How lending works: what a loan costs, and why

Next update. The Reserve Bank's next decision on the cash rate is due on 3 November 2026. We will update the rates and figures in this article after it.

A home loan, a loan secured on an office building, an unsecured loan to a small engineering firm and a loan to build forty apartments all start from the same number, the Reserve Bank's cash rate. They do not end at the same price. The gap between them is not arbitrary. Each rate is a sum of costs, and each cost can be traced: what the lender pays for its money, the losses it expects, the capital it must hold against the loan, what it spends to make and watch the loan, and the margin left over.

This is the first of seven articles on how lending works in Australia. It lays the foundations; the parts that follow take one piece each, from the home loan in Part 2 to the strategic use of debt in Part 7.

Cash rate target from 30 September 2026, after four rises this year

4.60%

RBA

Major banks' estimated average cost of deposits and debt in March 2026, when the cash rate was 4.10%

3.76%

RBA

Banks' CET1 capital as a share of risk-weighted assets, June 2026

12.4%

RBA

What a loan is

A loan is a promise with a price. The lender hands over a sum, the principal, and the borrower agrees to repay it over a term, paying interest for the use of the money in the meantime. Most of the rest of a loan agreement exists to make that promise more likely to be kept, and less costly to the lender if it is not.

Four features do most of that work.

• Repayment. A principal and interest loan pays off part of the principal with every instalment. An interest-only loan leaves the principal untouched until the interest-only period ends, so the lender is owed the full amount for longer.
• Security. Security gives the lender a claim on an asset if the borrower defaults: a registered mortgage over a property, or a security interest over a business's assets. It reduces what the lender stands to lose. It does not turn a weak borrower into a strong one, and APRA requires banks to assess credit risk "primarily on the strength of a borrower's repayment capacity" and not to place undue reliance on collateral instead (APS 220, paragraph 42).⁴
• Covenants. These are promises the borrower keeps for the life of the loan, such as to supply financial statements on time, to keep earnings above an agreed multiple of the interest bill, or not to give security to anyone else without the lender's consent. APRA requires banks to consider covenants that limit their exposure to changes in a borrower's risk (APS 220, paragraph 45(e)).⁴ For standard form small business loans, the banks that have adopted the Banking Code of Practice, called Code banks here, have agreed not to make an unspecified material adverse change an event of default (paragraph 92), and the Code lets financial covenants be a default trigger in such a loan only for property development and listed kinds of specialised lending (paragraph 91).⁵ That a breach of a financial ratio alone is not a default a Code bank can act on in other standard form small business loans is our reading of paragraphs 87 and 91 together. Negotiated and larger facilities sit outside those paragraphs, and covenant defaults are usual there.
• The rate. A variable rate moves when the lender changes it, or with a market reference rate such as the bank bill swap rate. A fixed rate is set for a period.

What happens to the security when a promise is broken is the subject of Part 6.

Banks, non-banks and private credit

Three kinds of lender make most of the loans in Australia, and what separates them is where their money comes from.

Banks are authorised deposit-taking institutions (ADIs: banks, building societies and credit unions). They can take deposits from the public, and APRA, the prudential regulator, supervises them and sets how much capital and liquidity they must hold.^6,7

Non-bank lenders lend but are prohibited from taking deposits, so they borrow from investors and from banks instead.⁸ A non-bank that extends credit and holds more than $50 million of debt assets must register with APRA as a registered financial corporation and report on its lending, but registration is not supervision: APRA does not set its capital or liquidity as it does a bank's, and holds instead what the RBA describes as a power under Part IIB of the Banking Act 1959 to extend macroprudential policy to non-bank lenders.⁹

Private credit funds lend money raised from investors, largely to businesses. In the RBA's words, Australian private credit funds "are more exposed to real estate, including construction and development".¹⁰

The same loan can come from any of the three, at different prices, and much of the difference starts with what each pays for its money.

Within the banks, the four majors stand apart from the rest in size and in the capital rules they follow, so in practice the market has four tiers.

Threefold Capital interpretation

The tiers of lender in Australia, side by side

Tier	Who	Where its money comes from	Who sets its rules	What it means for a borrower
The four major banks	ANZ, CommBank, NAB and Westpac, which APRA lists as domestic systemically important banks	Deposits around two-thirds, wholesale debt almost one-third, shareholders' equity less than one-tenth	APRA supervises them; they set risk weights with models APRA has approved and hold the largest buffer, 10.25% CET1	Deposits that pay little or nothing kept their average cost of deposits and debt at 3.76% in March 2026, below the 4.10% cash rate; theirs are the rates the other tiers are compared with
Other banks, building societies and credit unions	Every other authorised deposit-taker, from regional and smaller banks to customer-owned lenders	Deposits and wholesale debt	APRA supervises them as it does the majors; a bank on APRA's standard risk weights holds at least 8.00% CET1, one approved to use its own models 9.25%	The same deposit rules and supervision as the majors on a smaller balance sheet; appetite, products and price vary from lender to lender
Non-bank lenders	Lenders that do not take deposits, from home loan specialists to online lenders to small businesses	Warehouse lines, mostly from banks, while loans are written; then securitisation, selling pooled loans to investors	Prohibited from taking deposits; registered with APRA above $50 million of debt assets but not supervised as banks are; ASIC regulates consumer credit and conduct	Around 6% of the financial system's assets, with a growing share of smaller business loans since 2022; their funding is priced by investors each time it is raised, so their appetite moves with markets
Private credit funds	Funds that lend investors' money, largely to businesses	The investors in the fund	Not supervised by APRA as banks are; how the sector is watched is set out in Part 3	The return investors expect sets a floor under the rate, so it is seldom the cheapest money; the RBA finds the funds more exposed to real estate, construction and development

Simplified. Each tier holds lenders of very different sizes and appetites, and the price of a particular loan depends on the loan as well as on the lender. CET1 is Common Equity Tier 1 capital as a share of risk-weighted assets; the levels shown are those below which limits on dividends apply, set out in the section on capital below.

