Financial equity research

We research issues of concern with regard to financial equity.

Financial equity relates to the fairness of outcomes. We have identified a number of areas in which we believe financial equity has been compromised. The first one on our list is the back-book pricing of residential mortgages.

Back book pricing of mortgages

We believe a significant unaddressed issue within the financial services industry is the move over the past decade by most of the major participants in the banking sector to offer discounts to new home loans customers, in what could be described as 'back-book' pricing strategy, or similar, for the pricing of home loan mortgages. The 'Standard Variable Rate' is no longer the rate that most people pay on their mortgages. Most people are now on a 'discount' to the Standard Variable Rate (SVR), often paying 80-90 basis points less than the SVR. Often there is a fee or another condition that must be met to qualify for the discount. That said, the fee is generally much less than the interest savings arising from the discount.

We would like to see an investigation into the banking sector to identify if it is common practice for banks to price their SVR mortgages to maximise profits through the use of 'back-book' pricing. If so, they are not providing the same effective interest rate to existing customers on the SVR mortgage that they provide to new customers. We consider that this to be in direct contravention of the commonly understood basis of a 'standard' variable rate mortgage. If proven, we think there is a good argument that the banks by adopting 'back-book' pricing have reneged on the implicit contract with the SVR mortgage customers. Those customers on the SVR mortgage without discount are not being offered a competitive product, as there is limited or no market tension for new customers in the pricing structure of the SVR mortgage.

We would expect the composition of the 'back-book' SVR mortgage customers to be biased towards the less financially savvy. Those people more financially aware would have likely already refinanced their mortgage into a 'discounted' product, even if they did so with the same bank.

The interest rate on a standard variable housing loan is set at the sole discretion of the bank, despite a loan term often in excess of 20-years. The only way it is reasonable to hand over sole discretion to the bank as to what you would be charged for over the next 20+ years is if the interest rate charged was subject to market forces of competition for new customers. We intend to investigate if the banks have moved to a 'back-book' pricing approach which has the impact of making the SVR not sufficiently subject to the market forces of competition for new customers.

The following chart from the RBA shows the divergence between the 'Banks' indicator rate on new owner-occupier loans' and what the RBA calls the 'Actual rate on outstanding loans'. So why did these loans diverge around 1999? Why has the divergence increased over time? Does everyone get the 'Actual rate'? What has 'back-book' pricing to do with the divergence between the indicator rate and the 'actual' rate? We plan to answer those questions. 

We plan to conduct our own investigation into the banks which have been adopting a 'back-book' pricing approach to SVR mortgages, and to help people identify any excess amounts of interest they have been paying since adoption of any such 'back-book' pricing by the banking sector.

We believe the excess interest that people have been paying on SVR mortgages over the past decade could easily be in the billions of dollars.