Retail banks slash term deposit rates as RBA rate cut looms

Forget about the speculation of whether the RBA will cut official interest rates late this year or early next – the retail banks are already slashing interest rates.

Not, of course, the ones you pay them through housing, business or personal loans but the ones they pay you through term deposits.

So, it turns out that the couple of post-Covid years when term and other deposit rates rose to reasonable levels were a brief window of opportunity that is already beginning to close.

Already many of the 12-month deposit rates offered by banks have already shed between 20 to 65 basis points over the past six months, which is a massive change given that there is no change in the official RBA rates yet and unlikely to be any until next year.

That is very big and unwelcome news for the many Australians who together invest $1.4 trillion in deposits, which is not too far behind the total worth of the Australian share market which is around $1.6 trillion.

Lower deposit rates leave tough choices

That leaves the many Australians with term deposits maturing facing some difficult choices, particularly as the banks are competing hard for mortgages but not so much for deposits as they try to protect profit levels.

Do they lock in a much lower return on their money and make some lifestyle adjustments or do they look around for some other options that might keep their return higher than what the banks are “kindly” offering?

Or do they just start spending some of the principal as a way of keeping up with rising costs of living?

Fortunately, there are a few options for savers to choose from.

One which is perhaps more poorly understood is cash exchange traded funds, which are securities traded on the ASX that give access to Australian cash deposits.

Higher rates on offer

Due to the greater scale of the ETF providers, they can get much higher rates for their customers than those on offer inside banks to roll over a term deposit.

That is perhaps best reflected by the fact that the biggest cash ETF, BetaShares AAA (ASX: AAA) has consistently paid interest higher than the RBA cash rate since it was launched in 2012.

Other cash ETF’s on offer include iShares Core Cash ETF (ASX: BILL) and iShares Enhanced Cash ETF (ASX: ISEC), which have minor differences including lower daily turnover of around $27 million a day but all are arguably better options than what banks are offering as term deposits.

One important caveat to mention is that these are not bank accounts even though they invest largely through banks so they are not covered by the Federal Government’s $250,000 deposit guarantee.

If that guarantee is ever used we are all in very tricky circumstances with at least some financial institutions failing but it is a factor worth remembering for the extremely cautious.

More reward for more risk

There are also some other offerings in the ETF space that offer slightly higher yields along with higher risk with perhaps the most interesting being BetaShares Australian Major Bank Subordinated Debt ETF (ASX: BSUB).

This ETF effectively gives investors access to “wholesale” interest rates with monthly interest payments without adding a lot of risk.

It is a Tier 2 bank credit fund which offers attractive income, paid monthly and invests only in high quality Australian denominated Tier 2 bonds issued by the big four banks.

It should also offer protection against rising rates with subordinated debt at the moment delivering up to 1.8% above cash deposits and 0.9% above senior bank floating rate notes.

Interestingly, the return on subordinated floating rate notes often match and in some cases surpass the franked yields of the big four banks themselves but with a fraction of the volatility.

Further down the pecking order

The main extra risk of investing in the $250 billion bank credit market is pointed to by the word “subordinated”, which in shorthand means that investors are further down the pecking order for repayment compared to senior debt.

However, given the enthusiasm investors have had for listed hybrids – which are in the process of disappearing over time and rank even further down the repayment chain – this should be a highly competitive product for cash investors who can tolerate a little more risk for a higher return.

Another benefit of the listed ETF cash alternatives is that they should catch up quickly with any upward changes in interest rates.

However, is it more likely that they will also be responding to interest rate cuts given the looming easing cycle.

Still, at least they should wait until the cuts actually happen, unlike the big banks which are significantly front running the cuts through their term deposit offerings.