Where a lender's money comes from

Deposits, debt and equity

A bank lends mostly other people's money. In the RBA's latest description of the major banks' funding, deposits account for around two-thirds, debt almost one-third and equity, the shareholders' own money, less than one-tenth.¹ The mix has changed over two decades: the banks have replaced much of what they once borrowed in international wholesale markets with deposits from Australian households, which the RBA describes as more stable.⁸

Each source has its own price, and each price responds differently when the cash rate moves. That is the first reason a bank's cost of money does not track the cash rate one for one.

What the money costs

In March 2026, the RBA estimates, the major banks' deposits and debt cost 3.76% on average, when the cash rate was 4.10%.¹ An average below the policy rate looks odd until it is taken apart.

The figures are average rates on the whole stock of each kind of funding. The average on the major banks' outstanding at-call deposits was 3.24%. They include transaction accounts that pay no interest, savings accounts and offset accounts, and on average their rates have adjusted by less than the cash rate.¹ The average on outstanding term deposits was 4.15%, a little above the cash rate. Most term deposits are priced against bank bill swap rates, or BBSW, a market reference rate for bank funding, and new term deposit rates have moved broadly in line with the cash rate.^1,11 Outstanding wholesale debt cost 3.76%. On much of it the banks pay BBSW plus a margin, and they use interest rate swaps to turn fixed-rate debt into floating payments.¹

The swaps matter more than their name suggests. Banks also hedge their cheapest deposits, which smooths the cost of that money as rates rise and fall. Without hedging, the RBA explains, a cut in the cash rate could squeeze a bank's net interest margin, because the interest it earns on its loans would typically fall by more than the interest it pays on its funding.¹ The RBA attributes the fall in the banks' funding costs relative to the cash rate since January 2025 mainly to lower hedging costs.¹

Funding costs have since risen with the cash rate: by an estimated 18 basis points between the RBA's May and August Statements on Monetary Policy, a period that took in the 25 basis point rise of May, as the higher cash rate flowed through to deposit and wholesale debt rates.^12,13 A basis point is a hundredth of a percentage point, so 18 basis points is 0.18 percentage points: the banks' cost of money rose by less than the cash rate, as the slow repricing of at-call deposits would predict.

Reported data

Where the major banks' money comes from, and what it cost in March 2026

Source of funds	Share of the major banks' funding	Rate on outstanding balances, March 2026
Deposits, all	Around two-thirds	3.45%
At-call deposits	Part of deposits	3.24%
Term deposits	Part of deposits	4.15%
Wholesale debt	Almost one-third	3.76%
Equity	Less than one-tenth	Not estimated
Deposits and debt together	All but equity	3.76%
Cash rate target	For comparison	4.10%

RBA estimates for the major banks. The RBA gives the shares as fractions, not percentages. At-call deposits include transaction accounts that pay no interest, savings accounts and offset accounts. The rate for each source is the estimated rate on the balances outstanding. The total for deposits and debt is the RBA's estimate of the banks' funding costs, which also counts the cost of their interest rate hedging, a separate line in the RBA's table, and that, in our reading, is why the total sits above a weighted average of the rows. The estimate leaves out the cost of equity, and the RBA says its hedging estimates are uncertain.

The average and the next dollar

An average below the cash rate does not mean a bank can lend new money below it. In our reading, the funding a bank has to find for one more loan is priced at the margin: a new term deposit or a new bond, rather than the accounts that pay nothing. New term deposit rates had moved broadly in line with the cash rate,¹ and on new wholesale debt the banks usually pay BBSW plus a spread.¹

The cost of funding the next loan therefore sits at or above the cash rate even while the average sits below it, and the next dollar is the one a new loan's price has to cover. The RBA's own description of how banks measure the profitability of lending sets the revenue from a loan against "the cost of funding loans".¹¹ The model later in this article charges every loan the cost of new money, which we set at 0.10 percentage points above the cash rate.

That is a low stand-in, and it suits a home loan funded mostly by deposits better than the other scenarios. New wholesale debt pays a spread over BBSW, the liquidity rules described below carry a cost of their own, and a bank funds longer business and property loans partly with bonds priced over BBSW, so for those loans the true figure is higher still. The control in the model lets a reader set it higher, and every rate rises with it almost one for one: at 0.50 points over the cash rate the home loan is priced at 6.48% rather than 6.10%, and the business loan at 9.76% rather than 9.39%.

How non-banks and private credit are funded

Non-bank lenders cannot fall back on deposits. Securitisation, in which loans are pooled and sold to investors as securities, is a key source of funding for some of them precisely because they are prohibited from funding themselves with deposits, the RBA notes.⁸ The cycle usually runs in two stages: a lender funds new loans through a warehouse facility, a revolving line of credit mostly provided by banks, while it writes them, then from the securitisation market once the loans are packaged and sold.^8,9

Conditions have suited this model. Spreads on non-banks' residential mortgage-backed securities have narrowed considerably over the past three years, foreign investors have shown strong demand for Australian asset-backed securities, and non-banks report ample warehouse funding.⁸ The difference from a bank is that a non-bank's funding is priced by investors each time it raises money. In our view that makes a non-bank's appetite for a particular kind of loan more sensitive to the mood of markets than a bank's, in both directions.

Private credit funds are funded by their investors, and we read a fund's cost of money as the return those investors expect, which sets a higher floor under its rates than deposits set under a bank's: that is why private credit tends to be found where banks are cautious, and why it is seldom the cheapest money on offer. How large it is, how it is funded and what the Reserve Bank makes of it are set out in Part 3.

The cash rate, and how it reaches a loan

The RBA's monetary policy works through one price: the interest rate on overnight loans in the money market, which it calls the cash rate.¹⁴ Its Monetary Policy Board makes its decisions in terms of a target for that rate,¹⁵ with the aim of keeping consumer price inflation between 2% and 3%,¹⁴ and its August forecasts are framed around inflation returning to the midpoint of that range.¹⁶ Hardly anyone outside the money market borrows at the cash rate itself. Its influence comes from what it does to every other rate.

