Buoyant banks tread a fine line

It is sizing up to be another bumper year for Commonwealth Bank profit, with the third-quarter result putting it in pole position to meet, or even beat, market forecasts for cash earnings of $7.5 billion in the full year.

But the next few months could provide a tipping point for CBA and its fellow members of the "big four" club - it will be a decision about who gets to share in the spoils of what UBS calls the purple patch in the banking industry.

It comes down to a choice between shareholders and customers.

Commonwealth Bank has delivered a sufficiently strong result that consumers will start applying pressure for it to front up with out-of-cycle interest rate cuts. It was the fourth of the big retail banks to deliver its performance for the March period and it is abundantly clear that all are faring well despite the sluggish economy.

While there is historically low growth in loans in Australia, the banks are reaping the benefit of a very benign market for impaired loans and a decline in their cost of funding.

Since the Reserve Bank cut the cash rate this month some banks have hinted that they might give customers a little extra in rate cuts if they are affordable.

ANZ passed on a cut of 27 basis points after the RBA cut only 25 basis points. The other three matched the RBA.

CBA had $1.9 billion in cash earnings for the quarter, which is up on the $1.75 billion it made in the previous quarter.

It has been careful with costs and over the past year has avoided chasing unprofitable market share. However, in this latest quarter it gained a little share - which was probably a reflection of less aggressive competition from others in the market, particularly National Australia Bank.

CBA said its net interest margin - which reflects its funding costs against the amount it charges in interest - rose in the quarter, but the amount was not specified.

This was mainly due to not passing on the RBA's 2011 and 2012 rate reductions in full - and explains why the pressure will be on to give customers a bigger discount on rates.

The growth in deposits is now fully funding new lending, which takes the risk out of more volatile external funding sources. Having said that, wholesale funding has eased to its lowest point in five years.

Thus CBA can afford to reward its borrowers.

But what about shareholders? This voracious, dividend-yield-hungry market has been a boon for bank shares. The price-earnings multiples on which banking stocks are trading is heady, but still prices are being pushed up as demand for the fully franked dividend cannot be satisfied.

The banks would clearly love to reward shareholders, but reducing interest rates only crimps their margins and ultimately their profits.

They spent several years telling borrowers that their margins were under pressure because the global financial crisis had imposed a higher cost of funding on them.

Mortgage and small business borrowers wore the fact that the banks' costs had gone up. They also understand that these costs are coming down and they want to share in gains as well.

CBA does not get into speculation about its interest rate movements and a results announcement is not a trigger for interest rate changes.

The test will come for all the banks when the Reserve Bank makes its June call on whether to shift interest rates down again or to leave them alone. CBA is in the middle of the pack in terms of standard variable home loan rates - ANZ and NAB are at the competitive end and Westpac is charging hardest.

The argument for lowering rates further is to stimulate a home loan market still in the doldrums.

But there is no point in getting involved in a rate-cutting war. Indeed, this is just the game that the NAB is trying to get out of.

Thanks to the RBA's latest cut, the cost of borrowing is at historic lows. To entice borrowers beyond that point there needs to be some other factors at play - including positive sentiment and home loan affordability.