Why the Big Four might struggle to explain holding back the rate cut

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As a former treasurer of Newcastle Permanent Building Society and current director of Police Bank, I know that despite the fact the CBA reported a $9.45 billion full year cash profit, it’s much harder to run a bank in Australia the lower RBA interest rates go.

That’s because at its core, a bank is an intermediary between borrowers and lenders.

Banks make money based on the spread between what they pay depositors and other lenders, and what they can charge borrowers for loans for housing and other retail purchases, alongside corporate and institutional lending.

But because the Australian economy runs a persistent current account deficit, the banks also have an intermediary role between offshore investors willing to lend money to Australia, and the national banking system and economy.

For building societies, credit unions, and mutual banks, the transaction is more straightforward – deposits often roughly equal loans.

But for the majors, and larger regional banks, the funding mix, which determines the cost of the funds they can lend to borrowers, is a blended rate which takes into account a number of different areas of funding.

There are a lot of moving parts and in their prudential Pillar III disclosure today, the CBA stepped out how it funds itself. The bank said its key funding tools include:

  • Its consumer retail funding base, which includes a wide range of retail transaction accounts, savings accounts, and term deposits for individual customers;
  • Its small business customer and institutional deposit base; and
  • Its wholesale international and domestic funding programs

But while there are a lot of words about wholesale, and the CBA has a lot of charts in its analyst presentation about the increased costs of wholesale funds, the actual mix of funding shows that 66% is domestic retail sourced.

Source: CBA Analysts Presentation ASX.com

This reliance on retail as the core of the major banks’ funding is something ANZ CEO Shayne Elliott relied upon yesterday when he was defending his bank’s decision not to pass on all the RBA’s cut in official rates to home owners.

“It’s interesting to note, we have five times as many depositors as we do borrowers,” Elliott said when releasing the bank’s quarterly update yesterday.

Ian Narev also focused on depositors in his analyst call after the results.

“People will be very interested in the interest rate decision,” Narev said.

“What we are going to say is that our very reason for being is to balance between the interests of people who want to give us money to save and people who want to borrow money from us and our shareholders who give use the capital we need to survive.”

But while the CBA reported a 2 point drop in the group net interest margin to 207 basis points across the entire book, the analyst presentation shows the margin in the CBA’s Retail Banking Services division – the one where the 66% of deposits and home loans sit – actually improved.

That is, the RBS margin increased from 269 basis points in the first half of FY 2016 to 273 points in the second half of FY 2016.

One of the factors which appears to be driving that increase in margin is that CBA is growing its transaction accounts “which includes non-interest bearing deposits”. That is, deposits from customers who hold money with the CBA but receive no, or marginal, interest has grown by $11 billion in the past year.

So while the costs of wholesale funding may be rising, the trouble with the banks’ attempts to refocus attention on their vast army of depositors is that so many of them receive little or no interest for their deposits.

But that’s actually why managing a bank in a low-interest rate environment is becoming so hard. It’s also why passing on the full extent of RBA rates cuts becomes problematic with rates so low.

Many deposit accounts are already attracting zero, or very low interest rates. They’ve been at this level for some time. So when the RBA cuts rates, the banks take a hit to the income they receive from their home loans but can’t necessarily reduce the expense they pay on a large swathe of their deposit base.

At the same time, new APRA prudential regulations about stable funding put a premium on term deposits and the longer term wholesale funding. Both of which are at the expensive end of the banking funding cost curve.

The CBA’s result suggest Ian Narev and his colleagues might face some hard questions and find it difficult to explain why they held back such a large portion of the RBA rate cut.

But as the many smaller and mutual banks who also held back some of the RBA’s rate cut last week showed, Australian banking is under NIM pressure with rates so low in the economy.


Greg McKenna has been working in banking and finance for 30 years. He has worked at Westpac and NAB, is a former Treasurer of Newcastle Permanent Building Society, and is currently director at Police Bank.

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