Banks rattle the rates cage

Having had a week to think about ANZ's bold move to distance itself from future Reserve Bank rate decisions, two of its peers have passed up the opportunity provided by their annual meetings this week to announce they would emulate it.

While Westpac hinted that it may not move in lock step with the RBA in future, and National Australia Bank referred to the rising cost of funds and the need to 'carefully balance' the needs of customers and shareholders, neither suggested they were about to put in place the kind of separate and independent rate-setting process ANZ has said it will establish.

Last week, in becoming the first of the major banks to pass on the full 25 basis point reduction in official rates, ANZ announced that in future it would review its pricing of loans to retail and small business customers on the second Friday of every month.

That's the first attempt by a major to formally de-link itself from the RBA's rate decisions. To be effective, and to illustrate the point that its cost of funds isn't determined by the RBA's decisions, ANZ will have to follow up by actually moving its rates independently.

To be truly effective and to get customers used to the concept that its cost of funds and their rates are continuously moving, it would need to move rates relatively routinely in both directions, probably in relatively small increments and without departing too significantly from the rest of the bank herd.

Tactically, initially its rivals should sit back and watch and wait to see whether ANZ has the courage to follow through on its convictions and, if it does, to gauge the customer and political response to movements outside the RBA cycle.

Rationally, however, unless ANZ is damaged by that response, while they may not wish to be seen to directly copy ANZ and certainly will want to avoid anything that might suggest collusion, they will eventually do something similar, perhaps less formally. Gail Kelly suggested Westpac may not be able to pass RBA rate cuts in full in future.

Cameron Clyne stopped short of that kind of statement, but did say that it was now costing NAB more to raise funding than it was charging borrowers for their mortgages. That is, of course, on the marginal dollars of new funds raised but is not a sustainable position longer term.

It is conceivable that one or more of the majors could essentially do informally what ANZ proposes to do formally and announce rate rises, or reductions, on an ad hoc basis and out of sync with the RBA's announcements.

The banks have found it impossible to convince Wayne Swan, let alone their critics or customers, that while the RBA can influence the absolute levels of rates – it can push the yield curve up or down by where it sets the cash rate – it can't dictate the spreads the market seeks above the risk-free rates and it is the spreads that dictate the actual cost of funds and banks' profitability. Banks are mainly margin businesses.

With the spreads on offshore wholesale funds blowing out, to the extent they are available (and term funding hasn't been for some time), and the larger part of its funding locked up in term debt and deposits, the near term impact of movements in official rates is even more muted and distanced from the aspects of their funding costs that matter to the banks.

Given that, despite lots of attempts to explain their funding and routinely inserting graphs that chart the movements in their spreads in their responses to RBA rate movements, they haven't been able to convince the public of their case, the only obvious way to make that case more dramatically and weaken the nexus over time is to act.

Beyond the obsession with the cost of home loans there is a bigger picture. Last year the majors – with the exception of NAB, which was on a lending surge because of the success of its 'Breaking Up' campaign – were able to fund the growth in their lending from the growth in their customer depositors. That lending growth was, however, weak and lending to businesses was particularly weak, with some business loan books actually shrinking.

Despite the growth in their deposit bases, which now account for more than 60 per cent of their funding, the banks will have to raise about $100 billion of new term funding next year at a time when, globally, governments, banks and corporates will be hitting the markets for trillions of dollars of refinancings.

To the extent they raise new term funding, they will inevitably face wider spreads. Alternatively, of course, they could limit their balance sheet growth – or shrink their balance sheet – by lending less.

Mortgage rates have, of course, fallen and are in any event at historically low levels. What's more important, the absolute cost of credit – whether the banks fully pass on RBA rate cuts or retain a few basis points – or its availability?

The other question, of course, is whether from a systemic stability perspective it is better to have banks that are solidly profitable or banks that are unprofitable.

In Europe bank customers and economic managers can only yearn for good access to reasonably-priced credit and a stable banking system. It could be a decade or more before they get them.