Reported data

The cash rate target since 2000

RBA cash rate target in force at the end of each month, January 2000 to September 2026, per cent

• Cash rate target

Show the figures

Period	Cash rate target
Jan 2000	5.00%
Feb 2000	5.50%
Mar 2000	5.50%
Apr 2000	5.75%
May 2000	6.00%
Jun 2000	6.00%
Jul 2000	6.00%
Aug 2000	6.25%
Sep 2000	6.25%
Oct 2000	6.25%
Nov 2000	6.25%
Dec 2000	6.25%
Jan 2001	6.25%
Feb 2001	5.75%
Mar 2001	5.50%
Apr 2001	5.00%
May 2001	5.00%
Jun 2001	5.00%
Jul 2001	5.00%
Aug 2001	5.00%
Sep 2001	4.75%
Oct 2001	4.50%
Nov 2001	4.50%
Dec 2001	4.25%
Jan 2002	4.25%
Feb 2002	4.25%
Mar 2002	4.25%
Apr 2002	4.25%
May 2002	4.50%
Jun 2002	4.75%
Jul 2002	4.75%
Aug 2002	4.75%
Sep 2002	4.75%
Oct 2002	4.75%
Nov 2002	4.75%
Dec 2002	4.75%
Jan 2003	4.75%
Feb 2003	4.75%
Mar 2003	4.75%
Apr 2003	4.75%
May 2003	4.75%
Jun 2003	4.75%
Jul 2003	4.75%
Aug 2003	4.75%
Sep 2003	4.75%
Oct 2003	4.75%
Nov 2003	5.00%
Dec 2003	5.25%
Jan 2004	5.25%
Feb 2004	5.25%
Mar 2004	5.25%
Apr 2004	5.25%
May 2004	5.25%
Jun 2004	5.25%
Jul 2004	5.25%
Aug 2004	5.25%
Sep 2004	5.25%
Oct 2004	5.25%
Nov 2004	5.25%
Dec 2004	5.25%
Jan 2005	5.25%
Feb 2005	5.25%
Mar 2005	5.50%
Apr 2005	5.50%
May 2005	5.50%
Jun 2005	5.50%
Jul 2005	5.50%
Aug 2005	5.50%
Sep 2005	5.50%
Oct 2005	5.50%
Nov 2005	5.50%
Dec 2005	5.50%
Jan 2006	5.50%
Feb 2006	5.50%
Mar 2006	5.50%
Apr 2006	5.50%
May 2006	5.75%
Jun 2006	5.75%
Jul 2006	5.75%
Aug 2006	6.00%
Sep 2006	6.00%
Oct 2006	6.00%
Nov 2006	6.25%
Dec 2006	6.25%
Jan 2007	6.25%
Feb 2007	6.25%
Mar 2007	6.25%
Apr 2007	6.25%
May 2007	6.25%
Jun 2007	6.25%
Jul 2007	6.25%
Aug 2007	6.50%
Sep 2007	6.50%
Oct 2007	6.50%
Nov 2007	6.75%
Dec 2007	6.75%
Jan 2008	6.75%
Feb 2008	7.00%
Mar 2008	7.25%
Apr 2008	7.25%
May 2008	7.25%
Jun 2008	7.25%
Jul 2008	7.25%
Aug 2008	7.25%
Sep 2008	7.00%
Oct 2008	6.00%
Nov 2008	5.25%
Dec 2008	4.25%
Jan 2009	4.25%
Feb 2009	3.25%
Mar 2009	3.25%
Apr 2009	3.00%
May 2009	3.00%
Jun 2009	3.00%
Jul 2009	3.00%
Aug 2009	3.00%
Sep 2009	3.00%
Oct 2009	3.25%
Nov 2009	3.50%
Dec 2009	3.75%
Jan 2010	3.75%
Feb 2010	3.75%
Mar 2010	4.00%
Apr 2010	4.25%
May 2010	4.50%
Jun 2010	4.50%
Jul 2010	4.50%
Aug 2010	4.50%
Sep 2010	4.50%
Oct 2010	4.50%
Nov 2010	4.75%
Dec 2010	4.75%
Jan 2011	4.75%
Feb 2011	4.75%
Mar 2011	4.75%
Apr 2011	4.75%
May 2011	4.75%
Jun 2011	4.75%
Jul 2011	4.75%
Aug 2011	4.75%
Sep 2011	4.75%
Oct 2011	4.75%
Nov 2011	4.50%
Dec 2011	4.25%
Jan 2012	4.25%
Feb 2012	4.25%
Mar 2012	4.25%
Apr 2012	4.25%
May 2012	3.75%
Jun 2012	3.50%
Jul 2012	3.50%
Aug 2012	3.50%
Sep 2012	3.50%
Oct 2012	3.25%
Nov 2012	3.25%
Dec 2012	3.00%
Jan 2013	3.00%
Feb 2013	3.00%
Mar 2013	3.00%
Apr 2013	3.00%
May 2013	2.75%
Jun 2013	2.75%
Jul 2013	2.75%
Aug 2013	2.50%
Sep 2013	2.50%
Oct 2013	2.50%
Nov 2013	2.50%
Dec 2013	2.50%
Jan 2014	2.50%
Feb 2014	2.50%
Mar 2014	2.50%
Apr 2014	2.50%
May 2014	2.50%
Jun 2014	2.50%
Jul 2014	2.50%
Aug 2014	2.50%
Sep 2014	2.50%
Oct 2014	2.50%
Nov 2014	2.50%
Dec 2014	2.50%
Jan 2015	2.50%
Feb 2015	2.25%
Mar 2015	2.25%
Apr 2015	2.25%
May 2015	2.00%
Jun 2015	2.00%
Jul 2015	2.00%
Aug 2015	2.00%
Sep 2015	2.00%
Oct 2015	2.00%
Nov 2015	2.00%
Dec 2015	2.00%
Jan 2016	2.00%
Feb 2016	2.00%
Mar 2016	2.00%
Apr 2016	2.00%
May 2016	1.75%
Jun 2016	1.75%
Jul 2016	1.75%
Aug 2016	1.50%
Sep 2016	1.50%
Oct 2016	1.50%
Nov 2016	1.50%
Dec 2016	1.50%
Jan 2017	1.50%
Feb 2017	1.50%
Mar 2017	1.50%
Apr 2017	1.50%
May 2017	1.50%
Jun 2017	1.50%
Jul 2017	1.50%
Aug 2017	1.50%
Sep 2017	1.50%
Oct 2017	1.50%
Nov 2017	1.50%
Dec 2017	1.50%
Jan 2018	1.50%
Feb 2018	1.50%
Mar 2018	1.50%
Apr 2018	1.50%
May 2018	1.50%
Jun 2018	1.50%
Jul 2018	1.50%
Aug 2018	1.50%
Sep 2018	1.50%
Oct 2018	1.50%
Nov 2018	1.50%
Dec 2018	1.50%
Jan 2019	1.50%
Feb 2019	1.50%
Mar 2019	1.50%
Apr 2019	1.50%
May 2019	1.50%
Jun 2019	1.25%
Jul 2019	1.00%
Aug 2019	1.00%
Sep 2019	1.00%
Oct 2019	0.75%
Nov 2019	0.75%
Dec 2019	0.75%
Jan 2020	0.75%
Feb 2020	0.75%
Mar 2020	0.25%
Apr 2020	0.25%
May 2020	0.25%
Jun 2020	0.25%
Jul 2020	0.25%
Aug 2020	0.25%
Sep 2020	0.25%
Oct 2020	0.25%
Nov 2020	0.10%
Dec 2020	0.10%
Jan 2021	0.10%
Feb 2021	0.10%
Mar 2021	0.10%
Apr 2021	0.10%
May 2021	0.10%
Jun 2021	0.10%
Jul 2021	0.10%
Aug 2021	0.10%
Sep 2021	0.10%
Oct 2021	0.10%
Nov 2021	0.10%
Dec 2021	0.10%
Jan 2022	0.10%
Feb 2022	0.10%
Mar 2022	0.10%
Apr 2022	0.10%
May 2022	0.35%
Jun 2022	0.85%
Jul 2022	1.35%
Aug 2022	1.85%
Sep 2022	2.35%
Oct 2022	2.60%
Nov 2022	2.85%
Dec 2022	3.10%
Jan 2023	3.10%
Feb 2023	3.35%
Mar 2023	3.60%
Apr 2023	3.60%
May 2023	3.85%
Jun 2023	4.10%
Jul 2023	4.10%
Aug 2023	4.10%
Sep 2023	4.10%
Oct 2023	4.10%
Nov 2023	4.35%
Dec 2023	4.35%
Jan 2024	4.35%
Feb 2024	4.35%
Mar 2024	4.35%
Apr 2024	4.35%
May 2024	4.35%
Jun 2024	4.35%
Jul 2024	4.35%
Aug 2024	4.35%
Sep 2024	4.35%
Oct 2024	4.35%
Nov 2024	4.35%
Dec 2024	4.35%
Jan 2025	4.35%
Feb 2025	4.10%
Mar 2025	4.10%
Apr 2025	4.10%
May 2025	3.85%
Jun 2025	3.85%
Jul 2025	3.85%
Aug 2025	3.60%
Sep 2025	3.60%
Oct 2025	3.60%
Nov 2025	3.60%
Dec 2025	3.60%
Jan 2026	3.60%
Feb 2026	3.85%
Mar 2026	4.10%
Apr 2026	4.10%
May 2026	4.35%
Jun 2026	4.35%
Jul 2026	4.35%
Aug 2026	4.35%
Sep 2026	4.60%

