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What are the Banks cost of funds and how are they funded?

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Given how angry we as Australians get when the banks do not pass on the official drop in interest rates while posting absolutely ludicrous profit results I thought I would try and give a little insight into how the banks are funded and at least try and explain where they are coming from when you hear them talking about their cost of funds and how expensive it is to operate.

Currently we have the strongest banking sector in the world which is not a bad position to be in given the governments having to bail out banks in many established parts of the world. This creates much uncertainty, panic and is a burden on the tax payer short term and long term.

 Banks are funded in three main components of which the first is Short-term wholesale funding. This is the gap between the Bank Bill Rate and the Overnight Index Swap Rate which admittedly has increased significantly since June 2007 and in some cases was as high as almost .9% more than before the global crisis.

The Medium to long term wholesale funding provide banks with certainly to access funding for the next 3-5 years has seen a significant increase  due to increased investor risk aversion and a world decline in the availability of funds. In some cases this got almost 2% higher and is still significantly more expensive as those factors/fears have not disappeared although they have improved.

Customer deposits are the third and final source of funding for the banks and each bank has a different amount of available funds however a lot of their funding actually comes from this source. In particular term deposit rates have increased significantly relative to the bank swap rates due to banks having more competition to attract these funds as they are still a cheaper source of funding when you compare it to the other options available to the banks however it has still increased by almost 1%.

So to be absolutely clear I am not here to defend the banks as I mostly also do not agree with a lot of their decisions that affect so many hard working Australians. You only have to listen to Wayne Swan get stuck into them as we all find it a hard pill to swallow when the rates are not reduced in line with the Reserve Bank on occasion whilst pleading they are doing it tough and then announcing record Billion dollar profits. They are doing the right thing by one section of the community with these profits and that is the many Australians who are actually shareholders and I certainly would prefer to be in a situation with my bank making profits instead of looking at shutting their doors unless the government bails them out.

In either case if you would like to explore what options are available other than the big 4 banks then I would suggest a chat with myself or your current mortgage broker.


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