Measuring the Price of Indirect Banking Services in Australia

1. Recent Australian experiences measuring the price of indirect banking services Jessica Zhang, Michael Abbondante, Stephen Frost and Susan Kluth

2. Outline • History • Measurement methodology • Behaviour of index during global financial crisis • Analysis • Alternative approaches

3. History • Significant household expense (7.1 % of CPI) • Until 1997 interest included in the CPI • CPI moved to acquisitions basis • Experimental index for Financial services produced from 2000 to 2005

4. What are we trying to measure ? • Movements in prices paid by households for the acquisition of financial services • Financial services (7.1%) • Deposit and loan facilities (3.9%) • Other financial services (3.2%) • Deposit and loan facilities • Direct fees and charges • Indirect fees and charges

5. Direct fees Deposit and loan facilities Interest rate margins

6. Methodology • Based on the system of national accounts (SNA93) • Financial intermediation services indirectly measured (FISIM) • Product of the balance on the account and the difference between the interest rate payable or receivable and a reference rate of interest • Reference rate: risk free rate of interest • ABS: “mid-point reference rate”

7. Reference rate • Interest flows and balances from a number of financial institutions • Calculate average interest rate on all deposit products / all loan products • Reference rate = mid-point of deposit and loan interest rates • Separate reference rate for each institution • YD • YL • RR = (YD +YL )/2

8. Reference rate

9. Interest margins • i • Bi * CPIt/CPI0 • Yi • %Mi = Yi – RR (loans) • %Mi = RR -Yi(deposits) • Mi = %Mi*Bi *CPIt/CPI0 • M = SMi • Sample products • Base period balance increased by CPI • Calculate average interest rate (yield) on each type of account • Calculate difference between product yield and reference rate to give percentage margin • Multiply percentage margin by indexed balance to determine interest margin on product • Sum interest margins on all products

10. Interest margins

11. Interest margins

12. Base period weights • Products: percentage margin multiplied by balance in the base period base period balance • Sampled products take weight of all products they represent • %Mi0 * Bi0 Home loans Gold star home loan** Blue star home loan Red star home loan

13. Australian institutions Sampled institutions Base period weights

14. Results

15. Results

16. Results 2.5 1.25 0 Change in RBA cash rate -1.25 RBA cash rate (quarter of a percentage point) Deposit and loan facilities index -2.5 -2.75

17. Results

18. Effect of the GFC • GFC – caused banks to increase interest rates in excess of Reserve Bank rate rises • Reserve Bank rapidly changed interest rates • an increase in cost of offshore funds • increased deposit rates • securitisation • Prior to GFC • interest rates were already rising to combat domestic inflation

19. Other concerns • Banks increased cost of funds not reflected in reference rate Deposits Loans Off shore funding

20. Analysis – the ideal case Hypothetical scenario Equal increases in all product yields

21. Analysis – the ideal case Difference in average yield on deposits and loans remains constant

22. Analysis – the ideal case Ignoring balance indexation D&L index remains unchanged

23. Ideal vs real yields Replace ideal yields with real yields Increases in loan rates in excess of cash rate => Increase in D&L index

24. Ideal vs real yields Replace ideal yields with real yields “Zero” interest on transaction account has significant impact on D&L index volatility

25. Analysis – Current accounts In reality transaction accounts receive close to zero interest

26. Analysis – Current accounts Current account causes D&L to track the cash rate Not measuring interest rates

27. Analysis – Current accounts Zero interest on current account dampens rises and falls in reference rate Interest rates up => Loan margins widen Deposit margins widen => D&L index increases

28. Proximity to reference rate Products close to the reference rate most affected

29. Experimental series Financial services index tracking interest rates prior to GFC

30. Summary of observations • Lack of sensitivity of transaction account yield to general changes in interest rates causing tracking of cash rate • In times of volatile interest rates index is volatile • Results consistent with methodology • Index also affected by increase in loan interest rates only • Product representativity is important and should be updated regularly

31. Cost to the consumer • Does the methodology accurately capture the cost to the consumer for financial services ? • Influence of transaction accounts • “Extra” interest rate rises

32. Alternatives • Original approach based on system of national accounts (SNA93) • SNA08 states: “because there is no necessary equality between the level of loans and deposits, it [the reference rate] cannot be calculated as a simple average of the rates on loans or deposits” • Alternative (multiple ?) reference rates • Task force on FISIM – Prices involvement