The four rises of 2026 took effect on 4 February, 18 March, 6 May and 30 September.¹³ Announcing the last of them, the Board said it would "continue to do what it considers necessary to bring inflation sustainably back to target, including increasing the cash rate target further if needed".¹⁷ We cover the causes of this year's rises in our article on inflation and interest rates.

From the cash rate to the rate on a loan

A change in the cash rate reaches a loan in three steps. Short-term market rates move with it: the RBA reports that variable business rates rose this year alongside increases in bank bill swap rates and the cash rate.¹² Banks' funding costs follow: quickly for term deposits and wholesale debt priced against BBSW, more slowly for at-call deposits.¹ Then lenders reprice their loans, and borrowers' repayments change.

This year the steps have been short. Banks passed the first three rises of 2026 on to deposit and lending rates, and variable mortgage rates, as the RBA measures them, rose by nearly 75 basis points between January and June, against 75 basis points of rises in the cash rate over the same months.^12,13 Repayments lag rates a little: rises can take around three months to flow through to scheduled mortgage payments, the RBA notes, "because of minimum notice periods for higher repayments and differences in borrowers' repayment cycles".¹² It also expects pass-through to be faster for smaller businesses than for larger companies.¹⁸

Why a rise can take years to reach every borrower

It was not always this quick. From April to December 2022 the cash rate target rose 300 basis points. Over the same months the average rate on outstanding business loans rose by just over 260 basis points, and the average rate on outstanding home loans by around 190.²

Reported data

The 2022 rises and the average rates on outstanding loans

Change from April to December 2022, basis points. 100 basis points is one percentage point

1. Cash rate target300
2. Average rate on outstanding business loansJust over 260
3. Average rate on outstanding home loansAround 190

The spread over the cash rate

What a borrower pays above the cash rate is its spread, and spreads are narrow. The RBA reported in May that spreads between lending rates and the cash rate "have remained at their narrowest levels in almost two decades", reflecting low bank funding costs relative to the cash rate and strong competition between lenders.¹ On home loans the narrowing has been large. The spread between the average new variable mortgage rate and the cash rate has fallen by around 65 basis points since December 2019, most of it in 2021 and 2022, and in the RBA's assessment changes like these have made financial conditions less restrictive than they would otherwise be for a given cash rate.²⁰ The banks' own measure of what they keep tells the same story: their net interest margins, interest earned less interest paid as a share of the assets that earn it, stabilised around historical lows in 2025.¹

The way loans are sold has changed too. The RBA estimates that brokers originated around 65% of new home loans in 2025, up from around 50% in 2019, and comparison websites now let borrowers compare mortgage rates across lenders.²⁰ In our view, a market in which most new loans pass through someone comparing several lenders leaves less room for wide margins. Part 3 looks at what the data says about credit conditions in 2026.

