The banks were right to hold back from passing on rate cuts in full

The RBA would have been aware of the banks’ intentions and perhaps even supportive of them. Reuters/Tim Wimborne

The predictable outrage at the major banks’ decision not to pass the full extent of the Reserve Bank’s cut to the cash rate to mortgage rates yesterday ignores the probability that the RBA would have been aware of the banks’ intentions and perhaps even supportive of them.

In keeping with Labor’s tradition of bashing the big banks, shadow Treasurer Chris Bowen criticised Scott Morrison for not standing up to the big banks. Instead of saying it was up to the banks to explain their actions, the Federal Treasurer could have said the broad thrust of their responses was desirable.

The four majors have passed on between 10 basis points (NAB) and 14 basis points (Westpac) of the RBA’s 25-basis-point cut to mortgage rates. They also, however, announced cuts to business loan rates and increases in their rates on term deposits ranging from about 50 basis points through to 85 basis points.

While there is a fixation among politicians and within the community more generally with housing and mortgage rates, there are plenty of others also affected by movements in interest rates.

While mortgages rates have been steadily falling to their lowest level in about 40 years, so have the rates on term deposits.

Borrowers, particularly established homeowners, have had massive windfalls in both the cost of servicing their mortgages and through the impact of lower rates on the value of their homes, while savers, particularly self-funded retirees or those relying on their savings to supplement their pensions, have been under increasing pressure.

With those with mortgages generally using the benefit of the lower rates to pay off their mortgages faster rather than increasing their discretionary spending, and those with savings seeing their income dwindling steadily, there’s no great benefit to the wider economy — and potential risks — from the obsession with lowering mortgages rates.

Passing on at least some of the RBA rate cut to savers and to business, particularly the SMEs that are so reliant on bank funding because they have no access to market-based debt, is a far more productive option than allowing the full benefit to flow through to mortgages.

With competition for the modest demand for business credit intensifying (due to a series of regulatory changes and “macro-prudential” measures that have made lending for housing relatively less attractive), the real impact on the pricing of business loans could be more material than the headline reductions, which were similar to those announced for home loans.

The RBA and the Australian Prudential Regulation Authority have been so concerned about the impact of low rates on the housing market and the inflation in prices that has occurred that last year that they resorted to macro-prudential measures to reduce the rate of growth in lending for investment properties and to strengthen the quality of lending for housing generally. The availability of finance for apartment developments and purchases to offshore buyers has also been tightened.

The RBA’s primary concern, even though it never says so explicitly, is the value of the Australian dollar (which remains stubbornly high because of the even lower interest rates that are in place elsewhere) during the post-mining boom transition still occurring within the domestic economy.

Re-igniting the housing boom wouldn’t be anywhere on its list of priorities.

In deciding to cut the cash rate again, the RBA, which maintains a constant dialogue with the major banks, would inevitably have expected them to retain at least some of the rate reduction.

As discussed yesterday (Why banks split the difference, August 2), around the world, bank profitability and the ability of banks to generate organic capital through their earnings is being squeezed by the low interest rate environment even as regulatory responses to the financial crisis require them to hold more low-returning liquidity and capital — and deposits. Low rates (in some cases negative rates) also reduce profitability via their impact on non-interest-bearing liabilities.

The European banks provide a glimpse of a potential future. Negative central banks rates, anaemic or worse economies and weak demand for credit are undermining their profitability and stability. The European bank indices are down nearly 35 per cent this year and 50 per cent over the past 12 months, so the conditions are punishing shareholders as well as depositors.

In this market, the banks — predominantly owned by Australian individuals and their super funds because of the high franked dividend yields — are experiencing low growth in demand for non-housing credit, a turning of the asset quality cycle, increased pressure on their net interest margins and continuing pressure from APRA to add to their core capital bases even after the $20 billion-plus the four majors raised from shareholders last year.

To the extent that they do retain a few basis points of the latest RBA cut, it might enable them to maintain their margins, or at least offset most of the compression, but the dispersion of most of the cut among mortgages, deposits and business customers means they aren’t going to be able to meaningfully increase them.

It isn’t automatic nor necessarily desirable that banks should always pass on the full extent of RBA rate movements to mortgages. In the current circumstances, the RBA would almost certainly not have expected them to, and it probably wouldn’t have wanted them to.