.

  • Written by Kevin Davis, Professor of Finance, University of Melbourne
The prime minister says banks are "basically profiteering". It's a difficult case to make. Joel Carrett/AAP

The unwillingness of the major (and other) banks to immediately cut their headline mortgage rates by as much as the Reserve Bank cuts its cash rate always attracts bad press, as well as condemnation from treasurers and prime ministers.

After the big four passed to variable rate owner-occupiers only 0.13-0.15 percentage points of this month’s 0.25-point cut in the Reserve Bank cash rate, Treasurer Josh Frydenberg said they had decided to put profits “before their customers”, adding:

What we do expect the banks to do is to provide their customers with the best possible deal, and it’s very disappointing that they haven’t done that

Prime Minister Scott Morrison said the banks were “basically profiteering”:

How else do you describe it? I’ve never been one, whether as treasurer or prime minister, to give the banks a leave pass

Are the banks “profiteering”? Or are they right when they say their loan rates simply reflect their cost of funding?

‘Profiteering’ isn’t straightforward

My inquiries suggest that while there may indeed be some behaviour that could reasonably be described as profiteering, the banks’ complex funding arrangements explain much of their decisions not to pass on all of the past three interest rate cuts.

The cash rate is the rate for overnight lending between banks, and while it ultimately influences all interest rates, overnight lending and borrowing is a very small part of bank funding.

Most of the funds banks lend come from deposits and wholesale borrowings. They are typically provided for months or years rather than nights.


Read more: 0.75% is a record low, but don't think for a second the Reserve Bank has finished cutting the cash rate


The rates banks pay for these funds don’t necessarily change immediately or by the same amount as the cash rate. But even when they do, the average cost of funding for bank loans changes much more slowly because it also includes the cost of funding taken out at earlier rates, until that funding is replaced by new funding taken out at new rates.

So the banks’ argument that their funding costs don’t move with the cash rate has theoretical merit.

But how can we assess whether it is valid in practice?

The figures cast doubt on the “profiteering” claim

One way is to look at the behaviour of the net interest margin (NIM) of the banks. This is the difference between the amount of interest they earn on loans and other investments over and above the interest they pay on their funding, expressed as a percentage of their interest-earning assets.

If they are “profiteering” by not reducing loan rates in line with funding costs, the NIM should increase. Has this happened?

The figures suggest not – although they are not published frequently enough to give a definitive figure for developments over the past few months. Note also that there are always other factors influencing the NIM. A shift into higher risk-lending, for example, could be expected to see an increase in the NIM to reflect higher loan rates charged for greater risk.


Net interest margins of the big four

100 basis points = 1 percentage point. KPMG analysis from ANZ, CBA, NAB and WBC half yearly reports

But the figures aren’t conclusive

The net interest margins of the big four have fallen markedly since 2010 and appear to have plateaued.

But that needn’t mean home borrowers are getting better deals.

The banks might be widening their margins on highly profitable home loans while narrowing them on others.

And even small changes in net interest margins (the kind not easily seen on graphs) can generate large dollar sums of the sort the banks need to offset the seemingly ever-mounting costs of compensation and fines resulting from the banking royal commission.


Read more: Sam and the honest broker: why Commissioner Hayne wants mortgage brokers to charge fees


The difficulty of reaching a conclusion is compounded by the abundance of mortgage loan rates, such that it is the “headline” variable rate which attracts media and public attention, but which not all new borrowers pay.

Most banks offer significant discounts to new customers who are savvy enough to bargain and are good credit risks. There is not enough good contemporaneous information about what banks are charging these customers.

This isn’t to say that changes in the headline rate are unimportant. Headline rates are especially important because they apply to the mass of “back book” (existing) mortgage customers who are slow to rebargain or refinance.

Both headline and discounted rates matter

Changes in rates on the back book matter much more for bank profits than changes in rates on the front book (new borrowers). They adjust in line with the headline rate, the ones the politicians and bank critics notice.

Unfortunately for those existing borrowers, those rates move slowly because they depend on the banks’ past funding costs. They are funded from a mix of short term and other borrowings for terms of three months to several years.

Only as that existing funding matures and banks can refinance at lower rates can the average cost of their funds decline – and even then not generally by as much as the cash rate. Bank average funding costs are necessarily less variable than the cash rate, such that even over time after long lags we can’t necessarily expect their headline rates to track the cash rate.


Read more: Cutting interest rates is just the start. It's about to become much, much easier to borrow


Of course, it would be foolish to rule out the possibility that the major banks, all wearing costs as a result of the royal commission, are attempting to recoup some of those costs by a less than complete pass-through of their average funding costs.