Capital: the shareholders' money behind every loan

A lender prices for the losses it expects. Capital is for the ones it does not. It is the shareholders' stake in the bank, the money that takes the first loss, and APRA decides how much of it a bank must hold.

How much capital a bank must hold

APRA's capital standard, APS 110, measures capital against a bank's risk-weighted assets: its loans and other exposures, each counted at a weight that reflects its risk. Every bank must hold Common Equity Tier 1 capital, or CET1, of at least 4.5% of its risk-weighted assets, Tier 1 capital of at least 6.0% and total capital of at least 8.0%.⁷ CET1 is, in the RBA's words, "the highest quality of regulatory capital".⁸

On top of the minimum sit buffers, also held in CET1. The capital conservation buffer is 2.5% of risk-weighted assets for banks on the standardised approach and 3.75% for banks that APRA has approved to use their own internal ratings-based, or IRB, models (paragraph 27). A domestic systemically important bank adds a further 1.0% (paragraph 28), and APRA's list of those banks is ANZ, the Commonwealth Bank (CommBank), NAB and Westpac.^7,21 APRA also sets a countercyclical buffer, anywhere from 0% to 3.5%, and has kept it at 1%.^7,22 A bank whose CET1 falls into its buffers has not broken the rules, but it faces limits on its dividends, share buybacks and discretionary bonuses (paragraph 30).⁷

Reported data

The CET1 capital a bank must hold before limits on its dividends apply

CET1 capital	Standardised banks	Banks on their own models	Four major banks
Minimum	4.50%	4.50%	4.50%
Conservation buffer	2.50%	3.75%	3.75%
Systemic bank buffer	None	None	1.00%
Countercyclical buffer	1.00%	1.00%	1.00%
Total	8.00%	9.25%	10.25%

Common Equity Tier 1 capital, as a share of risk-weighted assets. Standardised banks use APRA's standard risk weights; banks on their own models are those APRA has approved to use the internal ratings-based approach. The four major banks are APRA's domestic systemically important banks, which carry the systemic bank buffer. The countercyclical buffer is the level APRA has set. APS 110 also sets minimum Tier 1 capital of 6.0% and total capital of 8.0%.

APRA has already made a revised APS 110 that starts on 1 January 2027. It raises the CET1 minimum for banks using their own models to 6.0% and sets the capital conservation buffer at 2.5% for every bank.²⁴

Risk weights: why some loans need more capital

Capital is held against risk-weighted assets, not against loans at face value, and the weights do much of the work in pricing. APRA's standard APS 112 sets standard weights by the type of loan, its security and its loan to value ratio, or LVR: the loan as a share of the value of the property that secures it.³ A weight of 30% means $1 million of loans counts as $300,000 of risk-weighted assets, behind which a bank at a capital ratio of 12%, the setting in our model and close to the banking system's 12.4%, holds $36,000 of capital; a weight of 150% means the same $1 million counts as $1.5 million and needs $180,000.

Banks that APRA has approved to use the IRB approach estimate risk weights with their own models instead, under a separate standard, APS 113, and APRA's capital tables give the four major banks the larger buffer that applies to IRB banks.^7,23 For those banks the weight on a given loan can differ from the standard one. We read the standard weights as the regulator's public ranking of the risk in different kinds of loan.

Reported data

Standard risk weights for home loans, by loan to value ratio

Loan to value ratio	Owner-occupied, principal and interest	Other standard residential loans
Up to 50%	20%	25%
50.01% to 60%	25%	30%
60.01% to 70%	30%	40%
70.01% to 80%	35%	45%
80.01% to 90%	40% insured, 50% not	50% insured, 65% not
90.01% to 100%	55% insured, 70% not	70% insured, 85% not
Over 100%	70% insured, 85% not	85% insured, 105% not

Insured means covered by eligible lenders mortgage insurance. Up to 80%, the standard sets one weight whether or not the loan is insured. Other standard residential loans include loans for investment or business purposes and interest-only loans with an interest-only period of five years or less. The loan includes accrued interest and fees, and the property must be valued independently on prudently conservative criteria.

Reported data

Standard risk weights for business and property loans

Loan	Risk weight
Commercial property repaid from its own income, loan up to 60% of value	70%
The same, 60.01% to 80% of value	90%
The same, over 80% of value	110%
The same, where the loan is not a standard loan	150%
Land acquisition, development and construction	150%
Residential development meeting APRA's conditions on debt and presales	100%
Small business loan (SME retail): under $1.5 million, not secured by residential property	75%
Other loans to businesses with revenue under $75 million (SME corporate)	85%

Weights under the standardised approach for borrowers without a credit rating. A commercial property loan repaid mainly from the borrower's business, rather than from the property's income, is weighted under a different table (Table 4). APRA's conditions for the 100% weight on a residential development include total debt of less than 75% of qualifying development costs and, where the exposure on one development is above $5 million, qualifying presales at least equal to the debt.

Liquidity

Capital protects a bank against losses; liquidity rules protect it against a sudden loss of funding. Under APS 210, a bank that APRA has classed as a liquidity coverage ratio ADI must hold enough high-quality liquid assets to meet its needs through 30 days of severe stress, a liquidity coverage ratio of at least 100% (paragraph 55), and enough stable funding to support its activities over a one-year horizon, a net stable funding ratio of at least 100% (paragraph 60). Banks under the simpler minimum liquidity holdings regime must hold specified liquid assets of at least 9% of their liabilities (paragraph 57).²⁸ The RBA reports that banks hold liquid assets well above these minimums.⁸ Liquid assets earn less than loans and stable funding costs more than short-term money, so in our view the rules add a small, permanent cost to every loan a bank makes.

What the rate pays for

The RBA's explainer on funding costs puts a bank's pricing in a sentence: banks set their lending rates "to maximise the profitability of lending, subject to an appropriate exposure to the risk that some borrowers will fail to repay their loans".¹¹ A rate has to cover the bank's costs and the return its shareholders require; how much more it can charge is up to the market.

