Australian Bank Mortgage Price-Setting Behaviour Pre- and Post-GFC: Does International Funding Cost Matter?

Abstract

This study is motivated by an ongoing controversy over banks’ interest rate setting conduct in the Australian mortgage market. We examine heterogeneity in the response of variable interest rates on owner-occupied housing loans to the ‘cost of funds’ rates, including the cash rate and the cost of overseas borrowing. The stability of the pass-through mechanism in the post-crisis period is further evaluated in comparison with the pre-crisis epoch. Our results highlight that Australian banks set their mortgage interest rates on funding costs. We also confirm a declining transmission of the cash rate after the GFC consistent with previous studies. Importantly, the close alignment of mortgage rates and international funding cost exists before and after the crisis. Banks partially transmit changes in the cost of offshore funding to their home-loan rates in both short and long term. Short-term pass-through coefficients of the offshore funding cost are heterogeneous, while the long-term traverses are fairly homogeneous. The fuller sizes of these long-term coefficients in the post-crisis subsample signify that Australian banks’ mortgage price-setting practices have been relatively stable after the crisis.

Keywords: Mortgage interest rate, pass-through, funding cost, Australian banks, global financial crisis, PMGE model

JEL Classification: G21, E43, E58