Prof Kevin Davis discusses interest rates on Sky News

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Featured on Sky News Australia News Day, 9 February 2012

News Day presenter Celina Edmonds interviews Professor Kevin Davis, Research Director at the Australian Centre for Financial Studies, “why the banks are considering raising interest rates this time?”

I think the issue that really needs to be addressed is the question of their cost of funding. The banks raise funds from a variety of sources including international wholesale capital markets and from depositors. And there is not necessarily a very close link between the cash rate… and the costs of bank funding. It is what we’ve seen in Europe for example, there is a lot of uncertainty, the cost of funding there has risen. One of the major banks issued a covered bond in Australia and the rates which they had to pay for that was somewhat higher than people expected. So it is quite conceivable that their average cost of funding has gone up……

All of the discussion seems to be focused on one side of their balance sheet – what is the cost of borrowing for housing borrowers. The other side of their balance sheet is the return that investors and savers get on their deposits, and I think it is always a pity that the debate is always about one side, the cost of borrowing compared to the return to investors which of course includes superannuation funds.

It is certainly true that the Australian economy is looking quite strong and our interest rates are, I think, are at about a level where it is about right. The Reserve Bank has kept them roughly similar and it may very well be that the banks need to increase their housing loan rates somewhat to keep their profits constant. Of course, the issue there that they keep getting bashed about is the question of whether their profits are too high.

One of the issues that we need to be careful of is that, if one goes back into history we had situations where the government, through the central bank, used to control the interest rates that the banks were able to charge. And of course, the consequence of government trying to interfere and set interest rates that organisations like banks can charge is you end up with constraints on borrowing. So in those dim dark days of the past it was very hard for housing borrowers to get a loan. The problem nowadays might be that they struggle to afford a loan but in those days they just were not, loans were just not available.

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