Welcome to Finance and Fury, The Say What Wednesday edition. 

Today’s question comes from David

Hi Louis,

I must commend you on your contribution to the finance community. If you have thought me one thing, it’s that the more you learn the more you realise how little you know. So, one thing that does perplex me is the Australian made product of the offset account. Whilst I understand how they work and the power they have when used correctly, I can’t figure out why the banks have them. I mean it’s the modus operandi of the banks to extract money from lenders via the mechanism of interest. Call me a cynic but I feel the banks must have an ulterior motive to this play. I would love to know your thoughts. – David 

 

That is a great question – made me think as well and do some further digging – today – Offset accounts and Why banks allow them?

  1. First – the basic = Offset accounts are a type of deposit account that is directly linked to a loan – like a mortgage
    1. Money deposited into offset accounts effectively reduce the loans net position and the interest payable
    2. Means where a borrower has a deposit account and a loan (usually a housing loan) with the same institution.
      1. Instead of receiving interest on the deposit account, the interest payment due on the loan is calculated on the net balance of the loan
    3. As they act as deposit accounts – only ADI can offer true offset accounts – non-banks will offer redraw facility instead – which means the money is on the loan – different
  2. In Aus – Offset account balances currently total around $90 billion – almost over 6% of housing loans outstanding
    1. Annual growth in total housing debt of around 7-8% – Offset account balances grown by 30% – annual growth in net housing debt is still growing by 6-7% due to new loans –

Why banks allow them? – number of reasons

  1. Simple one – Better with them than another bank – Incentive to have your money with them and not the competition
    1. Also – repayments come from the offset accounts – easy for banks to have their funds – but minor
  2. But one of the major reasons – they Allow for the further growth of credit – remember – they are deposit accounts
    1. Because Offset accounts are deposit accounts – banks can use them as part of reserves in fractional lending for the creation of money
    2. RBA – Offset account balances have also been making a significant contribution to household deposit growth
      1. If offset balances weren’t in deposits but had paid the loan back – would reduce growth in household deposits by around 1% (from around 7-8%) -12-14% or so reduction
      2. Mortgage payments reduce the ‘stock of outstanding credit’ – i.e. total amount of loans and are a negative growth factor on total credit – if everyone makes additional repayments the credit growth shrinks – the credit growth can be negative = no new lending and only repayments is negative credit growth
    3. Offset accounts are an alternative form of mortgage prepayment that like an at-call deposit account –
      1. Because it acts like an at-call deposit account, any accumulated funds are easily available for withdrawal or for purchasing goods and services – They are treated as such – can be used as any other deposit for lending by the bank
      2. Also – while funds in the account are reducing your outstanding debt for the interest on the loan – you still have the same loan
    4. For the individual with a mortgage and uses an offset account or redraw – similar household economic effects – net housing debt and interest payable are reduced
    5. But for a bank – loans and deposits are higher than they otherwise would be – offset provides deposit funds and doesn’t give a negative credit growth effect – like redraw facilities do
      1. If that $90bn was sitting in the loan (i.e. paid off) – less lending due to fewer depositor funds
  3. Therefore – offset accounts Can increase banks lending income – not decrease it-
    1. Say loans are 4% – you can save 4% or banks can charge it –
    2. $100k in an offset – you save $4,000
    3. Banks use it to lend $800k (12.5% deposit ratio) – they make $32,000 – net $28k better off

Also – Other factors like bail-ins and deposit schemes

  1. Bail in-laws – We’ll leave a link on the website to the episodes covering the bail-in regulations and pitfall of this
    1. In short – as it is a deposit account – can be used as bail-in provision –
    2. Most people with loans would have much more in offsets than savings – or should at least –
    3. But the catch is that all your deposits will likely to be with one ADI – and potentially above the $250k
  2. Government Guarantees – May not actually help – You have a few problems there: A guarantee only applies to a bank going insolvent and collapsing— with not enough money left over for depositors. Bail-ins (if they are in fact legal) will just take your money to prevent that from happening. That is, the government guarantee won’t cover a bail-in.
    1. Guarantees are capped at $20B per ADI – stated in Financial System Legislation Amendment (Financial Claims Scheme and Other Measures) Bill 2008
      1. Activation of the EAFD 1.20 – A declaration outlines the total amount available to make payments to depositors of a declared ADI. For the first three years of the scheme (from 2008), the amount that can be appropriated for the purposes of meeting depositors’ entitlements is unlimited. After three years, the maximum that can be appropriated is $20 billion. The declaration must also outline the amount available for the administration costs for implementing the scheme up to a maximum of $100 million
      2. RBA aware of this – in their “Depositor Protection in Australia” – Payouts of deposits covered under the FCS [The Australian Government’s Financial Claims Scheme] are initially financed by the government through a standing appropriation of $20 billion per failed ADI [Authorized deposit-taking institutions]
    2. The total size of deposit accounts totalled $2 trillion (Commonwealth Bank— $581 billion, ANZ — $467 billion, NAB— $407 billion and WESTPAC — $533billion). This includes savings, term deposits, chequing, debit card, transaction accounts, mortgage offset accounts, pensioner deeming accounts, retirement savings accounts etc… So only $80 billion (or 4%) out of this $2 trillion dollars is actually covered by the guarantee.
    3. The question remains – once they activate it – where will the money come from?

In Summary

  1. Does benefit you – But so does repaying your home loan in most other means – except the accessibility – offsets are best for this
  2. But benefit the bank as well – you repaying the loan doesn’t benefit them as much as you keeping the loan and then being able to keep expanding credit using the deposits – take your $100k and lend $900k – which they make 3% –
    1. Also – more money with the bank to be used in ‘resolution proceedings’ with Bail in regulations

Thanks for the Great question David

Thanks for listening to today’s episode. If you want to get in contact you can do so here: http://financeandfury.com.au/contact

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