Rate cuts are on the horizon. Will it spell gloom for big banks?

Australia’s big four banks are expected to face a squeeze on profit margins this year, amid financial market bets that the Reserve Bank will respond to cooling inflation by cutting interest rates as many as three times in 2025.

Australian Bureau of Statistics figures released last week showed inflation has fallen to 2.4 per cent – its lowest level since March 2021. This has firmed up predictions, including from the major banks, that a rate cut is imminent – at the Reserve Bank’s next meeting in February.

The banking oligopoly could be under pressure from potential interest rate cuts in 2025.Credit: Ryan Stuart

Traders are pricing in an almost 95 per cent chance the central bank will slash the cash rate by 25 basis points on February 18, after its next two-day policy meeting. Market consensus has also suggested as many as three rate cuts this year, which could bring the current cash rate of 4.35 per cent down to 3.6 per cent.

“Banks traditionally do well when interest rates are higher; it theoretically means they’re earning more money,” said Jessica Amir, market strategist at trading platform moomoo.

But just as rising interest rates over the past three years boosted banks’ net interest margins (NIM) – a key measure of profitability that compares funding costs with what banks charge for loans – falling rates are expected to eat into bank margins.

NAB on Monday became the first big bank to cut fixed-interest mortgage rates, following challenger Macquarie, as the expectations of a Reserve Bank rate cut grow.

Experts predict a rate cut could reduce the NIMs of big banks by 4 to 5 basis points on average.

J.P. Morgan estimates ANZ and Westpac will be the hardest hit, with their margins projected to fall by 4.8 and 4.7 basis points respectively, before accounting for loan or deposit repricing offsets.

However, Morningstar equity analyst Nathan Zaia said banks could find ways to offset these impacts.

“If the banks pass on all reductions to home loans, third-term deposits and online savings accounts, then margins would probably be softened a little,” Zaia said. “But there are levers they can pull to offset the direct impact you would expect.

“There are many moving parts – sure [if there is a rate cut], then margins come down, but banks are pricing both sides of the balance sheet to make decent margins, so they’ll respond accordingly,” he said.

The likely pressure on margins comes amid ongoing debate about whether Australian banks are overvalued. Although year-on-year profits for the big four banks were down 5.7 per cent in 2024 due to margin pressures and increased costs, shares in Westpac surged 42 per cent, while Commonwealth Bank (up 39 per cent), NAB (up 26 per cent), and ANZ (up 20 per cent) similarly reached new heights.

Morgan Stanley said the banks’ outperformance was thanks to their haven status within the market, as investors shifted from the struggling materials sector and funnelled money into banks. This led to CBA overtaking mining giant BHP to become the biggest company on the Australian sharemarket in July.

A report by the investment bank said: “The major banks are expensive and current share prices are hard to justify based on their growth and return profiles”, which increases the risk of banks underperforming on the sharemarket this year.

Another factor inflating bank performances is major superannuation funds overcrowding the sector, with their stake in banks now almost 30 per cent, up 2 per cent from September 2023. This prompted the Reserve Bank to note that super funds’ investment decisions “have the potential to amplify shocks” in the financial system.

Richard Wiles, head of research at Morgan Stanley, said a combination of factors had “driven more money into superannuation”, and in turn, the banking sector.

“We’ve had strong population growth, a strong labour market, and last year we had an increase in the superannuation guarantee rate from 11 to 11.5 per cent,” he said.

With AAP

The Business Briefing newsletter delivers major stories, exclusive coverage and expert opinion. Sign up to get it every weekday morning.