Australia’s higher interest rates have been a huge draw card for foreign investment throughout  the past 5 years of the GFC.

Despite certain media reports that Australia has now achieved the “safe haven” status among global investors (a statement that I don’t personally agree with), it’s the RBA’s sensible interest policy that has ensured that we remain an attractive investment destination for foreign capital starving for low volatility and more importantly, higher yield.

The Central Bank policies of the US and Europe, of flooding the market with cheap credit and forcing interest rate low for an extended period of time, is designed to force investors to take on risk and move their capital out of cash and into higher risk, higher yielding investments.

Despite what you may read and believe about the economic credentials of our country and the Australian dollars new “safe haven” status, the number one reason that global capital has continued to gravitate towards Australian shores, is the higher interest rates on offer in Australia, compared to the rest of the world.

If the RBA didn’t act so prudently over the past 5 years, and instead followed the desperate path of our overseas counterparts by flooding the economy with cheap credit, Australia could have found itself having to pay much higher interest rates to attract foreign capital, as it would have lost its current competitive advantage.

So be careful what you wish for and ask yourself, should our interest rates continue to drop as a means to spurring economic growth, at what point will Australia lose its appeal as an investment destination for foreign capital and what effect could it have on real interest rates, in the future ?

Con Katsiouras – Director
Folio Finance Pty Ltd

Beware of Banks Bearing Gifts

Recently I have come across many Borrowers who were pleased about the low Interest Rate they are currently paying on their Commercial Property Loans.  Many of them are paying between 6.00% and 6.50% which are historically low rates, actually lower than some current home loan rates .

But these opinions completely contradict the many recent newspaper articles that  have reported claims by many members of the Business Community, of Banks passing on higher lending margins to their Business clients, to subsidise their lower margin Home Loan and Wealth Management Businesses.

So how can we have such a contrast of views from different members of the Business Community? Could it be possible that Banks really are going out of their way to offer cheap Commercial loans? If so what has inspired this benevolence from our Banks?

Generally, Commercial Loans are priced as a Bank Bill Swap Rates (BBSY or BBSW rate ) plus a margin and it is these two components that make up the actual interest rate paid by borrowers  (for simplicity we have assumed that there are no other costs associated with the interest rate charged. In reality, Banks can have many fees and charges, treasury fees, line fees etc, that can impact the actual interest rates/costs associated with a Commercial Loan). Prior to the GFC when competition was at its peak,  it was not uncommon to have clients priced at margins between 1.25% – 1.50% (many clients enjoyed much lower margins).

So taking the 30 day BBSW rate of 3.63%  on the 27th July 2012 (Australian Financial Markets Association) and assuming a borrowing rate of 6.00% per annum, we calculate that this Borrower is being charged a Margin in the vicinity of 2.37%.  From this simple calculation, we  can see that despite borrowers benefiting from what may be perceived as a Low Interest Rate,  the actual margin being charged above the BBSW, is well in excess of the pre GFC averages (by as much as 64% conservatively).  This is a substantial increase in Margin at a time when many Businesses are doing it tough. This increase in Margin has also had the effect of further intensyfying the current economic downturn by removing much of the stimulus that would have been created from a lower interest rate environment. At the same time , it  has ensured that Banks can continue to make record profits by pushing up costs to Business’s disguised behind “Low Interest Rates”.

So whilst many Borrowers may believe they are benefitting from a “Low Interest Rate”, their Banks are actually profiting from much higher Margins, justifying some of the claims of fee gauging by Banks towards their SME clients.

In finance, we refer to this as “Margin Creep” and the Banks have used this process very effectively during the current downturn in both the Home Loan (Retail Banking) and more aggressively with their Business clients. However, Business Clients have borne the brunt of these fee increases as Banks understand how difficult it can be for SME’s to refinance, making them easier targets for rate and fee increases (compared to highly transient, Retail customers who have more competition ,more options and cheaper entry and exit costs).

So next time you find yourself negotiating a Commercial Loan with your Bank, do your homework, review the current BBSW or BBSY rates and ensure the discussion focuses on your lending Margin and NOT your Interest Rate. That way you won’t give your Bank the opportunity to hide an overpriced margin behind a cheap interest rate and your facility will remain competitive over the long-term.

Should you wish to discuss any aspect of this post or any general matter, please contact me on :

Ph: 0388445555

E: con@foliofinance.com.au