to six months, bringing them in line or just higher than benchmark interest rates.

Virgin Money currently offers the highest savings rate in the market at 6.75 per cent, followed by UBank offering 6.51 per cent, Citbank at 6.45 per cent.

Three of the majors, the CBA, NAB and Westpac, offer 6 per cent, while ANZ lags the field at 5.25 per cent. The headline rates of the majors are 129 basis points above the 90-day bank bill.

The rates which seem quite attractive to begin with are rolled back within the first three months.

According to Craig Turton, an analyst with Macquarie, lenders began the trend of raising their online rates in tandem with official interest rate hikes at the end of 2009.

“In mid 2008, when the cash rate was 3 per cent, term deposits grew much more rapidly than savings account rates because of 200 basis points difference between headline rates. The increased competition in the online market coincided with six increases in the cash rate. The cash rate increases flattened the yield curve, narrowed the difference between online savings and term-deposit headline rates and stemmed the flow to term deposits.” Mr. Turton said.

Headline term deposit rates continue to remain high, with one and three-year deposit accounts still the most expensive source of retail funding for the major banks. The one and three-year term deposit rates are up to 250 basis points above the bank bill rate.

Gail Kelly, chief executive of Westpac last week said that the lender would not engage in an online savings war with her other Big four rivals. Westpac has one of the most aggressively priced term deposits in the market.

The research from Macquarie also suggests that that the margin pressure from higher retail deposit rates would not have as large an impact as expected for the banks with greater residential lending market shares.

Previously the assumption had been that lenders which were weighted more towards institutional lending would be able to offset the costs of higher deposit rates, by raising business lending rates.

“The banks with more term-deposit funding on the liability side and mortgages on the lending side should fare better than those banks with proportionately larger institutional lending books,” he said. “The spreads on new institutional loans are now falling due to two emerging sources of competition.”Mr. Turton said

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The Melbourne Institute household financial conditions index rose 17.2 per cent to 33.7 in June, up from 28.8 in March.

“Credit card debt overtook mortgage debt as the main form of household debt in June, 36.6 per cent compared to 33.9 per cent. This is the first time since November 2006 that households nominate credit card, and not mortgage debt, as their main form of debt.” Melbourne Institute research fellow Dr Edda Claus said in a statement on Thursday.

51.5 per cent of respondents cited saving for a rainy day as the main reason for their savings, a figure which remains unchanged from the March quarter.

55.8 per cent of respondents cited saving for a holiday or travel as the main reason for their savings, up from 55.0 per cent during the March quarter.

Credit card debt became the main form of debt carried by Australian households, replacing mortgages, and the level of debt rose by 3 per cent to 36.6 per cent.

“About 48.8 per cent of Australian households saved part of their income in June 2010, up from 46.2 per cent in March,” the report said.

The survey results from the June quarter suggest that nearly 75 per cent of Australians own their home outright or hold a mortgage, a figure which declined from previous surveys.

More than 40 per cent of households said they were debt free, while a third said they held mortgage debt, down almost four per cent since last quarter.

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“We have proved to ourselves that we could turn the deposit switch on pretty rapidly through our branch network last year and we did that, but we weren’t prepared this year to compete in what I think is unsustainable competitive markets. Can we go back into that market? Yes, but you would need to remain competitive, and at the moment I think it is quite dysfunctional.” he said.

Mr. Liddy added that as a result of the government’s necessary response to the financial crisis a banking oligopoly had formed.

“The demise of two of the major regional banks and several significant non-bank lenders, and the funding pricing disadvantage placed on smaller industry players, has and will continue to place more power in the hands of four major banks,” Mr Liddy said.

“I continue to urge our government to look for solutions and regulatory measures that not only maintain and improve our world standing in financial services but provide real options in restoring a competitive banking landscape in our country.”

BoQ said its normalised cash net profit — its preferred measure of profitability, which strips out volatile items — had climbed 15 per cent in the six months to the end of February to $97.2m amid cost savings and higher net interest income.

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In Australia, fortunately the government so far has yet to raise tax rates, the top marginal tax rate is the same as it was last year however it is still at a hefty 45 per cent.

