Here's how much the tax on banks will crush their margins

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The biggest losers in the federal budget, Australia’s five largest banks, will likely see a profit erosion of 2.5% to 6% and a drop in return on equity from a levy on them aimed at raising $6.2 billion over four years and may elect to raise to mortgage rates to offset it.

Federal treasurer Scott Morrison on Tuesday unveiled a major bank levy, a six-basis point charge on the big banks’ liabilities. The tax starts from July 1 and will only affect five lenders with assessed liabilities of $100 billion: the ANZ, CBA, NAB, Westpac and Macquarie. Also, senior executives will be held to account at these lenders.

That earnings assessment from CLSA and Deutsche Bank analysts is based on assumptions that the lenders don’t increase mortgage rates. The lenders would need to raise rates by 14 basis points or more than half the usual 0.25 percentage point move to offset the levy, analysis by Goldman Sachs showed.

The Banks could increase owner occupied mortgage rates by 10 basis points and and investment property loans by 25 basis points, UBS analysts Jonathan Mott and Rachel Bentvelzen wrote in an investor note.

The banks, which have been subject to increased regulation ever since the global financial crisis, have so far limited the margin and returns impact of holding more capital and liquidity by repricing mortgages, which they did again last month.

This time around treasury officials think it will be different. They say that if the banks cut deposit rates or lift interest levels on home loans, smaller banks not paying the levy can step in and take market share, although the largest four banks already have an 80% market share in lending and deposits and have deeper pockets and access to global funding markets.

Passing on the levy may prove difficult given the competition commission will monitor mortgage pricing until mid 2018 and the lenders will need to explain movements in mortgage pricing, UBS said.

“It is a tax that will hit Australians by hurting investment and could have unintended consequences,” Anna Bligh, chief executive of the bank lobby group Australian Bankers Association said in a statement.

The tax will cut cash financial year 2018 earnings, which excludes one-time items, by 2.5% for Macquarie, 3.2% for CBA, 5.1% for Westpac, 5.2% for ANZ and by 5.9% for NAB, according to CLSA analysts Brian Johnson and Ed Henning. That would in turn chip away at the return on equity, a measure of how efficiently they reinvest shareholder funds.

“The release of the 2017-2018 Budget brings some pretty sobering news for the four Australian major banks plus Macquarie,” they said in an investor note. “Add in naming and shaming of naughty bank executives, and bigger breach fines and bank bashing is reaching a new high.”

This Table from CLSA sums up the impact

Deutsche Bank analysts Andrew Triggs and Anthony Hoo see the profit impact at 3% to 6%, assuming banks don’t increase interest rates and may eventually hurt dividends.

Speculation of the tax slashed more than $10 billion from the market valuation of the banks on Tuesday with CBA, the biggest of the four, leading losses.

The four major banks posted a combined underlying cash profit of $15.63 billion in the first six months of their financial years. This was an average rise of 6.25% in an increasingly competitive environment.

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