With housing affordability remaining a persistent headline issue, and following sustained regulatory scrutiny into Australia’s financial system generally, the ACCC’s preliminary findings on the pricing of residential mortgage products have been highly anticipated by borrowers and lenders alike.
On 15 March 2018, the ACCC handed down its Interim Report (“Report”) on the pricing of residential mortgage products (“Inquiry”). The Inquiry follows the Australian Government’s announcement of the Major Bank Levy.
This is the first time the ACCC has considered the pricing of residential mortgage products following the introduction of the Major Bank Levy, which requires ANZ, CBA, NAB, Westpac and Macquarie Bank (the “Big Five”) to pay 0.015% per quarter on its liabilities (to raise around $1.5 to $1.6 billion every year). Read our previous post on the Major Bank Levy here.
The Report also considers the introduction of APRA’s new prudential benchmarks relating to investor-only and interest-only loans and the level of competition in the market for residential mortgage products.
The Inquiry forms part of a trend of sustained regulatory scrutiny into the financial system, including:
In this post, we consider the ACCC’s findings and the implications for both lenders and borrowers.
Banks have not passed on Major Bank Levy to consumers
A question on everyone’s mind, not least the ACCC’s was: will the banks pass on the Major Bank Levy to consumers by increasing interest rate?
In the Interim Report, it was revealed that as at November 2017, there had been no changes to headline rates announced by the Big Five since the Major Bank Levy commenced and no specific decisions have been made to adjust residential mortgage prices.
It is unsurprising to see that the banks refrained from making such a move. While the ACCC does not have the express power to stop banks from passing the levy onto consumers, ACCC Chair Rod Sims has previously warned that the ACCC’s new role over mortgage pricing would significantly improve transparency with respect to the drivers of pricing, allow it to understand the decision-making logic of the banks and assess whether pricing changes could be attributable to the levy in order to deter its pass-through to customers.
The ACCC’s key findings are set out below:
Pricing currently lacks transparency
- The overwhelming majority of borrowers are paying interest rates significantly lower than the relevant headline interest rate by virtue of a combination of advertised and discretionary discounts. However, this means that it is difficult for consumers to gauge the relative attractiveness of residential mortgages based on the headline interest rates.
- Moreover, discretionary discounts are based on criteria which vary from bank to bank, borrower to borrower, and are often highly opaque to borrowers.
- The average rates paid for basic or ‘no frills’ products (which include less features than standard variable rate residential mortgages) tend to be higher than for standard products after discounts are factored in.
- The ACCC has raised concerns that borrowers may assume that a broker is independent in circumstances where some of the large mortgage broking businesses are owned by or affiliated with one of the Big Five. The report finds that these brokers and aggregators have tended to refer a disproportionately high share of customers to the Big Five which have an ownership interest in them.
Borrowers benefit from switching
- New borrowers pay significantly lower interest rates on average than existing borrowers.
- Borrowers who switch mortgage providers would likely enjoy considerable savings.
- The Big Five favoured increasing headline variable interest rates to support revenue targets, as small increases in headline variable rates tend to have a significant impact on revenue without a considerable loss of existing customers.
Signs of a lack of vigorous price competition
- The Big Four banks overwhelmingly focus on the pricing actions of each other to the exclusion of other lenders.
- The pricing behaviour of the Big Five appears more consistent with “accommodating a shared interest in avoiding the disruption of mutually beneficial pricing outcomes,” rather than offering the lowest interest rates to compete for market share.
Media attention and public criticism act as effective constraints
- The Big Five are highly sensitive to the reputational impact of the timing of their interest rate announcements.Generally, announcements of headline rate changes by the Big Five are timed to follow the RBA’s cash rate announcements. This may be because the public expects a change in headline interest rates or that other Big Fives will also change their headline rates then, thereby providing some public relations ‘cover’.
- The Big Five do not tend to fully disclose considerations underpinning changes to headline rates to the public, referring to this as “selective reporting”.
What effect have APRA’s measures on investor-only and interest-only loans had on pricing?
- The two initiatives by APRA aimed at addressing the risks to the stability of the financial system arising from the housing sector (setting a 10 per cent annual growth benchmark for residential mortgage lending to investors and setting a 30 per cent benchmark on the share of new residential mortgages with interest only repayments) have led the Big Five to (amongst other measures) reduce discretionary discounts available on residential mortgages to investor borrowers and tighten loan approval criteria for investor borrowers.
- Importantly, APRA’s prudential benchmarks have impacted the scope for banks to compete on price for mortgages for investor- and interest-only borrowers as offering lower rates may attract too many new borrowers and risk the bank breaching APRA’s benchmarks.
What to expect in the Final Report
The ACCC will issue a final report after 30 June 2018 which will consider the pricing decisions of the Big Five through to 30 June 2018 and explain how the Big Five have addressed the Major Bank Levy in their pricing decisions and more generally. The ACCC will also examine:
- fees for residential mortgages;
- the forms of non-price competition engaged in by lenders;
- the ability of smaller lenders to compete with the Big Five; and
- the effect of consumer behaviour on residential mortgage pricing. transparency and encourage more vigorous competition between lenders in this space.
- It will be interesting to see what measures the ACCC will recommend to improve pricing