Our model builds a rate in five parts. Its settings are our assumptions, chosen to be plausible and to show the mechanism. They are not any lender's prices, costs or targets. For a home loan to an owner-occupier at 70% of the property's value, with the cash rate at 4.60%, the parts are these.

The cost of the money: 4.70%. The cash rate plus 0.10 percentage points, our stand-in for the cost of new funding described above. It is the same for every loan the bank makes.

Expected loss: 0.05% a year. The chance that the borrower defaults in a year, times the share of the loan the lender would lose if it did. A loan that stops performing is not the same as a loss. A bank's loan is non-performing when it is in default, which includes the borrower being 90 days or more behind (APS 220, paragraph 13(a)),⁴ and the RBA reports that most of the banks' non-performing housing loans, and a smaller majority of their non-performing business loans, are well secured; Part 3 has the figures on arrears, security and provisions.⁸ Good security keeps the expected loss on a home loan small. An unsecured business loan has nothing behind it but the business.

The cost of capital: 0.40%. At a 30% risk weight and a 12% capital ratio, the bank holds capital equal to 3.6% of the loan, $36,000 for each $1 million. We assume its shareholders want 11% a year after tax, 15.7% before company tax at 30%. The bank saves the cost of funds on that slice, so what capital adds to the rate is 3.6% of the loan times the gap between 15.7% and 4.70%.

Operating and distribution costs: 0.45%. Staff, systems, credit assessment, valuations, monitoring, and the cost of finding the loan in the first place. Lenders generally pay mortgage brokers a commission, a percentage of the loan with an upfront and an ongoing part,²⁹ and a bank that uses brokers must oversee them (APS 220, paragraphs 39 and 59).⁴

Margin: 0.50%. What is left for profit above the required return, and the room that competition allows.

Together they make 6.10%, 1.50 percentage points above the cash rate, or $60,965 of interest a year on each $1 million.

Illustrative model

Model: what a loan's interest rate pays for

Choose a loan, or move the controls to set your own. The top bar is the rate in five parts, with the cash rate marked; the thinner bars below it compare the five scenarios on the same scale.

Home loan, 70% of valueCommercial property, 65% of valueUnsecured small business loanProperty developmentHome loan, cash rate at 0.10%

Without JavaScript the model shows one scenario: Home loan, 70% of value.

The money

Cash rate target

4.60%

−+

Cost of the bank's funds above the cash rate, percentage points

0.10

−+

The risk

Expected loss, a year

0.05%

−+

Risk weight

30%

−+

Capital held, share of risk-weighted assets

12.0%

−+

Return shareholders require, after tax

11.0%

−+

Running the bank

Operating and distribution costs, a year

0.45%

−+

Margin for profit and competition, a year

0.50%

−+

Interest rate 6.10%above the cash rate +1.50

Interest rate on the loan

6.10%

Above the cash rate, percentage points

+1.50

Shareholders' capital behind each $1 million lent

$36,000

Interest a year on $1 million

$60,965

Of the 6.10%, 4.70% pays for the money the bank lends. The other 1.40% covers expected losses, the capital behind the loan, the bank's costs and its margin.

Behind each $1 million lent, the bank holds $36,000 of its shareholders' capital, which costs 0.40% a year of the loan.

The rate, built up from its costs

Cost of funds4.70%Expected loss0.05%Cost of capital0.40%Operating and distribution costs0.45%Margin0.50%

The other scenarios change the loan, and with it the expected loss, the risk weight, the costs and the margin.

• Commercial property at 65% of value, repaid from the rent. The standard weight of 90% triples the capital, to $108,000, and we set expected loss higher, at 0.30%. The rate is 7.29%.
• An unsecured small business loan under $1.5 million, at the 75% weight for small business retail loans. It needs less capital than commercial property, $90,000, but expected loss of 1.50% and running costs of 1.20% take the rate to 9.39%.
• A property development loan at 150%. Its $180,000 of capital costs 1.98% a year, five times the home loan's 0.40%. With expected loss of 0.75%, the rate is 9.23%.
• The home loan again, with the cash rate at 0.10%, its level from November 2020 to May 2022.

Illustrative model

What each scenario assumes

Assumption	Home loan, 70% of value	Commercial property, 65% of value	Unsecured small business loan	Property development	Home loan, cash rate at 0.10%
Cash rate target	4.60%	4.60%	4.60%	4.60%	0.10%
Cost of the bank's funds above the cash rate, percentage points	0.10	0.10	0.10	0.10	0.10
Expected loss, a year	0.05%	0.30%	1.50%	0.75%	0.05%
Risk weight	30%	90%	75%	150%	30%
Capital held, share of risk-weighted assets	12.0%	12.0%	12.0%	12.0%	12.0%
Return shareholders require, after tax	11.0%	11.0%	11.0%	11.0%	11.0%
Operating and distribution costs, a year	0.45%	0.50%	1.20%	0.80%	0.45%
Margin for profit and competition, a year	0.50%	0.60%	1.00%	1.00%	0.50%

Our assumptions, not any lender's. The risk weights are APRA's standard weights for each type of loan as described. Company tax is 30%.

Illustrative model

What each loan's rate pays for

Part of the rate	Home loan, 70% of value	Commercial property, 65% of value	Unsecured small business loan	Property development	Home loan, cash rate at 0.10%
Interest rate	6.10%	7.29%	9.39%	9.23%	1.76%
Above the cash rate, percentage points	+1.50	+2.69	+4.79	+4.63	+1.66
Cost of funds	4.70%	4.70%	4.70%	4.70%	0.20%
Expected loss	0.05%	0.30%	1.50%	0.75%	0.05%
Cost of capital	0.40%	1.19%	0.99%	1.98%	0.56%
Operating and distribution costs	0.45%	0.50%	1.20%	0.80%	0.45%
Margin	0.50%	0.60%	1.00%	1.00%	0.50%
Capital behind each $1 million	$36,000	$108,000	$90,000	$180,000	$36,000

Rates and their parts are per cent a year. Capital is the shareholders' money behind each $1 million lent: the loan, times its risk weight, times the capital held.

