There is little evidence to support denying the full benefit of an interest rate cut.
LAST weekend I got around to digging up my long-neglected veggie garden, and discovered why the silver birch tree is doing so well. The soil that once grew my veggies was permeated with new root growth, nourishing that beautiful big tree. Tough luck, I told the silver birch as I hacked them off: you'll still be a handsome tree without them.
Right now Australia needs a gardener to do something like that to our beautiful big banks. Since the global financial crisis more or less killed off their competitors, they have been spreading their roots into the soil that nourishes the rest of the economy. We want healthy banks but we do not want them sucking nutrients from the rest of the economy.
It's a matter of having the right balance. The banks will be healthier long term if they have healthy customers. But that balance has been lost and there is no good reason for the banks to worsen it by using their market power to take even more from their customers.
Today the Reserve Bank is expected to cut its cash rate by another 0.25 percentage points. It might not do so there are good arguments to cut, and good arguments to wait but most of the economy is clearly weak. More nutrient, such as lower interest rates, would help it survive, if not thrive.
But the big banks are flagging that they may hold back part of any rate cut from their customers. They point out, rightly, that the cash rate has little relevance to what it costs them to borrow money. And they say their costs have risen, so don't expect to see the Reserve's cut reflected in your mortgage rate.
Let's hear their case. The Australian Bankers' Association says 60 per cent of the banks' funding comes from bank deposits, 20 per cent from short-term bonds (less than a year) and 20 per cent from the long-term bond market. It is the last one that has risen: the extra cost of our banks borrowing long-term from the market rather than each other rose about half a percentage point in the second half of 2011.
The association's chief executive, Steven Munchenberg, pleads for understanding. "Banks do not underestimate the anger many borrowers will feel if all RBA rate cuts are not passed on," he says. "For these reasons, banks have been absorbing the higher costs of bank funding for over six months now, and have not passed these costs on to borrowers.
"But banks need to balance the interests of borrowers, on the one hand, with the interests of lenders, including retail depositors and superannuation funds, on the other. In globally uncertain times, Australia's banks need a clear signal to investors around the world that our banking system is solid and healthy. A vital sign of this is the profitability of our banks.
"If investors become concerned with Australia's strength, they will charge more for the money they lend our banks, compounding bank funding cost pressures. In the worst case, banks would not be able to raise enough money to meet demand, resulting in a credit squeeze."
Steve, you can rest easy. Shareholders may fret if the banks' profits stop growing: some of them seem to think bank profits should keep growing even if the economy goes bust. But Australia's bank profits are already in the stratosphere, whether compared with global banks or other service industries in Australia.
As the ratings agencies point out, the main risk to the ratings of Australian banks is their dependence on a property market widely seen as overvalued. If the banks hold back the full RBA rate cut, that would increase the longer-term risks they face, not reduce them.
But the biggest problem with the banks' case is that their main funding source is not the global market. Most of their funds come from ordinary Australians, through our bank deposits. And the rates the banks pay depositors have shrunk in recent months as the rival options, the share and property markets, slid sideways and downwards.
In the six months to last month, the Reserve Bank reports, the average rate the banks paid on term deposits fell from 4.5 to 4.2 per cent. The average rate paid on "special" deposits fell from 6 per cent to 5.35 per cent. The banks also cut the rates they paid on cash management accounts, bonus savings accounts, and online savings accounts.
Their funding costs have risen? Show us the evidence.
As Reserve deputy governor Ric Battellino pointed out in December, the banks in fact reduced their market borrowings in 2011 their deposits rose by more than their lending. It adds up to a very weak case for the banks to make off with the relief the Reserve wants to give to those who actually need it.
Why do the banks behave this way? Because they can. As the graph shows, since 2007 they have taken from mortgage customers the equivalent of five interest rate cuts. Some of that was necessary, especially in 2009. But there is now a good case for them to start handing it back to give customers bigger cuts than the RBA offers.
The worst victims of the banks' greed are small businesses. Since 2007, the margins banks charge them above the cash rate have shot up from 3.45 per cent to 6 per cent the equivalent of 10 interest rate cuts. Again, some of that was necessary, but it has become excessive and counterproductive.
Julia Gillard and Tony Abbott should unite to tell the banks: hand it back. A healthy garden needs more than four healthy trees.