The big four's Mexican standoff

Now the RBA has changed the parameters again, the banks are eyeing margins, deposit loads, price promises and each other before they make their next move.

That awkward silence from the major banks in response to this week’s latest cut in official interest rates flows from the now usual cat and mouse games the big banks play around politically sensitive mortgage rates.

It would seem ANZ’s peers are waiting for ANZ, the only bank with a stated policy of reviewing its rates independently of the Reserve Bank, to reveal its hand tomorrow. This is one of those months when the ANZ review, held on the second Friday of each month, coincides with the Reserve Bank board’s meeting held on the first Tuesday of the month.

The majors’ response to last month’s 50 basis point reduction in the cash rate makes this set of mortgage decisions particularly interesting.

Last month the range of responses to the RBA decision was relatively wide, with Commonwealth passing through 40 basis points, Westpac and ANZ 37 basis points each and NAB 32 basis points.

That created a real convergence of the majors’ home loan rates, which are now grouped within a range of 6.99 per cent (NAB) to 7.09 per cent (Westpac).

NAB’s decision to retain 18 basis points last month and CBA’s decision to hold onto the least amount of the reduction means that NAB’s boast of offering the lowest headline mortgage rate was hung onto by the merest of margins. Its stand variable mortgage rate is only two basis points cheaper than CBA’s.

Given that it has re-stated that promise of offering the lowest rate until at least the end of this year, NAB, which has been growing its home loan book at above-system rates ever since it launched its ‘’Breaking Up’’ campaign – and having to fund that growth in an environment where funding costs have been pressuring margins -- could face even greater margin pressure if its peers decide to play hardball and pass on the full 25 basis points of the latest rate cut.

The banks will be tempted to keep at least some of the RBA reduction. Bank of Queensland, for instance, passed through 20 basis points and it would not be at all surprising if the majors’ moves were similar.

While the banks aren’t directly affected significantly by the turmoil in the eurozone and the costs of accessing wholesale debt markets there because they have been staying out of those markets, the competition for deposits as an alternate and less volatile source of funding has created its own cost pressures.

As the RBA’s rate cuts have pushed the yield curve down, the benefit of the 'free' customer deposits the banks hold in transaction accounts also reduces, adding to the margin squeeze that is occurring in an environment where lending rates are falling by more than funding costs.

It is the pressure on deposit pricing, and the opportunity cost created by the impact of a lower interest rate environment on their free deposits, that has forced the convergence of their lending rates. One of the majors can’t materially under-price its home loans relative to its peers without risking being uncompetitive on deposit pricing.

Interestingly, Westpac, which has been loudest in articulating its shift in strategy from a focus on lending volumes to deposit volumes, has had the most expensive home loan in the market for some time. That gives it an edge in competing for deposits, while using its regional brands to compete more directly on mortgage rates.

It would appear ANZ will provide the reference point for its peers, who will then cluster around it. For NAB to protect its claim to have the lowest priced mortgages it is going to have to out-wait the other three majors and go last. Westpac will remain the outlier, with the most expensive home loan rate.

Wayne Swan will grizzle if the banks hang onto even a few basis points of the RBA move but the losers from this rate cycle aren’t borrowers, who will tomorrow see home loan rates with a ‘’six’’ in front of them, but savers.

While the competition for deposits has pushed their cost up significantly relative to the cash rate, the downward shift in the entire yield curve means that in absolute terms the income generated from those savings has been diminishing steadily. They should be hoping the majors retain as much of the 25 basis points as possible.

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