Do higher US interest rates affect Commonwealth Bank of Australia (ASX: CBA) shareholders and property borrowers?

Around 33% of Commonwealth Bank’s funding does not come from customer deposits. For other banks like Westpac Banking Corp (ASX: WBC) and Australia and New Zealand Banking Group (ASX: ANZ) the figure is somewhat higher at around 39%. Meaning, the funding must come from a variety of other sources, and borrowing in the US (where rates are ultra low) is a popular choice.

However, US bond yields have been rising recently, reflecting the USA’s improving economy, and this is commonly seen as a signal that the US central bank may raise interest rates soon. This could increase the cost of funds for Australian banks who borrow significant amounts from the US.

U.S. short-term interest-rate futures fell on Wednesday following the inflation report, adding to the conviction the Fed will raise rates twice this year, and increasing the chance of a third rate hike,” Reuters reported.

Why is bank funding important?

Banks can be very complex, but in simplest terms, customers put their money in the bank, and once a bank has enough money, it can then loan some of that money to other people. Banks earn the “spread” between what they pay for a deposit, and what they receive on a loan.

For illustration, a bank might borrow money from the USA at a 2.5% interest rate, then lend that money to a property buyer at a 4.5% interest rate, earning a ‘spread’ of 2% on the loan. Indeed, after accounting for costs, most of the larger Australian banks earn a Net Interest Margin (‘spread’) of around 2%.

If interest rates rise, Australian bank Net Interest Margins could fall unless they ‘pass on’ the rate rises to borrowers and mortgagees.

Fortunately, US rates are an important factor in both bank profits and the cost of borrowing, but are a relatively small portion of Australian bank funding. Australia’s interest rates, set by the RBA, are another important consideration.

Locally, most economists are tipping the RBA to return to historically ‘normal’ interest rates in the next few years.

HSBC Australia economists, Paul Bloxham and Daniel Smith, expect the RBA to start lifting interest rates by mid-2018. “Our central case is for the RBA to begin to lift its cash rate from mid-2018,” the duo wrote in the latest Asian Economics report.

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