Westpac’s first-quarter trading update provides a clearer and more contemporary insight into conditions in the banking sector, and economy, than yesterday’s Commonwealth Bank result. It also provides a better context for the recent round of small but controversial increases in mortgage rates.
Westpac’s earnings actually fell marginally in the December quarter, mainly because of a $200 million decline in markets related income.
The broader picture, however, was a flat-lining revenues – retail and business banking revenue was up only 1.3 per cent – and of increasing pressure on margins.
When National Australia Bank reported its first-quarter earnings earlier this month, it shocked the market (despite reporting an eight per cent increase in profit) by disclosing that its net interest margin had fallen nine basis points. CBA’s December half experience was similar – it lost 10 basis points of net interest margin between the June and December halves.
Today Westpac said its net interest margin, too, had narrowed by 10 basis points relative to the average of its third and fourth quarters last year although, stripped of the impact of the declines in treasury and markets income, the underlying margin compression was two basis points.
The problem for the banks has been well articulated by them, and the Reserve Bank, even if the politicians and big bank critics won’t accept it.
They are experiencing rising funding costs as all their sources of funds, including deposits, rise relative to the cash rate but with demand for credit from households and business so weak there is no volume growth to offset the margin squeeze. And the politics of home loans makes it difficult for them to fully pass on those increased costs to borrowers.
While wholesale borrowing costs spiked in January and have fallen back this month, they remain higher relative to the cash rate than they were for most of last year.
Westpac, like CBA, is experiencing very low levels of lending growth – only one per cent for the quarter – and essentially keeping its level of lending in line with its ability to fund it through growth in its deposits to limit its exposure to the volatile wholesale funding markets. Deposits grew by about $5 billion and 63 per cent of Westpac’s loans are now deposit-funded.
Along with its peers Westpac is holding a lot of liquidity and capital, with its tier-one capital adequacy ratio 9.8 per cent and its stable funding ratio 78 per cent providing solid insurance against the risk of contagion from another flare up in the eurozone or a deterioration in domestic conditions.
That conservatism, while necessary in the circumstances, does of course come at some cost. And if the current settings remain in place through this year, the banks’ critics may have opportunities to rail against out-of-cycle rate rises by the banks but the focus on "excessive" returns on equity might turn out to be misguided.