Australia is indeed one of the few countries that has not aggressively raised taxes, whilst at the same time has also begun tightening monetary policy, so interest rates are no longer at near half century lows.

If however you find yourself living in a place where like the UK for example, the top marginal tax rate has been raised to 50 per cent, whilst the bank rates are less than half a per cent, then clearly difficulties in obtaining returns on one’s savings does become a problem.

Those seeking returns are therefore being extremely inventive in sourcing methods to beat their savings problems, using offset mortgages, cash back credit cards, paying private school fee upfront.

Here is how it works

CASHBACK

Low bank interest rates are not the main problem in Australia, with the official cash rate at 4.25 per cent, and many lenders offering term deposit rates well in excess of that level. But for those who want easy access to their cash, and want to find a way of making some savings at the same time, then a cash back card is a good idea.

Many lenders seem to offer better rates for spending money using their credit cards, in some countries it is more profitable to spend on a credit card than using your savings.

The card issuer typically offers a cash back rate of something like 1 per cent, when you spend money using your credit cards with participating retailers.

The big advantage is cash back spending is tax free, so if you live in a place where the bank rates are puny, and a 1% cash back rate is competitive relative to the interest on your savings, then it makes sense to use the card to spend, not only do you earn cash back, but that is not taxable, unlike the cash sitting in your savings account.

OFFSET MORTGAGES

For those income earners who find themselves in the top tax bracket, holding a mortgage and a savings account, now would be a good time to enquire about the possibility of switching your mortgage over to an offset deal.

Offset mortgages work by simply offsetting the borrowers savings against their mortgage debt, with interest accruing on the remaining balance.

This means that the mortgage debt is paid off far earlier than otherwise would be, with the interest only accruing on the remaining balance, which is far less than the tax payable on the same amount.

The best thing about offset mortgages is the fact that cash balances can be accessed whenever you have the need to dip into them.

Ann offset mortgage allows the borrower to earn tax free interest on their savings at the same level as the mortgage, and is very useful for top rate taxpayers, who have a decent amount of savings.

PAY SCHOOL FEES UPFRONT

If you are sending your children to private school, then one way to save cash and reduce tax is pay the fees upfront. What the school will tend to do is place the money in a separate account, which is supposed to protect you from any closure or bankruptcy.

The school places the money in a deposit and returns the interest earned from the deposit in the form of discounts. Most schools have charitable status, so their interest income is tax free, which has the effect of the discounts often being far better than the interest received were the money held in a taxable savings account.

Bursars report increased interest in paying fees in advance, thereby netting a higher effective return than on cash deposits. Your money tends to be kept separate from a school’s financial affairs, so it should be protected if it closes or gets into difficulties.

When you pay upfront, the school puts the money on deposit and passes back the interest earned in the form of discounts. Schools earn interest tax-free thanks to their charitable status, which means the discount is often far better than the interest you would receive on a taxed savings account.

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The policy is as a result of the successful implementation of a pilot project last year in branches located along the eastern seaboard, which saw the introduction of retirement bankers in over 220 branches.

The specialists are available to offer free advice and tailored banking products for people planning or already in retirement.

Louis Hawke, ANZ’s managing director for retail distribution, said that less people were retiring in the traditional manner.

“Today’s retirees have different priorities, such as further education, travel, caring for grandchildren, starting businesses or working part-time,” Mr. Hawke said.

Mr. Hawke said, with an average retirement age 59 and the average life expectancy reaching 81, the average person has 20 years of retirement to fund.

ANZ believes that retirement is much more than just superannuation, and that many people had to change the way they bank in order to prepare for it or to draw from their savings.

The introduction of the policy of having dedicated retirement bankers comes after research by the lender on people older than 50 showing a majority of account holders had not reviewed their status since their accounts were first opened.

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Deposits have flowed in the coffers of the Big Four lenders, which in comparison to their smaller regional rivals, credit unions and building societies, offer lower interest rates.

Despite Prime Minister Kevin Rudd pledge not to let any financial institution, large or small fail, Australians still feel safer holding their money in accounts with a Big Four lender, which allows the Big Four banking groups to pay less in interest than smaller lenders pay.

