The way banks fund themselves and set mortgage rates plays an important role in how monetary policy affects the interest rates that households and businesses use to save and borrow.
The ongoing effects from the policy response to the COVID-19 pandemic has had a significant impact on this process. This has influenced how quickly, and fully monetary policy adjustments are passed on to retail interest rates, like mortgage and term deposit rates.
This Bulletin outlines a framework to show how changes in bank funding dynamics have affected the interest costs that banks face and the mortgage rates they offer. This starts by explaining where banks get their funding from and the various factors that they consider when deciding on their funding structure.
It then details how bank funding costs declined significantly at the start of the COVID-19 period, particularly the cost of deposit funding, and explains how these dynamics shifted as the Official Cash Rate (OCR) began to move higher from October 2021 onwards. Importantly, the ongoing influence of additional monetary policy tools and fiscal policy, alongside changes to depositor behaviour, contributed to more accommodative funding conditions during this period.
Finally, the Bulletin explores how changes in bank funding costs have influenced mortgage rate pricing, showing a reduction in the pass-through of OCR increases to mortgage rates. This has meant that the level of the OCR has needed to be more contractionary than otherwise, to offset the impact of lower bank funding costs.
