Reserve Bank of Australia Analysis

Introduction

The Reserve Bank of Australia from time to time raises and lowers interest rates depending on the prevailing economic conditions. The Reserve Bank of Australia lowers interest rates to encourage credit flow when there is enough evidence of a credit crunch (Baumgarten 2012, p. 98). Reserve banks take such measures to enable commercial banks pass the low-interest rates to consumers effectively making credit facilities such as loans and credit cards affordable (Erb 1989, p. 79). While some commercial banks pass the benefit to the consumers, some do not. Free enterprise mechanisms existing in Australia as in most countries with capitalist economies limit central banks and finance ministries’ powers in enforcing low-interest rates by commercial banks (Nier 2009, p. 40). The global financial crisis led to a credit crunch that starved economies worldwide of much-needed funds for growth and made bulk borrowing by banks an expensive undertaking.

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The reserve bank of Australia (RBA) is one of the central banks that have kept interest rates low with the aim of encouraging uptake of credit by consumers (Meltzer 2010, p. 229). As said earlier, some Australian banks have passed the benefit to consumers while some of them are yet to. The following are some of the reasons advanced by some banks on why they cannot lower interest rates. There is also a focus on the arguments by the treasurer that they should follow Reserve Bank of Australia’s move and lower interest rates. Additionally, the paper will examine the response of commercial banks to similar moves by the central banks in Ireland India and China.

Reserve Bank of Australia Rate Cuts

In February 2012, the RBA announced interest rate cuts in move aimed at cushioning the Australian economy from global economic shocks such the Euro zone crisis, and also to boost consumer confidence. Most analysts however, were not optimistic about possibility of banks passing the benefit to the public. In fact, the Australian Bankers’ Association (ABA) chief executive came out to dampen customers’ expectations of a drastic interest rate cut by banks following Reserve Bank of Australia’s announcement. Surprisingly, it is the smaller banks that passed the benefit by the biggest margin. The big four banks including Commonwealth Bank, ANZ, National Australia Bank and Westpac cited various reasons in their refusal pass considerable benefit to consumers.

While the Reserve Bank of Australia influences short-term interest rates, the banks cited the uncertainties generated by the global financial crisis, the Euro zone crisis, strong demand for deposits and rising bank costs as the reasons why they cannot pass the benefit. According to the ABA local deposits form the main source of funds that banks lend out to customers. Short and long-term borrowing accounts for the remaining 40% of funds that banks lend out (SMH 2012). The banks contend that a good amount of their money comes from overseas where the Reserve Bank of Australia has little or no influence. Given the crisis in Europe and the fragile recovery in the US, the cost of borrowing money internationally is considerably high. Reducing the interest rate in line with Reserve Bank of Australia levels will therefore negatively impact on the banks’ earnings.

The above assertion by the banks has however not gone down well with the treasurer who faults the decision not to pass the benefit to the public. He cites the fact that Australian banks, especially the big four that earned a record $24 billion combined as sufficient ground for interest rate cuts. Additionally, the treasurer cites data by the reserve bank that show Australian banks as not exposed to negative economic conditions to the extent that they claim. While the treasurer’s suggestion is sensible, it may not be workable to some extent. It is important for the banks to consider reducing their rates as a measure of reciprocating the Reserve Bank of Australia move, also, to boost consumer confidence. However, banks take into account many factors some of them unique to every bank when they source for loan funds. It is therefore not right to expect them to lower rates to an extent that their return on investments will be lower than their projected income. Besides, banks have a right to use their profits in whatever way it suits them. They don’t necessarily have use their profits to cushion consumers from high interest rates.

Banks Reactions in India, China and Ireland

The above-mentioned economies with exception of China follow free enterprise principles. It is important to note that China and India have high growth rates and their economies are not subjected to the same economic conditions present in the US and European economies. Ireland on the other hand is in the Euro zone where a recession is more likely and banks are operating in an environment of economic uncertainty. China’s leadership has also implemented a series of economic reforms incorporating a number of capitalist practices. As said earlier, most central banks have cut interest rates on the face of the global financial crisis.

India’s central bank like Australia revises its interest rates up and down depending on the economic conditions in the global market. The country, compared to China has a more liberal economy that exposes it to world economic shocks (Khademian 1996, p 92).

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In April 2012, India’s central bank cut interest rates with the aim of stimulating the Indian economy. However, like the Australian case, most banks initially resisted passing the benefit to consumers citing high costs of borrowing. However, pressure from government did finally force a number of leading Indian banks to cut their lending rates, earlier than most analysts had expected.

