• 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

We could have more coronavirus outbreaks in tower blocks. Here's how lockdown should work

The recent lockdown of nine social housing towers in Melbourne’s north to contain the spread of COVID-19 led to widespread concerns for residents’ welfare.Among the concerns was that imple...

Thea van de Mortel, Professor, Nursing and Deputy Head (Learn & Teaching), School of Nursing and Midwifery, Griffith University - avatar Thea van de Mortel, Professor, Nursing and Deputy Head (Learn & Teaching), School of Nursing and Midwifery, Griffith University

7 Tips to Get Your New Website Indexed by Google Quickly

So, you have just launched a new website; congratulations!! But then soon enough, you are confronted with the challenge of your website or some pages not showing up on Google. The dream of every...

Media Release - avatar Media Release

Making it harder to import e-cigarettes is good news for our health, especially young people's

ShutterstockFrom next year, access to e-cigarettes and related products containing liquid nicotine will require a doctor’s prescription. This is to ensure liquid nicotine is handled like the poi...

Becky Freeman, Senior Research Fellow, University of Sydney - avatar Becky Freeman, Senior Research Fellow, University of Sydney

288 new coronavirus cases marks Victoria's worst day. And it will probably get worse before it gets better

Victoria has recorded 288 new COVID-19 cases since yesterday, the largest daily increase we’ve seen so far.This big jump must have the Victorian government and health authorities very concerned...

Adrian Esterman, Professor of Biostatistics, University of South Australia - avatar Adrian Esterman, Professor of Biostatistics, University of South Australia

Which face mask should I wear?

ShutterstockAustralia’s chief medical officer Paul Kelly today recommended people in Melbourne and the Mitchell Shire wear masks when leaving the house:[…] If people have symptoms and the...

Abrar Ahmad Chughtai, Epidemiologist, UNSW - avatar Abrar Ahmad Chughtai, Epidemiologist, UNSW

Rising coronavirus cases among Victorian health workers could threaten our pandemic response

ShutterstockOver the past week, we’ve seen a spike in the number of COVID-19 infections among health-care workers in Victoria.This includes a doctor at Melbourne’s St Vincent’s Hospi...

Rochelle Wynne, Director, Western Sydney Nursing & Midwifery Research Centre, Western Sydney University - avatar Rochelle Wynne, Director, Western Sydney Nursing & Midwifery Research Centre, Western Sydney University

3 Easy Demi-Glace Recipes

Demi-glace holds a very special place in the traditional cooking world. It’s a rich brown sauce used traditionally in French cuisine, and can be used by itself or as a base for other delectabl...

News Company - avatar News Company

Thinking about working from home long-term? 3 ways it could be good or bad for your health

ShutterstockThe coronavirus pandemic has forced many of us to work from home, often in less than ideal circumstances.Many employees had little choice in the decision, limited time to prepare, patchy t...

Carol T Kulik, Research Professor of Human Resource Management, University of South Australia - avatar Carol T Kulik, Research Professor of Human Resource Management, University of South Australia

why NZ's law lacks necessary detail to make a fully informed decision

Photographee.eu/ShutterstockWhen New Zealanders go to the polls in September, they will also be asked to vote in a referendum on assisted dying.Parliament already passed the End of Life Choice Act in ...

Rhona Winnington, Lecturer, Auckland University of Technology - avatar Rhona Winnington, Lecturer, Auckland University of Technology

News Company Media Core

Content & Technology Connecting Global Audiences

More Information - Less Opinion