Lay off the banks, they're entitled to hike rates

Let’s not bash the banks.

Well, perhaps lay off a little, given that they are only doing what every business does when the costs of running the business increases.

Think of any business, big or small. A bank or a suburban baker.

When the various costs of running each business increase, selling prices will be ramped up so that it will not only keep its head above water, but will hopefully maintain profits.

When the price of flour rises, so too does the price of bread.

Any business with rising costs that does not pass on higher costs will go out of business and as a result the economy will be weaker and jobs will be lost.

This is very basic business management and economics.

Also read: Where are interest rates heading?

It is true that no one likes to pay more for goods and services and when prices go up, there are often howls of complaint.

Think electricity, petrol, childcare and now interest rates.

For consumers, mortgage interest rates reflect the price you and I pay to borrow money to buy a house.

The interest rate charged by the banks reflects, at its most simple level, the cost of raising money that is lends to borrowers.

Those costs include what the banks have to pay for deposits from savers or they pay in the money market for funds, plus costs of staff, offices, technology, regulatory costs and the like.

Most often, but not always it is important to emphasise, the biggest variable cost is when the Reserve Bank of Australia adjusts official interest rates.

Interest rate increases and cuts are usually passed on more or less to consumers with the RBA managing the economy by impacting on what we consumers and businesses have to pay to borrow, invest and spend.

What is happening now with the mortgage interest rate rises from the Big Four banks is a response to the change in global regulations that require banks to hold more ‘safe’ capital against their loan portfolio.

This policy change is designed to fire-proof the banks against another global financial crisis by forcing the banks to have a bigger buffer if house prices fall or new lending slows to a crawl.

The change means the banks have to accept a lower return for this capital which if unchecked, would squeeze profits and increase the bank’s vulnerability to the next economic crisis.

Petrol stations pass on changes in global oil prices to consumers, as they should.

Fast food outlets increase their prices when the price of bread, meat and other ingredients rise.

Even workers increase their prices (that is their wage) when ever they can to help deal with cost of living pressures.

Also read: Bouris: ‘Why the banks are really hiking rates’

In all instances, including with the banks, those having to pay more don’t like it. No one wants to pay more for their borrowing, their petrol, their hamburger or their wages bill.

In a well run market economy and with a good degree of competition, the price of these items, including interest rates, will reflect the cost of doing business plus a profit.

If that profit gets too large, competitors will ramp up their market presence.

This is happening now with many of smaller banks and non-bank lenders offering significantly lower interest rates than the big banks.

And by the way, if the Reserve Bank doesn’t like the fact that you are paying a bit more for your mortgage as a result of these changes, it will adjust the official interest rate down to move interest rates to where it wants them.

Right now, with the housing market still strong, it would not be too concerned.

Stephen Koukoulas is a Yahoo7 Finance expert with 

more than 25 years experience as an economist in government, as Global Head of economic and market research, as Chief Economist for two major banks and as economic advisor to the Prime Minister of Australia.