Had Australians chosen deposit their savings with small regional lenders instead, savers would have collectively earned at least $3.6 billion more in interest over the last year, according to a research report commissioned by the Daily Telegraph and conducted by research firm Core Data.

Retail deposits held with the Big Four banking groups amounted to a record $356 billion, representing an 18 per cent increase in the same month last year, or a staggering $54 billion rise in deposits held with the Big Four.

The huge increase in deposits held with the Big Four banking groups came as a result of a flight to quality by depositors, caused by a global financial crisis, which prompted depositors to seek out banks which they perceived as being the safest, rather than those which offered the highest returns for their deposits.

In actual fact, the Federal Government guarantee of all deposits held by banks, building societies and credit unions, means that deposits held with smaller financial institutions are just as safe as those held at the Big Four.

High interest bearing internet accounts at the Big Four, under perform those offered by many smaller rivals by as much as 1 per cent, which according to Core Data, means that Australian depositors are losing out on as much a $10 million a day or $3.6 billion a year in interest.

The highest paying at call internet accounts offered by the Big Four banks, pay just 3 per cent in annual interest once introductory offers and conditions are stripped out. Smaller regional lenders, building societies, credit unions and even foreign banks who were also covered by the deposit guarantee, pay 4 per cent or more in annual interest, with no conditions attached.

This means for an individual who has $10,000 in savings, depositing that money with a Big Four bank means they would be forgoing an average of $100 a year in interest alone, or one third of the total interest paid by a Big Four bank, this despite the fact that there is no difference in risk.

This means that on $10,000 in savings, Big Four customers are giving up an average $100 a year in interest alone, or one-third of the total return made on online accounts at the major banks, despite no difference in risk.

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After the Federal Government implemented its guarantee on all Australian bank deposits in response to panic in financial markets last October, around $8 billion of financing to SME’s was cut as panicked investors moved funds into guaranteed products from non guaranteed investments including those of mortgage funds.

There is little doubt that the effect of the guarantee had on the Australian banking and investment landscape was one of large scale distortions. New deposits into non guaranteed products ceased resulting in the halting of new lending and fund managers freezing capital redemptions in a bid to cease the haemorrhaging.

Now that credit markets seem to have stabilized along with the global banking system, the industry is calling for the government to give the industry a boost by managing a staged lifting of the guarantee ahead of its three year expiry date.

Mortgage income funds have been instrumental in providing financing to small business, with many investors finding the high interest rates offered and the ability to withdraw without notice extremely appealing.

Chairman of the Investment and Financial Services Association David Deverall said that the larger mortgage income funds were able to offer redemptions to about 25 per cent of those who requested it, but only over the course of a quarter.

An alternative to freezing of funds being mooted is for investors to convert their funds, which were previously available at call into term deposits with defined or fixed terms.

“If we can do this, it will help existing investors and borrowers,” Balmain Funds chief executive John Thomas said.

Mr. Thomas believes that re-opening fund products to new investors would allow existing investors to exit or redeem capital that is currently frozen.

“It will allow existing investors who are content with the income stream to stay where they are, while others would have access to their capital over time.”

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Superannuation minister Nick Sherry wants the Federal Government to review and scrutinise fees and commissions generated by financial planners and brokers when they advise their clients on superannuation investment strategies and products.

The Government hopes to examine the structure, operation and efficiency of the sector. Mr. Sherry in an interview with ABC said that the fees and commissions structure is a concern for many people.

“Why aren’t the fees coming down, why don’t we have lower fees in a compulsory system? We know from international experience that as a system grows and we have got one of the largest systems in the world – fees come down. It hasn’t happened in Australia.” Mr. Sherry said

Mr. Sherry made the point that the fees and commissions charged by superannuation products had implications on the amount of funding available to people when they reach retirement age.

“The important thing about fees is that if you have a 5 per cent long-term rate of return after you have 1 of 2 per cent fees, those fees reduce your retirement savings very significantly by the time you get to your 60s,” he said.

The Combined Pensioners and Superannuants Association has welcomed the Federal Government’s plans for greater scrutiny of superannuation fees and commissions.

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