If they are, the offerings of alternative mortgage providers with different funding models will be become relatively more attractive and there will be more in it for customers who switch.

Ultimately, it’s customer awareness and action that will inhibit bank “profiteering”, far more than jawboning by politicians and the media.

Kevin Davis, like most Australians with superannuation and a share portfolio, hold shares in Australian banks.

Authors: Kevin Davis, Professor of Finance, University of Melbourne

Read more http://theconversation.com/our-leaders-ought-to-know-better-failing-to-pass-on-the-full-rate-cut-neednt-mean-banks-are-profiteering-124874

Golf Polo Shirts - Dressing Etiquette While Playing Golf

Have you ever pondered as to why the game of Golf has a more formal look and feel than most other sports? The origin of the sport has a lot to do with the dress code. Yes, you may be already guessin...

News Company - avatar News Company

Albanese promises a 'productivity project' in an economic vision statement harking back to Hawke and Keating

Anthony Albanese puts a “productivity project” at the centre of his economic agenda in the second of his “vision statements”, which seeks to further distance him from the Short...

Michelle Grattan, Professorial Fellow, University of Canberra - avatar Michelle Grattan, Professorial Fellow, University of Canberra

Friday essay: George Eliot 200 years on - a scandalous life, a brilliant mind and a huge literary legacy

A portrait of George Eliot at 30 by Alexandre-Louis-François d'Albert-Durade. Her masterpiece Middlemarch is often claimed to be the greatest novel in the English language. Wikimedia CommonsMa...

Camilla Nelson, Associate Professor in Media, University of Notre Dame Australia - avatar Camilla Nelson, Associate Professor in Media, University of Notre Dame Australia

These young Muslim Australians want to meet Islamophobes and change their minds. And it's working

While most research participants believe in the power of contact, dialogue and exchange to transform negative attitudes. ShutterstockThe political influence of the far-right, along with a more salien...

Ihsan Yilmaz, Research Professor and Chair in Islamic Studies and Intercultural Dialogue, Deakin University - avatar Ihsan Yilmaz, Research Professor and Chair in Islamic Studies and Intercultural Dialogue, Deakin University

From Marie Kondo's tuning fork to vibrators for 'hysteria': a short, shaky history of curing with vibrations

Vibration devices have been used to treat everything from 'hysteria' to hair loss. So Marie Kondo's tuning forks and crystals are nothing new. from www.shutterstock.comYou might remember how Gwyneth P...

Philippa Martyr, Lecturer, Pharmacology, Women's Health, School of Biomedical Sciences, University of Western Australia - avatar Philippa Martyr, Lecturer, Pharmacology, Women's Health, School of Biomedical Sciences, University of Western Australia

Five ways parents can help their kids take risks – and why it’s good for them

Have real conversations with your kids about what they're doing, and the potential consequences of their actions. from shutterstock.comMany parents and educators agree children need to take risks. In ...

Linda Newman, Associate Professor, University of Newcastle - avatar Linda Newman, Associate Professor, University of Newcastle

Smoke haze hurts financial markets as well as the environment

Sydney is currently blanketed by smoke haze from severe bushfires that have burned through New South Wales. Air pollution levels on Thursday reached hazardous levels for the second time in a week. T...

Naomi Soderstrom, Professor of Accounting and Deputy Head of Department, University of Melbourne - avatar Naomi Soderstrom, Professor of Accounting and Deputy Head of Department, University of Melbourne

Vital Signs. Untaxing childcare is a bold idea that seems unfair, but might benefit us all

Win-win? No-one would be worse off under the UNSW proposal. Over time it should pay for itself ShutterstockAustralia’s system of childcare support is pretty good. It ensures high-quality care ...

Richard Holden, Professor of Economics, UNSW - avatar Richard Holden, Professor of Economics, UNSW

Curious Kids: why does wood crackle in a fire?

If you've ever put wet wood on to a fire, you may have noticed it makes a lot more noise than dry wood. Shutterstock Why does wood crackle in a fire? – Rocco, age 6 (nearly 7!) Hi Rocco, th...

Rachael Helene Nolan, Postdoctoral research fellow, Western Sydney University - avatar Rachael Helene Nolan, Postdoctoral research fellow, Western Sydney University

How 1 bright light in a bleak social housing policy landscape could shine more brightly

In the year since the Australian government created the National Housing Finance and Investment Corporation (NHFIC), its bond aggregator, AHBA, has raised funds for affordable housing providers, allo...

