FHR vs SIBOR sign

Is Deposit-Based Peg For Home Loans Beneficial?

DBS has in recent years scored first in the department of innovation amongst all consumer banks in Singapore foreign ones included. For example, it was the first to introduce a savings account with higher deposit interests based on the depth of banking relationship one has with the bank (or product bundling) by launching the DBS Multiplier Account, before rivals like OCBC and UOB introduced their own versions called OCBC 360 Account and UOB One Account.

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Last year once again DBS was the first and still the only bank in the market to offer a new peg for home loans by introducing its FHR or Fixed Deposit Home Rate as an alternative to the more traditional Sibor (Singapore Interbank Offer Rate), Sor (Swop Offer Rate) or bank’s internal Board rate. At the launch of FHR back in June 2014, most of its rivals shrugged it off as just another marketing gimmick but the bank’s financial results in 2015 thus far has been nothing but sterling and vindicated the bank’s move. DBS’s chief executive shared in its latest results briefing that they have done some $3b worth of mortgages in the first 6 months of 2015 with $1b of that coming from home loan refinancing.

What is FHR and why has it been so successful? DBS defined FHR as the average of their 12-month and 24-month fixed deposit board rates for the deposits between $1,000-$9,999, which at 0.25% and 0.55% p.a. respectively translates into 0.40% for FHR. This rate has not moved since its launch last Jun 2014.

Will deposit-based peg for home loan prove to be so popular that the other two local banks will be forced to roll out a similar peg against their wishes? And if that happens how will foreign banks with a higher costs of funds choose to compete now that you have an alternative to money market index like Sibor and Sor? It will be interesting to watch this space.

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In this article we examine from homeowners point of view, does it make sense to choose a deposit-based peg over the more familiar Sibor. Before we go on remember a lot depends on what deposit rate is chosen as the peg. Another bank could introduce for example a savings account deposit rate as the peg in which case all the underlying dynamics might be slightly different from what is discussed here.

There are 4 reasons why we think deposit-based peg may be more beneficial:

Reason 1 : Conceptually deposit-based peg should be the last to go up when interest rises

Traditionally banks borrow from depositors by paying a deposit interest, and makes a profit by lending out that money to businesses by charging a much higher interest, hence they will always seek to increase their margin by managing their cost of funds well. Then there is the interbank market where local banks flushed with excess local deposits lend out to foreign banks for a smaller margin which is how you derive your interbank Sibor rates for 1-month, 3-month etc. Hence local banks are usually net lenders rather than net borrowers in the interbank.

If we look at things at the very surface level, it follows then that there should always be a gap between Sibor and deposit rates in order for local banks to make money with their excess funds. Conceptually this gap is always there and cannot be zero otherwise it makes no sense to lend out to interbank and local banks will just have to lower their deposits interest when there is no demand in the interbank.

For this reason, Sibor being interbank rate will always rise first as it tracks the amount of liquidity in the banking system whereas deposit rate will always play laggard and rise or fall in response to demand for interbank funds. When liquidity dries up say in event of rate hike in US with capital flight out in search of higher yields, sibor rises and banks need to raise deposits interest to attract more funds.

Reason 2 : It is determined solely by the bank, but yet retains some element of market control

Although just like bank’s internal Board rate, deposit-based peg is solely determined by the bank, there is still some element of market forces at play. First as explained above unlike Board, which is a pure lending rate, which the bank would have no qualms adjusting it up to maximize profits, doing so for a deposit-based peg would hit the bank in terms of higher costs of funds.

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This is where if we look deeper beneath the surface, we can understand why DBS has defined its deposit-based peg based on fixed deposit rates for the lowest tier of between $1,000 and $9,999. I put to you even though the bank has explicitly stated it has the right to vary this definition it is unlikely to do so. A look at its Sing dollar deposits composite as at end of 2014 shows that of its total deposits base of $138b, the main bulk of it 72% comes from savings accounts and only 10% comes from fixed deposit. And if we further assume Pareto’s 80:20 rule it is likely most the fixed deposit funds (80%) will come from the small base (20%) of bigger placement accounts above $10,000. Hence DBS home loan’s FHR is actually pegged to a very small deposits base of 2% out of the $138b reported.

Prima facie it may seem reasonable to peg the interest rate for home loans, a longer-term asset to the bank by nature, to longer-term liabilities or deposits of longer tenure like 12-month and 24-month. There is actually a more strategic reason to do this from the bank’s perspective. Even if the bank were to raise its FHR or longer tenure deposits interest, it will only hit them on costs for only 2% of their deposits base!

Another bank local or foreign may later roll out and defined a deposit-based peg based on their savings account interest rate instead. And depending on the composite of its deposits base the dynamics involved may be very different. Any bank that introduces a deposit-based peg will need to look at its deposits strategy carefully as there are market demand and supply forces at play which will hit their margins and costs.

Reason 3 : A peg based on longer tenure Fixed Deposit is less volatile and more stable than 3-month sibor

The best way to illustrate this is to look at the historical trending analysis where data is available on 12-month fixed deposit rates from MAS over a 28-year period.

Overall deposit rate (red and green line) correlates with Sibor (blue line) but swings in a narrower band or is less volatile. In fact for a long period since 2004 till now this correlation is off and deposit rate stays low amidst periods of rising interest rates and if this same trend persists it is good news for those with home loans pegged to deposit rates.

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Reason 4 : With deposit-based peg one may not need to refinance so often

As discussed earlier each bank may have its own unique deposit-based peg considerations depending on their deposits composite and funding strategy.

In the case of DBS FHR, if we assume that the bank continues its strategy in the last one year where it held FHR at 0.40% for as long as it could but instead increases its spread for new signups, and if FHR only doubles to say 1.00% by end of year 3 when Sibor also doubles to 2.00%, watch what happens:

DBS FHR Pegs 2015 Aug

By start of year 4 when the spread typically reverts to higher rate for most banks, one would still be enjoying very competitive floating rates, as long as a certain gap is maintained between Sibor and FHR. In fact if FHR rises so slowly in our assumptions above, the average rate over next 3 years (on straight-line basis) at 1.70% p.a. is even lower than prevailing fixed rates!

Caveat Emptor! This is only our view on how DBS might move its FHR which may or may not be at such slow pace. Ultimately for the bank it is a tradeoff between gaining more market share by holding out FHR increases or grow interest margin by adjusting FHR up quickly. At the moment, we think it is leaning more towards the former.

At MortgageWise.sg, we seek to be your mortgage solutions partner and take pride in being able to give truly independent advice sometimes asking clients to re-price and stay with their existing bank if it doesn’t make sense for them to move. We may not get to do business with you the first time round, but we will try again. We strive to be your first choice mortgage partner when you buy Singapore condo. Meanwhile do sign up for our newsletter on our website and stay tuned to this blog as we bring you purposeful and proprietary news summary & insights.

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