A bank’s view of high interest

Press, 21 April 1986, Page 29

A bank’s view of high interest

Inflation is running under 10 per cent a year yet borrowers are paying interest of more than 20 per cent for their money. The Government believes the margin between the inflation rate and lending rates, representing a real rate of return of more than 10 per cent, is too high. Why is the price of money so high? In regional personal lending the Trusteebank Canterbury is 50 per cent as big as the Post Office Savings Bank and twice as big as all the four trading banks in Canterbury. Simon Louisson, Wellington business reporter of “The Press,” talked to Clive Thorp, executive director of the Trustee Banks Association and reports on some of the problems facing the industry and the trusteebanks in particular.

Clive Thorp believes there is a generation of New Zealanders which does not know the price of money. For more than 20 years lenders have subsidised borrowers. When the present Government lifted interest rate controls and deregulated the finance Industry the position as reversed. For the first time for many years people were receiving a real rate of return on their savings — a rate in excess of the inflation rate.

In addition to lifting interest-rate controls the Government almost totally freed up competition in the finance sector, hoping that competition would force interest rates down, and it instituted a neutral monetary policy, which meant the supply of available money would not expand. It put on further pressure by funding its own deficit from within New Zealand, which meant the Government was in competition with other lenders for available funds.

So, says Mr Thorp, institutions such as the trustee banks were being squeezed from both ends.

On the one hand, the Government was attempting to choke inflation out of the economy by allowing the price of money to

rise, and on the other hand, trustee banks were being jostled aside by other financial institutions, which were being forced by the high price of money to look for cheaper areas of the market

The trading banks, which had relied on the wholesale lending market found that it was paying percentage rates in the mid-20s and so turned their attention to the personal lending market — a source they had relatively ignored. The fight was on for market share and this translated into offering higher deposit rates, says Mr Thorp.

If an institution fails to pay the market rate, the effect is felt very rapidly. Even rates 1 to 1/4 percentage points below the market can have a dramatic effect. When deposits decline, the bank has to stop lending and if the trend continues it has to start calling in loans.

The trustee banks have lost some market share: their lending has dropped from 13 per cent in December, 1983 to 11 per cent two years later. Deposits have fallen from 16 to 14 per cent in the same period. Mr Thorp says that depsit growth over the last year has been slightly below the rate of inflation.

He says that the trustee banks could have fought more aggressively for market share but they would have been doing a disservice for borrowers by putting up the price of deposits and therefore lending.

But' even the trustee banks have to go with

market dictates to reward borrowers more fairly than has been the case over the last 15 years, he says.

“There is a psychlogy in New Zealand which says that house lending should be subsidised. Farmejjs and home loan borrowers were sacred cows.”

In the past, people put their money into property as a hedge against inflation because they were not getting a real return on their money from the savings institutions. He

says the New Zealand phenomenon of the holiday bach was really a consequence of the need in the past to invest in property as a protection against inflation. What worries Mr Thorp is that people are still buying property on the expectation that it will

carry on rising in value as it has in the past 20 years. “I’m frankly rather worried that people won’t see the price signals and wil continue to buy sections at the beach. They will go backwards when they might have done better to have noted such things as changes In marginal tax rates, and have a look at the better deal offered depositors in banks.”

Mr Thorp acknowledges that the community is extremely reluctant to commit itself to the belief that

inflation will actually fall after 20 years of monetary laxity. That is why New Zealand interest rates are experiencing an inverse yield curve: where short-term deposit rates are higher than long-term ones. Borrowers expect rates to fall so they do not want

to lend long term while lenders are not prepared to commit themselves so far ahead. The key measure of what drives interest rates is the average cost of deposits. This accounts for the fact that while Government stock rates may be declining, Institutions such as the trustee banks are forced to put their mortgage rates up. The average term of deposit is

for one year so there is a long lag as people move from lower rates on to current rates and the

average total cost of funding for the bank rises. “It is very difficult for institutions to get this across to people,” says Mr Thorp.

People are annoyed when they read about Government stock rates declining and then receive a letter to say their mortgage rate is being increased. Trustee bank customers are also paying for the fact that In the past the banks were forced to deposit up to 60 per cent of their funds in Government stock. They are carrying hundreds .of millions of stock units at interest rates yielding less than 10 per cent; the average is only 12 per cent

The banks have been criticised for failing to take their losses at the time and re-lnvest in higher yielding stock, but Mr Thorp says this argument is absurd. “It was a ridiculous position of making the institutions buy the stock and ‘allowing’ them to trade it at a loss. “Had the trustee banks run a policy of taking losses every year on all stock that was at less than market through their books, and expressing profit afterwards, it would hav explicitly represented the degree to which they were subsidising the Gov-

erament's borrowing requirements,” says Mr Thorp. The trustee banks hope that restrictions which prevent them moving into commercial areas will soon be lifted. “The market-share pressure puts pressure on trustees which have nowhere else to go.” The quid pro quo of greater freedoms will be the removal of the Government guarantee. The other key to restoring market share is to continue to hold costs through the imaginative use of technology, and to offer a wider range of financial type services such as insurance and advisory services, says Mr Thorp.

The increasing trend will be towards user-pays banking. This will mean the customer chooses the type of service and pays accordingly. For example, people will receive lower interest rates on deposits If they make more withdrawals.

In the meantime, people are still having to pay high interest rates. Mr Thorp believes this will continue until people realise the real cost and, that with the real interest rates offered, it may be more valuable to save than to borrow.