Report slams banks’ funding argument

New research claims the big four’s overall cost of funding is “very similar” to RBA’s cash rate.

The research provides fresh insight into the banks’ opaque funding and pricing.

The big banks’ attempts to justify holding back half the Reserve Bank’s rate cut have been dealt a blow after new research claimed their overall cost of funding was “very similar” to the cash rate.

Weighing into the heated debate surrounding the banks’ response to the RBA cut, analysts at investment bank Citi today warned clients the banks were battling to explain their re-pricing of mortgages, which saw them hold back around half the official 25 basis point reduction.

While claiming the banks’ profitability was their “Achilles’ heel” in the debate, analyst Craig Williams said attempts to explain they they are intermediaries passing on higher input costs to borrowers was “also not offering much strength to the argument”.

“While the major banks don’t fund their loan books with the RBA, their overall cost of funding is very similar to the RBA cash rate,” he said.

“This is because most (not all) debt securities and deposit products either automatically adjust or are hedged using interest rate derivatives against adverse interest rate movements.

“(And) while wholesale funding costs have risen in key observable markets, the impact has been limited so far.”

The research provides fresh insight into the banks’ opaque funding and pricing that the banks will soon have to explain after Prime Minister Malcolm Turnbull this month ordered the big four banks’ CEOs to appear at least annually before the House of Representatives standing committee on economics in the wake of the rates controversy.

Commonwealth Bank, Westpac, ANZ and National Australia Bank blamed rising funding costs, more onerous regulation and the need to satisfy shareholders, borrowers and depositors for holding back the rate cut and increasing a handful of term deposit products for new customers.

The banks also claimed mortgages were not directly priced off the official cash rate and they had to charge a margin for providing “maturity transformation”, or facilitating long-term loans for borrowers from short-term deposits.

But Mr Williams claimed the banks’ were struggling to win the debate and warned investors that the big four had relied to heavily on mortgage re-pricing in recent years “to solve the industry’s profitability challenges”.

“Our analysis shows the major banks face an increasing challenge in convincing the public of the need for continuing mortgage re-pricing given...profitability is still high by international standards,” he said.

“Group profitability has subsided since the GFC, but it has been mortgage customers that have had to bear the brunt of re-pricing to support falling bank profitability.

“(And) recent net interest margin and revenue growth pressures have been largely self-inflicted as successive mortgage re-pricing has increased the profitability for smaller providers. This, in turn, has intensified competition and asset spread compression, which has lowered bank return on equity, but has benefited borrowers.”

According to Citi, 65 per cent of the banks’ total funding is sourced from retail and business customers’ deposits. A further 15 per cent comes from short-term wholesale money markets with the remainder from the most expensive source -- long-term debt markets, primarily offshore.

Despite higher funding costs since the GFC, Citi claimed mortgage repricing had lifted the banks’ ROE from home loans from 15 per cent in 2007 to around 36 per cent. But this would fall to around 23 per cent following stricter “risk weighting” rules that recently increased mortgage capital requirements.