At a cash rate of 0.10%, the home loan's rate falls to 1.76%, but its spread over the cash rate widens from 1.50 to 1.66 percentage points. In the model the return shareholders require does not fall with the cash rate, so when the money is almost free the capital becomes relatively dearer: 0.56% of the rate, against 0.40%.

That is a property of the model, and it is not what happened: spreads narrowed when rates were low, as the section on spreads above showed. The model holds the return shareholders require at 11% whatever the cash rate, whereas in practice that return tends to fall when risk-free rates fall; in our reading that, together with competition, the cost and mix of funding and lenders' own choices, outweighed the arithmetic of capital. It is a fair illustration of what a cost model can and cannot do: it explains why loans are priced differently from each other, not where the whole market's prices sit.

What the model leaves out

Real pricing differs from the model in several ways.

• Competition. The margin in the model is an assumption. In the market it is whatever lenders can earn while competing for the same borrowers, and the RBA's October Financial Stability Review refers to "ongoing strong competition in lending".¹⁰
• Banks' own models. A bank using the IRB approach sets its own risk weights, so its capital cost for a given loan can differ from the standard weights the model uses.
• Cheaper capital. The model charges all of the capital at the return shareholders require. Banks also meet part of their capital requirements with Additional Tier 1 and Tier 2 instruments, which cost less than ordinary shares.
• Term. The model charges every loan the same cost of funds. Banks' internal pricing charges longer loans for the longer-term funding they need, which weighs on a 30-year mortgage more than on a two-year business loan.
• Fees and fixed rates. The model has no fees, which can be a large part of what a business loan costs, and it prices only variable rates.
• Time. The model prices one year at today's settings. A real loan lives through changes in all of them, which is one reason lenders write covenants and reviews into their loans.

Who is who

Threefold Capital interpretation

Who is who in Australian lending

Arrow: from one party to the other, as its label says

A diagram of eight parties: Wholesale investors, in Australia and overseas; Savers, households and businesses; Non-bank lenders, including private credit funds; Banks, deposit-taking institutions; Borrowers, households and businesses. To one side: ASIC; Reserve Bank; APRA. How they connect:

How they connect

1. 1Savers to Banks Deposits
2. 2Wholesale investors to Banks Bonds and other debt
3. 3Wholesale investors to Non-bank lenders Securitised loans, fund units
4. 4Banks to Non-bank lenders Warehouse lines
5. 5Banks to Borrowers Loans
6. 6Non-bank lenders to Borrowers Loans
7. 7Reserve Bank to Banks Sets the cash rate target
8. 8APRA to Banks Capital and liquidity rules
9. 9ASIC to Non-bank lenders Consumer credit, conduct

Simplified. Arrows show money, or rules, flowing from one party to another. ASIC regulates consumer credit and the conduct of banks and non-banks alike, and APRA registers larger non-banks without supervising them as it does banks. Brokers, valuers and mortgage insurers sit between these parties and are described in the text.

The lenders. Banks remain the centre of the system. Non-bank lenders still account for only around 6% of the financial system's assets, despite strong growth over the past decade,⁸ though their share of business lending has grown strongly since 2022, especially in smaller loans to small and medium businesses.²⁰

Brokers. Most new home loans now reach a lender through a broker, as the section on spreads noted. Since 1 January 2021, mortgage brokers have had to act in the best interests of the consumer when they give credit assistance, under section 158LA of the National Consumer Credit Protection Act 2009.³⁰

Valuers. A valuer tells the lender what the security is worth, and both the capital and the expected loss depend on the answer. APRA requires banks to value security before a loan is drawn down, independently of the people who originate, assess and approve it (APS 220, paragraph 48 and Attachment A, paragraph 3),⁴ and its guidance expects valuers to be chosen by a bank's risk management area, not its sales staff.²⁷

Lenders mortgage insurers. A lenders mortgage insurer covers the lender, not the borrower, against a loss on a home loan, as the reading of the home loan weights above describes, and the borrower pays its premium.²⁶

The regulators. The RBA, under the Reserve Bank Act 1959, sets monetary policy and contributes to the stability of the financial system,^31,6 but prudential supervision is APRA's job.¹⁵ APRA supervises banks, insurers and most of the superannuation industry,⁶ institutions holding around $9.8 trillion in assets.²² ASIC describes itself as Australia's integrated corporate, markets, financial services and consumer credit regulator, set up under the ASIC Act 2001.³² The three coordinate with Treasury through the Council of Financial Regulators, which has no legal powers separate from those of its members.³³

AFCA. Complaints about a bank's conduct belong with ASIC or the Australian Financial Complaints Authority (AFCA), not the RBA.¹⁵ AFCA takes complaints about the lenders and brokers that belong to it, banks among them, so a customer who cannot resolve a complaint with a lender can take it there if it fits AFCA's rules. Complaining is free, and a determination binds the lender once the customer accepts it;³⁴ the Banking Code records the same commitment for Code banks.⁵

How we read it

What follows is our interpretation of what the mechanics mean for a borrower, and for an investor in a business that borrows.

A rate is the lender's view of the loan, written as a number

The most useful thing a borrower can do with a quoted rate is take it apart. Subtracting the cash rate, or the bank bill swap rate if the loan is priced from it, leaves the lender's estimate of everything else: what its money costs above the cash rate, the losses it expects, the capital it must hold, what it costs to make and watch the loan, and its margin. A spread like the 1.50 points of the model's home loan says the lender sees a well-secured loan that is cheap to run and contested by other lenders. A spread like the 4.79 points of its unsecured business loan (a model figure, not a quote) says it sees a loan that could lose money, needs more capital or takes more work, and often all three.

Two lenders can read the same loan differently. One may weight it with its own model and another with the standard; one may lend from cheap deposits while another pays investors for every dollar. A difference between two quotes is therefore information, not just a price to beat. It shows which lender is more comfortable with the business, its security or its industry, and we think that lender is also the one more likely to stay when conditions turn.

What a borrower can change

Five parts of the rate are, at least in part, in the borrower's hands.

