Mortgage rate cuts fail to match Central Bank fall

After months of waiting, interest rates have finally begun to fall

After months of waiting, interest rates have finally begun to fall. But the official cuts sanctioned by the Central Bank in recent weeks have not been matched in full by the lending institutions.

On October 9th, the Central Bank surprised the markets with its first move to lower rates, cutting its key money market or repo rate by 1.25 percentage points.

In the days that followed, the financial institutions announced they were reducing mortgage rates but none matched the full Central Bank cut. Although many institutions have yet to respond to last week's reduction in official rates, those that have done so have again failed to drop mortgage rates by the full amount.

The failure to cut home borrowing costs - and other levies such as the rate of interest charged on credit cards - by the full amount has raised questions as to why. Given the deep suspicion of financial institutions harboured by many in the wake of over-charging, interest loading, churning and tax evasion scandals, some borrowers are wondering if the banks and building societies are not simply seeking to improve their bottom line at the customers' expense.

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The institutions, however, are adamant that they are not making any money from falling interest rates. They have not passed on the full benefits of the falls to borrowers mainly because of the need to protect savers, they say.

If they were to slash lending rates to the full extent, many depositors who are already earning miniscule returns, would be facing negative interest rates. Savers, who are earning less than one percentage point on their money and often as little as 0.2 per cent, would quickly find themselves in this position if the interest rate on their accounts was subject to a one percentage point cut. But not passing on the cut, or the full amount of it, to savers eats into the other side of the bankers' book as they attempt to match their funding and lending costs.

"We have two sides to our book, assets and liabilities. One is having good times, the other bad times," says Mr Donal Doran, product manager at Irish Permanent, the State's largest mortgage lender. "We have to balance and apply rate cuts in as equitable a manner as we can."

Mr Sean Curtis, head of marketing with TSB Bank, points out that lending costs are made up of the funding cost or the cost of deposits which he describes as "the raw material" of the banking business. In addition, institutions have to factor in their costs and, like all other businesses, on top of this they take a margin for themselves.

It is the higher raw material costs that are the main factor in keeping borrowing costs from falling further at present, not higher margins, bankers say.

In addition the Central Bank, although it no longer has a formal role in setting interest rates, is known to discuss such matters with the institutions in a bid to ensure that they do not benefit on the margin from rate cuts.

The concern for savers demonstrated by the banks and building societies is not pure altruism, however. Deposits are an important source of funding for all financial institutions as they do not want to put all their eggs in one basket by having to raise all their money in the financial markets.

"Having a large spread of retail customers who are consistent savers is better than having to rely on other banks for funding," says one banker. "If the other banks feel they are in control, if they know you are struggling for funding, they will squeeze you."

Indeed, in attempting to protect their deposit and investment base, sources in the industry suggest that some financial institutions, rather than benefiting from the rate falls, may be taking a hit on their margins.

The net interest margin - or the difference between the average interest rate on loans charged by a financial institution and the average interest it pays on deposits - has been under increasing downward pressure in recent years.

Figures from the Irish Banks' Information Service show that the net interest margin of the retail banks has fallen from a range of 3.1 to 4.4 per cent in 1996 to a 2.6 to 4.3 per cent range in 1997 although margins in the personal banking area are higher. Margins in this area are also understood to be below those of the British banks but above the margins enjoyed by their counterparts in continental Europe, against whom Irish financial institutions could soon be competing.

Many believe margins will be further eroded as competition for both lending and deposits increases further following the introduction of the euro.

However, if the financial institutions have not used the last two rounds of rate cuts to fatten their margins, some may be trying to stave off some of the pain that lies in store for the moment by choosing to maintain their margins or by hitting them only slightly.

Official rates - and consequently mortgage rates - have a little further to fall but many deposit rates are close to their floor and cannot realistically be cut from current levels which will eat into the industry's profit margins.

"Most banks are looking at margins being squeezed by the process under way. They may be lightening that squeeze slightly," says one industry source.

Normally this should effect their competitive position in the market. But the fact that many lenders are taking a cautious stance against the background of the current property market boom, putting increased emphasis on the quality of their home loans rather than aggressively expanding lending volumes, may partly explain why they are happy to do so.

But if the banks and building societies are not boosting margins as a result of the easing in monetary policy, neither are they doing a great job explaining why rate cuts are not being passed on in full to the borrowing public, consumer advocates say. They believe that the financial institutions are proving less than transparent in the way in which they treat their customers.

"Our concern is that borrowers would be able to see the reason for the full benefits of rate cuts not being passed on, that a transparent explanation be given to them," said a spokesman for the Office of the Director of Consumer Affairs. "The reason for the gap has not been fully explained to consumers."

Consumer bodies also complain that financial institutions are quick to flag rate cuts for borrowers, often detailing the precise amount the borrower will save each month.

But information on the impact on depositors often follows at a much later date, accompanied by far less detail.