Julie Lawson, Honorary Associate Professor, Centre for Urban Research, RMIT University - avatar Julie Lawson, Honorary Associate Professor, Centre for Urban Research, RMIT University

Grattan on Friday: Scott Morrison will go into 2020 with a challenging cluster of policy loose ends

Scott Morrison’s government is heading to the end of 2019 amid a debate about its economic judgement and with a number of substantial policy moves started but not completed. Morrison this week ...

Michelle Grattan, Professorial Fellow, University of Canberra - avatar Michelle Grattan, Professorial Fellow, University of Canberra

Office Interior Design Trends for 2020

We are approaching the end of yet another year filled with a combination of pleasant memories and those less memorable. It is usually at this moment that we start reflecting on what we’ve done a...

Diana Smith - avatar Diana Smith

New report shows the world is awash with fossil fuels. It's time to cut off supply

Australia's coal production is expected to jump by 34% to 2030, undercutting our climate efforts. Nikki Short/AAPA new United Nations report shows the world’s major fossil fuel producing countri...

Peter Christoff, Associate Professor, School of Geography, University of Melbourne - avatar Peter Christoff, Associate Professor, School of Geography, University of Melbourne

Enough ambition (and hydrogen) could get Australia to 200% renewable energy

Hydrogen infrastructure in the right places is key to a cleaner, cheaper energy future. ARENAThe possibilities presented by hydrogen are the subject of excited discussion across the world – and ...

Scott Hamilton, Strategic Advisory Panel Member, Australian-German Energy Transition Hub, University of Melbourne - avatar Scott Hamilton, Strategic Advisory Panel Member, Australian-German Energy Transition Hub, University of Melbourne

Dramatic and engaging, new exhibition Linear celebrates the art in Indigenous science

Maree Clarke's Men in Mourning (2011). Vivien Anderson GalleryAboriginal and Torres Strait Islander readers are advised this article contains images and names of deceased people. Review: Linear, Powe...

Heidi Norman, Professor, Faculty of Arts and Social Sciences, University of Technology Sydney - avatar Heidi Norman, Professor, Faculty of Arts and Social Sciences, University of Technology Sydney

NZ remains unscathed by US-China trade war, but that's no reason for complacency

While tariffs have a direct impact on exporters in the US and China, third-party countries like New Zealand are more affected by non-tariff barriers. EPA/Aleksandar Plavevski, CC BY-NDDespite disrupti...

Hongzhi Gao, Associate professor, Victoria University of Wellington - avatar Hongzhi Gao, Associate professor, Victoria University of Wellington

The NDIS is changing. Here's what you need to know – and what problems remain

Improving the provision of NDIS plans is a good thing. But in some parts of Australia, having a plan doesn't always mean being able to access services. From shutterstock.comNational Disability Insuran...

Helen Dickinson, Professor, Public Service Research, UNSW - avatar Helen Dickinson, Professor, Public Service Research, UNSW

Why Australia can no longer avoid responsibility for its citizens held in Syria

Detention camps in Syria hold about 100,000 Syrian and foreign family members of IS suspects. Murtaja Lateef/EPAThe small number of Australians being held in prison camps in northern Syria has been...

Anthony Billingsley, Senior Lecturer, School of Social Sciences, UNSW - avatar Anthony Billingsley, Senior Lecturer, School of Social Sciences, UNSW

An American company will test your embryos for genetic defects. But designer babies aren't here just yet

No gene for cuteness has yet been identified -- but give it time. ShutterstockDesigner baby, anyone? A New Jersey startup company, Genomic Prediction, might be able to help you. Genomic Prediction cl...

Dennis McNevin, Professor of Forensic Genetics, University of Technology Sydney - avatar Dennis McNevin, Professor of Forensic Genetics, University of Technology Sydney

Sick and Tired of Your Dead End Job? Try Teaching!

Tired of the same old grind at the office? Want an opportunity to impact lives both in your community and around the world? Do you love to travel and have new experiences? Teaching English is the perfect job for you! All you need is a willingness to ...

News Company - avatar News Company

The Impact of an Aging Population in Australia

There’s an issue on the horizon that Australia needs to prepare for. The portion of elderly citizens that make up the country’s overall population is increasing, and we might not have the infrastructure in place to support this. Australians h...

News Company - avatar News Company

LifeStyle

5 Things to Do On Your Wedding Morning

After months of meticulous planning, wedding mornings usually find the bride excited but stressed ...

How to Make Your Girlfriend’s Birthday Extra Special

Your girlfriend’s birthday is your opportunity to show her how much you care. But how exactly do...

A Guide to Building Your Kid’s Confidence

As your child grows, confidence is key. Having low self-esteem as a child can have a detrimental e...

3 Hacks that Will Extend the Life of Your Hair Extensions

Everybody has the right to enjoy beautiful, long hair, including you! If you’ve always heard a...