How Australian banks can manage interest rates holistically across both sides of the balance sheet.
Banks in Australia had not been exposed to rising interest rates for over a decade. However, following a period of historically low rates, over the past months the Reserve Bank of Australia (RBA) raised the cash rate to 3.60 percent in a staggered approach. “It will be some time before inflation is back to target rates,” shared RBA governor Philip Lowe in his February statement on monetary policy.
Based on RBA’s cash rate hikes, banks updated their rates for loans and deposits inconsistently. On the loan side, the entire rate increase was passed on to all clients – usually on the same day of RBA’s increase. On the deposit side, rates were increased for some deposit products and selected client segments only. In addition, rate increases did not necessarily match the cash rate hike and were rolled out with some delay. These inconsistencies triggered the Australian government to ask the consumer protection regulator to conduct an inquiry into rate setting for deposits and loans by banks.
Banks must find a way to achieve profitable growth in both deposits and loans while paying close attention to strict regulations and delicate client sentiment. Rising interest rates only exacerbate the situation against a backdrop of existing challenges.
How are Australian banks impacted by rising interest rates?
Higher revenues but decreasing volume growth on the loan side
The higher interest rates on loans permitted banks to post large profits – and especially the big lenders had stellar results. On the downside, higher costs of loans for clients will limit volume growth of the loan book. Fewer new clients want to lock in their financial future in loans at higher prices. Furthermore, existing clients strive to decrease their financial burden through higher repayments and roll-overs to competitors or challengers like Fintechs.
Based on the preliminary and final findings of the regulatory inquiry into rate setting, more deposit products are expected to be repriced for more client segments. Increasing rates for more deposit products and client segments will compress the net interest margin (NIM) – spread between cost of funding and loan revenues. On top of that, NIM increases achieved due to delays in repricing deposit products (compared to loans) will vanish. NIM is expected to compress further.
Public perception of pricing
Rising living costs and increasing interest rates on home loans added pressure on private household budgets. Some households were forced to cut spending to make ends meet. This stands in contrast to the large profits of the big lenders which, in the perception of the public, caused the constraints on the household budget in the first place. In their opinion, banks did not meet the expectations of the community, i.e., to provide services at a fair value.
Action plan for Australian banks as interest rates rise
With the current inflationary economic outlook, banks in Australia not only need to manage the cost for the funding and revenues from loans. They also have to manage expectations of the regulator and community. This requires competitive products and services for their clients at prices perceived to be fair by the community.
Understand the price sensitivity of your deposit book
Create transparency on your deposit book and identify price elasticities. Knowing how different clients have reacted to price changes in the past can help you identify patterns in price sensitivity for your different segments. This enables you to run simulations that determine the right products and prices for the right client segment. On that basis, volume targets per client segment can be set, enabling you to maintain deposit levels.
Avoid high acquisition cost for new clients
It may be tempting to match competitor offers for deposits in an undifferentiated manner. However, this would result in higher than necessary acquisition costs, as all new clients receive the same rate. Especially for digital banks, this quickly becomes a challenge due to the increasing cost of funding, resulting in NIM compression. A more optimal approach is to match new clients to existing client segments and leverage the price elasticity of respective segments to set a differentiated price. This would also address the imbalance of rates between new and existing clients.
Target the right client segments
The rising interest rates for loans will cause a higher rate of loan losses. Based on these losses, banks will introduce more stringent loan approval requirements. The loan book contracts – at a higher cost of funding. To maintain current levels of the loan book, new loans must be acquired which meet these stringent requirements. Here, it’s important to understand your client segments, product preferences, risk profiles, and price sensitivities. Identify low-risk client segments with a positive spare cash flow after interest rate increases and refocus lending activities on these segments.
Improve the loan life cycle experience
Loan applications are usually cumbersome and time-intensive for new clients, creating a barrier for successful submissions. This barrier can be lowered with digitalized process with gamification components. This could include quizzes about financial literacy or games to understand financial concepts. In addition, as digital channels incur lower costs, loans submitted online could enjoy lower rates. Further along the loan life cycle, borrowers can be incentivized to repay their loans on time with special rewards and bonuses.
In the new digital world, the best designs and concepts win. We at Simon-Kucher have extensive experience in digital platforms, dynamic pricing, and behavioral analytics and can help your bank revolutionize the way you price and offer products. We have developed numerous innovative platforms for banks to improve client acquisition, retention, and cross-selling by including gamification and nudging effects.
And all our platforms are future proof: Our comprehensive monetization strategies are not limited to high rate offers. We develop engines that forecast and recommend the best rates for efficient book management. Now and in the future.
Interested? Check out Simon-Kucher Dynamica Deposits – our end-to-end software for data-driven deposit managers within the financial services industry.