From a trickle to a torrent

If the Reserve Bank board does as expected and cuts official interest rates again at its meeting next week the big banks are going to be presented with an opportunity to both do their duty and make a bit more money in the process.

Even before the Rudd government announced its guarantee of the liabilities of authorised deposit-taking institutions (ADIs), deposits were pouring into the banks. Even Bendigo and Adelaide Bank reported $2 billion of inflows in the September quarter, ahead of the guarantee, as frightened investors sought refuge within the banking system.

Since the guarantee was announced there has been a tidal wave of deposits surging toward the banks – the reason that more than $15 billion of investors' funds has been frozen within mortgage trusts.

There are suggestions that the rate of growth in deposits for the big banks since the guarantee was announced has significantly out-stripped growth in lending, which wouldn't be that surprising given the slowing economy and emerging risk-aversion within households and small and medium-sized enterprises that are starting to de-leverage.

The banks will be happy to take all the deposits they can. Even at the 6 per cent per annum interest rate attracted by large deposits, retail deposits are cheaper and are likely to be less volatile than borrowing short-term in wholesale markets offshore.

The banks were already highly liquid before the guarantee. St George, for instance, lifted its liquidity more than 37 per cent, to nearly 15 per cent of its total assets, in the year to September. They would now be drowning in liquidity.

While that's a positive in terms of balance sheet flexibility and a reduced reliance on wholesale markets in such a volatile environment, if the trend of higher deposit growth than loan growth were to be sustained for any length of time it would start to squeeze margins and profitability.

Unless. If the RBA does cut official rates again there is no doubt that the Government would expect the banks to pass on the full amount of the reduction to borrowers, and not just to those with home loans.

There are also suggestions that the government is putting pressure on the big banks to lower their deposit rates to open up a differential with smaller ADIs and non-banks in an attempt to reduce the exodus from non-guaranteed investments.

Whether creating a better risk premium in the non-ADI sector would have any impact or not is an open question.

At present it would appear that investors are far more concerned about the security of their capital than they are with the returns that capital might generate. The big banks could exploit that emphasis on security by lowering deposit rates by more than any reduction in official rates in the belief that it would only have a marginal impact on inflows.

In an environment where asset growth is modest, term funding remains expensive and bad and doubtful debts are rising, the ability of the banks to generate any earnings growth will depend heavily on their ability to offset the pressure on interest margins. The flood of retail deposits is helpful but lowering their cost would be even more so.

Thus, if they were to pass on a bigger reduction in rates to their liabilities than to their assets, they could both act in the perceived national interest while claiming a bit more margin and profit for their shareholders in the process. What good corporate citizens that would make them.