# Recent Australian experiences measuring the price of indirect banking services Jessica Zhang, Michael Abbondante, Stephen Frost and Susan Kluth.

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Recent Australian experiences measuring the price of indirect banking services Jessica Zhang, Michael Abbondante, Stephen Frost and Susan Kluth

Outline History Measurement methodology Behaviour of index during global financial crisis Analysis Alternative approaches

History Significant household expense (7.1 % of CPI) Until 1997 interest included in the CPI CPI moved to acquisitions basis Experimental index for Financial services produced from 2000 to 2005

What are we trying to measure ? Movements in prices paid by households for the acquisition of financial services Financial services (7.1%) Deposit and loan facilities (3.9%) Other financial services (3.2%) Deposit and loan facilities Direct fees and charges Indirect fees and charges

Deposit and loan facilities Direct fees Interest rate margins

Methodology Based on the system of national accounts (SNA93) Financial intermediation services indirectly measured (FISIM) Product of the balance on the account and the difference between the interest rate payable or receivable and a reference rate of interest Reference rate: risk free rate of interest ABS: “mid-point reference rate”

Reference rate Interest flows and balances from a number of financial institutions Calculate average interest rate on all deposit products / all loan products Reference rate = mid-point of deposit and loan interest rates Separate reference rate for each institution Y D Y L RR = (Y D + Y L )/2

Reference rate

Interest margins Sample products Base period balance increased by CPI Calculate average interest rate (yield) on each type of account Calculate difference between product yield and reference rate to give percentage margin Multiply percentage margin by indexed balance to determine interest margin on product Sum interest margins on all products i B i * CPI t /CPI 0 Y i %M i = Y i – RR (loans) %M i = RR -Y i (deposits) M i = %M i *B i * CPI t /CPI 0 M =  M i

Interest margins

Base period weights Products: percentage margin multiplied by balance in the base period base period balance Sampled products take weight of all products they represent %M i0 * B i0 Home loans Gold star home loan** Blue star home loan Red star home loan

Australian institutions Base period weights Sampled institutions

Results

RBA cash rate (quarter of a percentage point) Deposit and loan facilities index Change in RBA cash rate 0 1.25 2.5 -2.5 -1.25 -2.75

Results

Effect of the GFC GFC – caused banks to increase interest rates in excess of Reserve Bank rate rises –Reserve Bank rapidly changed interest rates –an increase in cost of offshore funds –increased deposit rates –securitisation Prior to GFC –interest rates were already rising to combat domestic inflation

Other concerns Banks increased cost of funds not reflected in reference rate Loans Deposits Off shore funding

Analysis – the ideal case Hypothetical scenario Equal increases in all product yields

Analysis – the ideal case Difference in average yield on deposits and loans remains constant

Analysis – the ideal case Ignoring balance indexation D&L index remains unchanged

Ideal vs real yields Increases in loan rates in excess of cash rate => Increase in D&L index Replace ideal yields with real yields

Ideal vs real yields “Zero” interest on transaction account has significant impact on D&L index volatility Replace ideal yields with real yields

Analysis – Current accounts In reality transaction accounts receive close to zero interest

Analysis – Current accounts Current account causes D&L to track the cash rate Not measuring interest rates

Analysis – Current accounts Zero interest on current account dampens rises and falls in reference rate Interest rates up => Loan margins widen Deposit margins widen => D&L index increases

Proximity to reference rate Products close to the reference rate most affected

Experimental series Financial services index tracking interest rates prior to GFC

Summary of observations Lack of sensitivity of transaction account yield to general changes in interest rates causing tracking of cash rate In times of volatile interest rates index is volatile Results consistent with methodology Index also affected by increase in loan interest rates only Product representativity is important and should be updated regularly

Cost to the consumer Does the methodology accurately capture the cost to the consumer for financial services ? Influence of transaction accounts “Extra” interest rate rises

Alternatives Original approach based on system of national accounts (SNA93) SNA08 states: “because there is no necessary equality between the level of loans and deposits, it [the reference rate] cannot be calculated as a simple average of the rates on loans or deposits” Alternative (multiple ?) reference rates Task force on FISIM – Prices involvement

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