Security. Property security moves a loan into a category with lower expected loss and, often, a lower risk weight. It cannot stand in for the ability to repay. APRA requires banks to assess repayment capacity first (APS 220, paragraph 42), so security improves the terms of a loan the business can already service, and does little for one it cannot.⁴

Loan to value. The standard weights step at particular LVRs, and lenders' appetite tends to step with them. In the model, moving the home loan from 70% to 80% of the property's value lifts the standard weight from 30% to 35% and the rate from 6.10% to 6.16%, before any allowance for higher expected loss. Above 80% without insurance, at 50%, the model's rate is 6.36%. Keeping a commercial property loan at or below 60% of value moves the weight from 90% to 70%, and the model's rate from 7.29% to 7.03%.

Information. Complete, timely and consistent financial information lowers a lender's uncertainty and its cost of assessing and monitoring the loan. APRA requires banks to consider a business borrower's historical financial results and future cash flows (APS 220, paragraph 46(b)),⁴ and under the Banking Code, a small business borrower's failure to provide the financial information its loan agreement requires is one of the defaults a bank may act on (paragraph 87(i)).⁵ A business whose numbers arrive late or need explaining pays for it in the rate, in the conditions, or in the size of the loan. Part 5 follows a loan through the credit decision.

Structure. The term, the repayment profile, the covenants and, for property, the equity and presales all change how a lender sees a loan. In the model, a residential development that qualifies for the 100% weight instead of 150% has a capital cost of 1.32% rather than 1.98%, and its rate falls from 9.23% to 8.57%.

The rest of the relationship. Lenders, we believe, price a business on the whole return they earn from it, not on the loan alone: the deposits and transaction accounts it holds, the merchant facilities, the foreign exchange. The model leaves this out, and for a business borrower it is often the largest of the five. A business that borrows from one bank and banks with another can expect to pay for the difference.

What a borrower cannot change

The cash rate, the lender's cost of funds, the capital rules and the state of competition are outside any borrower's control, and together they set most of the rate on a well-secured loan. The right response, we think, is not to forecast them but to plan around them: to test a business's borrowing at a cash rate well above today's, to avoid structures that work only at today's spreads, and to keep enough headroom under covenants for a year when everything moves the wrong way at once. A plan that depends on today's spreads lasting carries a risk that is easy to miss, because it does not appear in the cash rate.

Conclusion

A loan's rate is the sum of what the lender's money costs, the losses it expects, the capital it must hold, the cost of making and running the loan, and a margin that competition decides. The first is set mostly by the cash rate, through deposits and wholesale markets that respond at different speeds; the average cost of the major banks' money sat below the cash rate in March 2026, but in our reading the cost of the next dollar did not. The middle three are where loans differ. APRA's standard risk weights put a home loan at 70% of value at 30% and a development loan at 150%, and in our illustrative model the extra capital is the largest single part of the gap between a 6.10% home loan and a 9.23% development loan.

For a borrower, the practical lesson is that a rate is information. It says how a lender sees the loan, and the parts a borrower controls, its security, its LVR, its information, the structure of its borrowing and the rest of its banking, are the parts a lender prices most carefully. The rest of this series takes each piece further, starting with the home loan in Part 2.

Method and sources

Cut-off. This article uses information published on or before 12 October 2026. The RBA's November decision and Statement on Monetary Policy, and APRA's September quarter statistics, fall after it.

Sources. We use the original publisher of each figure and rule: the RBA, APRA, ASIC, the Council of Financial Regulators, the Australian Banking Association for the Banking Code of Practice, and federal legislation and prudential standards. The brokers' share of new home loans comes from the description of a graph in the RBA's February 2026 Bulletin rather than from its text. Each figure is numbered to its source below.

Periods and measures. The RBA's funding cost estimates are for the major banks only, as at March 2026, and the RBA notes that its estimates of hedging costs are uncertain. Its Table 1 gives the rates on outstanding balances for each kind of funding, and its funding shares as fractions. The Statement on Monetary Policy's figure for variable mortgage rates in the first half of 2026 does not say whether it is for new or for all outstanding loans. The 2022 pass-through figures are changes in average rates on all outstanding loans, not on new loans. The cash rate chart shows the target in force at the end of each month.

Our calculations. The count of 73 changes in the cash rate target since January 2000, 40 up and 33 down, is ours, from the RBA's table of decisions. The 4.25 percentage points of cuts from 3 September 2008 to 8 April 2009 (7.25% to 3.00%) and of rises from 4 May 2022 to 8 November 2023 (0.10% to 4.35%) come from the same table, as do the 75 basis points of rises in the first half of 2026 (4 February, 18 March and 6 May) and the 25 basis point rise of 6 May that fell between the May and August Statements. The gap of 0.34 percentage points is 4.10% less 3.76%. That around 190 basis points is a little under two-thirds of 300 is our division. The risk-weighted amounts of $300,000 and $1.5 million are $1 million times the weights of 30% and 150%, and the multiples of three and five divide the standard weights of 90% and 150% by 30%.

The model. The cost of funds is the cash rate plus 0.10 percentage points, our stand-in for the cost of new funding, which the text describes as a low one. Expected loss, operating and distribution costs and the margin are our assumptions for each loan. The cost of capital is the risk weight, times the capital held (12% of risk-weighted assets, close to the banking system's 12.4% in June 2026), times the gap between the return shareholders require before tax (11% after company tax of 30%) and the cost of funds. The risk weights are APRA's standard weights for each loan as described. What the model leaves out is listed under the model. It is written twice, once to produce the figures printed on the page and once to recalculate them as the controls move, and the two are tested against each other on every scenario and thousands of other settings. Results are rounded, so parts can differ slightly from their total.

Labels. Each chart, table and model carries one of four labels. Reported data: figures or rules published by the source named. Threefold Capital interpretation: our reading of the evidence. Illustrative model: hypothetical figures from our model. Forward-looking scenario: a planning case, not a forecast.

Limitations. Standard risk weights apply to banks on the standardised approach; banks using their own models set their own. The model prices a single loan for a single year and is not a quote, a forecast or a description of any lender's pricing. Several of the RBA's figures are estimates or come from graphs, and published figures can be revised.

Corrections. If you see an error, please tell us at threefoldcapitalau@gmail.com. We correct published articles and record what changed at the top of the page.