Negative Arbitrage in 2025: Impacts for Australian Borrowers

As interest rate volatility continues into 2025, financial concepts like negative arbitrage are resurfacing in discussions among Australian borrowers and investors. While the term might sound like financial jargon, its real-world impact on loan costs, especially for those with fixed-rate or pre-funded debt, is very tangible. Understanding how negative arbitrage works, and its relevance to today’s rate environment, can help you make smarter decisions when structuring loans or managing surplus funds.

What Is Negative Arbitrage?

At its core, negative arbitrage occurs when the interest earned on deposited funds is less than the interest paid on borrowed funds. This mismatch typically arises in situations where a borrower receives loan proceeds up-front (such as with a pre-funded loan or certain project financings) but cannot immediately deploy the funds for their intended purpose. Instead, the unused cash is parked in a low-yield account while the borrower is already obligated to pay a higher interest rate on the full loan amount.

• Example: Suppose a local council in New South Wales secures a $10 million fixed-rate loan at 5.5% to fund a major infrastructure project. Due to construction delays, the council holds the funds in a term deposit earning 4% for several months. The negative arbitrage is the 1.5% gap between what the council pays and what it earns—effectively a direct cost.

While negative arbitrage has long been a feature in large-scale corporate and government finance, more Australians are encountering it in 2025 as banks and lenders tweak loan structures in response to RBA rate movements and higher funding costs.

Why Negative Arbitrage Matters More in 2025

Several factors are making negative arbitrage a timely issue for Australian borrowers this year:

• Interest Rate Swings: The RBA’s ongoing adjustments to the cash rate have caused a wider spread between fixed borrowing rates and short-term deposit rates. This means the cost of negative arbitrage is often greater in 2025 than in the past.
• Prefunding and Project Delays: Infrastructure and property projects are facing supply chain lags and regulatory hurdles, leading to longer periods where borrowed funds are idle and exposed to negative arbitrage.
• Loan Covenants: Some 2025 loan agreements include stricter drawdown schedules or limitations on how borrowed funds are managed prior to deployment, which can restrict the borrower’s ability to optimise interest earnings.

Notably, the 2025 Federal Budget included new transparency requirements for public sector borrowing, aiming to highlight the cost of negative arbitrage on taxpayer-funded projects. Banks and non-bank lenders are also under pressure to clarify the true cost of holding undrawn loan balances.

How Borrowers Can Minimise Negative Arbitrage

If you’re taking out a loan—especially a large or staged facility—there are practical steps to manage or reduce negative arbitrage exposure:

• Negotiate Drawdown Timing: Where possible, align loan drawdowns with your actual cashflow needs. Many lenders in 2025 offer flexible drawdown schedules for construction or business loans, reducing the time borrowed funds sit unused.
• Explore Offset Accounts: Some lenders allow surplus loan proceeds to be parked in offset or redraw accounts, effectively reducing the interest charged until the funds are needed.
• Shop for Higher-Yield Cash Products: While term deposits remain a safe option, some digital banks and money market funds are offering competitive rates that can narrow the negative arbitrage gap. Just be sure to check liquidity and access terms.
• Understand All Fees and Conditions: Lenders may charge break costs or early repayment fees if you attempt to return undrawn funds. Always model the total cost of the loan—including negative arbitrage—before signing.

For example, a Queensland developer recently structured a $15 million facility with staged advances and an offset feature, saving an estimated $75,000 in negative arbitrage over the course of the project compared to a traditional lump-sum loan.

Is Negative Arbitrage Always Bad?

While the term has a negative connotation, there are cases where accepting some negative arbitrage is a trade-off for certainty or flexibility. For instance, locking in funding ahead of an expected rate rise might protect against future interest cost spikes, even if it means a temporary negative arbitrage cost. The key is to quantify the cost and weigh it against the benefits of certainty, liquidity, and project timelines.

With 2025’s evolving financial landscape, negative arbitrage is a cost you can’t afford to ignore—whether you’re a business owner, property investor, or local government finance manager.