The Inflation Tax · Part 0 · Start here
The Price of Money
What is the RBA cash rate, and why does it end up in your home loan when no law requires it?
Opinion and general information only, not financial advice. Scott, Charlene, FMA and SBA are fictional.
The number everyone hears, and few can explain.
Every few weeks the evening news leads with the same story. "The Reserve Bank has lifted the cash rate." Economists nod, the dollar moves, and most of us change the channel.
Scott and Charlene were walking their dog Bouncer down Ramsay Avenue in Modbury when they heard it on the radio. On 30 September 2026 the Reserve Bank of Australia (RBA) lifted the cash rate to 4.60%. Two weeks later, a letter from their bank, Fat Margin Australia (FMA), arrived. Their home loan rate was going up too.
Charlene asked the obvious question: "We don't borrow from the Reserve Bank. So why does their number decide what we pay?"
It's a fair question, and the answer is surprisingly simple.
The short answer
The cash rate is the baseline price of money in Australia. No law forces any bank to copy it into your home loan. But every bank measures its prices against it, so in practice they all follow it.
Three things explain why.
1. It's the price banks charge each other overnight
The RBA defines the cash rate as "the interest rate on unsecured overnight loans between banks" (RBA).
Why would banks lend to each other overnight? Picture a normal day. Thousands of people pay bills, get paid and transfer money between banks. By evening, some banks have more cash than they need and some are a little short. The short banks borrow from the others until the next morning.
Example: FMA finishes Monday $100 million short. Its rival, Skim Bank Australia (SBA), has $100 million spare. SBA lends it to FMA overnight at 4.60%. On Tuesday FMA pays it back, plus about $12,600 in interest for that one night.
The RBA doesn't order banks to use 4.60%. Instead, it builds a floor and a ceiling around it (RBA):
- The floor (4.50%). Every bank has an account with the RBA. Spare cash left there overnight earns 4.50%, risk-free. So SBA, with $100 million spare, has two choices: leave it with the RBA at 4.50%, or lend it to FMA. SBA only lends if FMA pays more than 4.50%. At 4.60%, SBA earns about $274 extra for one night. That's small, but it's free money, so SBA lends. No bank will ever lend for less than 4.50%, because the RBA pays that for doing nothing.
- The ceiling (4.85%). Yes, the RBA does lend, overnight, to banks that put up safe assets such as government bonds as security. It charges 4.85%. So FMA, $100 million short, also has two choices: borrow from the RBA at 4.85%, or borrow from SBA. Borrowing from SBA at 4.60% saves FMA about $685 that night, so FMA goes to SBA first. The RBA is the backstop, not the first stop. No bank will pay another more than 4.85%, because the RBA is always there at that price.
Squeezed between the two, the overnight rate settles at 4.60%. Think of the RBA as the market manager who sets the lowest and highest price any stall can charge.
2. No law says your bank must follow it
Here's what surprises most people. There is no law that forces a bank to change your home loan rate when the cash rate moves. The cash rate is a benchmark, not a rule. Your bank sets your rate, and it can move by more, less or not at all.
So why do banks almost always follow? Three everyday reasons:
- Their costs move with it. Scott and Charlene's $500,000 didn't come from the RBA. Most of it came from other customers' savings, and the rest from investors. Those savers and investors expect returns that track the cash rate. If the bank doesn't pay them, they take their money elsewhere.
- Competitors are watching. If the RBA cuts and one bank doesn't pass it on, borrowers refinance with a rival offering a cheaper rate.
- Pricing too low loses money, fast. A bank's cost of money is mostly the interest it pays savers and investors. On top of that come wages, branches, IT and an allowance for loans that go bad. Say a bank pays its savers 4% but lends at 2%. It loses about $2 on every $100 it lends, every year, before it pays a single staff member. Worse, borrowers across Australia would rush to refinance with it. It would soon run out of money to lend, and have to raise its rate or stop lending.
No one is forced to follow the baseline. Following it is simply the cheapest, safest way to stay in business.
3. Without a baseline, money would have no common yardstick
Imagine the RBA stopped setting a cash rate tomorrow. Banks could still lend to each other, but nobody would know what a fair price was.
On Monday, FMA needs $100 million overnight. One lender asks 3%, another 7%, a third won't lend at all because it can't judge the risk. FMA pays 7% to be safe. On Tuesday it reprices home loans to cover itself. SBA, which borrowed at 3%, doesn't. By Friday, two families on the same street are paying very different rates for the same loan, and neither knows why.
| Without a cash rate | With a cash rate (today) | |
|---|---|---|
| Overnight borrowing | Price is haggled every night; can swing wildly | Held close to 4.60% by the RBA's floor and ceiling |
| Setting loan rates | Each bank guesses its own costs | Every bank starts from the same baseline |
| Comparing deals | Hard to tell a fair rate from a bad one | Rates quoted as a margin above a known number |
| Planning ahead | Banks hold extra cash "just in case", so less is lent | Banks can lend with confidence |
| Fighting inflation | No single lever to cool or boost spending | The RBA moves one number and the whole system follows |
The cash rate isn't there to protect banks. It gives everyone, banks and borrowers, the same starting point.
So what does this mean for Scott and Charlene?
The RBA never touched their loan. It moved the baseline, and FMA chose to move with it, within a fortnight.
That choice matters. A baseline that banks choose to follow means they also choose how fast and how far. When the cash rate rises, loan rates tend to follow quickly. When savings rates are due to rise, banks are often slower. That gap is where this series is heading.
This article is general information and the author's opinion. It doesn't consider your personal circumstances. The author is not a licensed financial adviser. Before making financial decisions, speak with a licensed professional. Figures are illustrative.