Unlike the Australian situation, it was India’s largest banks that led the way in reducing interest rates. The country’s largest private bank the ICICI Bank and the second-largest, state-owned bank Punjab National Bank bowed to government pressure and cut lending rates by 25bps, a move that came two days after the Reserve Bank of India cut rates by 50bps. Besides, the State Bank of India which is the country’s largest also announced plans to cut its base rates (Munshi 2012, Par 2). It is important to note that many analysts expected the banks to take a while longer before they passed he benefit to the consumers. However, Government pressure especially on state-owned banks succeeded in compelling the banks to lower rates earlier than expected. It is also important to note that India’s banks are as profitable as banks in Australia. In this case however, the government did not cite banks’ earnings as the basis on which banks were required to lower lending rates. This is perhaps another point that illustrates the weakness of the treasurer’s assertion that banks should consider lowering rates solely based on the earnings they have made.

In November 2011, the European Central Bank cut lending rates by 0.25%, a crucial move aimed at saving the Euro Zone economy especially through increased lending to small businesses. It is important to note that Ireland is one of the countries worst affected by the Euro zone crisis. The European Central Bank plays an important role in regulating financial transactions in the trading bloc. That is why its move to raise or lower lending rates affects individual countries just like their domestic reserve banks do. Banks in Ireland especially the big three moved to dampen expectations of passing the interest rate cut to consumers. Allied Irish Bank (AIB), Bank of Ireland and Ulster Bank all refused to budge under government pressure to cut their lending rates in order to boost small businesses and mortgage holders. The banks did not cite specific reasons for their refusal to pass the rate cut benefit to the public. Like in India, there was pressure from the government with the Economic Management Council (EMC) summoning bank chiefs for explanations (B.T 2011, Par. 4, 5, 7).

Given the precarious state of the European economy, it’s safe to conclude that banks were cagey about reducing lending rates to cushion themselves from a potentially crippling recession. Reducing interest rates would effectively eat into their earnings through increased costs. Additionally, there was consensus among banks that the decision by all banks earlier on not to raise interest rates was enough to cushion their customers. Reducing the interest rates therefore was likely to negatively affect their margins.

As earlier said, the Chinese economy is mostly centrally planned. In most cases banks have few options but to comply with government monetary policies (Saez 2004, p. 106). Unlike in the western economies, China’s central bank does not adjust the interest rates very often, perhaps due to the largely stable economy. Mostly, when the Chinese Central banks cuts interest rates, it is because of factors such as inflation. There is consensus among many economists that credit flow in the Chinese economy is healthy and stable. The last time the Chinese Central Bank cut interest rates was in 2008 when the People’s Bank of China lowered the one-year lending rate by 27 basis points, to 7.2 per cent per annum (Anderlini 2008, Par. 2). In 2012, the economy of the country has been negatively impacted by the Euro zone crisis and slowing recovery in the US which has effected demand for its exports. The Chinese central bank was expected to cut interest rates to boost investments to raise the flagging economy. However, rising inflation has cast doubt on such a move.

In most cases, when the Chinese Central Bank lowers interest rates, banks are expected to pass the benefit to the public. It is a different scenario altogether from what is experienced in Australia with a liberal economy where government relies purely on the banks’ volition to pass the cuts to the public.

Discussion

It is important to note that all of the countries discussed above operate in conditions unique to each one of them. It is clear from the examination in task one and task two that India and China have formal mechanisms through which they ensure the benefits of interest rate cuts are passed on to consumers in the soonest time possible. Australia on the other hand has limited mechanisms to enforce such a move.

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Reference List

Anderlini, J 2008, China’s central bank cuts interest rate, Web.

Baumgarten M 2012, The Role of Central Bank Independence in a World of Capital Mobility, Cengage Lerning, Chicago.

B.T, 2011, Banks rule out interest rate cut, Web.

Erb, R 1989, The Role of Central Banks: A View from the International Monetary Fund, Cengage Learning, New York.

Khademian, A 1996, Checking on banks: autonomy and accountability in three federal Agencies, Sage Pulications, London.

Meltzer, A 2010, A History of the Federal Reserve, Volume 2: Book 1; Books 1951-1969, Routledge, New York.

Munshi, N 2012, Indian banks bow to government pressure and cut loan rates, Web.

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Nier, E 2009, Financial Stability Frameworks and the Role of Central Banks: Lessons from the Crisis, Springer, Berlin.

Saez, L, 2004, Banking reform in India and China, Cambridge, Cambridge University Press.

SMH, 2012, Banks must pass on interest rate cut: ACTU, Web.

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