Who's the bravest of the big four?

One, two, three, four. I declare a bank war.

Well, a little one, anyway. A thumb war, if you will.

With the Reserve Bank widely tipped to keep its official cash rate on ice at 3 per cent today, focus has turned to whether one of the big four banks will seek a first mover advantage by being the first to chip 5 basis points or so off its standard variable rate.

Such a move would be unprecedented in our history – the first time a bank has taken it upon itself to voluntarily cut its standard variable rate out of step with the Reserve Bank. Of course, the path of increasing rates independently of the bank, or not passing on rate cuts in full, is well established. We just haven’t done it in reverse yet.

There has been a lot of wild talk lately about a vast easing in bank funding costs. UBS analyst Jonathan Mott put out an investment note last week which created quite the stir in banking circles by arguing: ''Banks are now making more money from originating a mortgage than any time previously.”

But opinions vary.

Other analysts say bank funding costs have stabilised at best. Longer term wholesale borrowing charges may have subsided in recent months, but they remain, of course, well above pre-GFC lows.

Meanwhile, with new Basel requirements for banks to hold a higher proportion of deposits, cash is king. Banks are offering higher term deposit rates to lure savers and this – a large slab of funding – is creating margin pressure.

Thirdly, the cost of short-term funding – set against the 90 day bank bill – has been benefiting from an expectation that rates will fall further from here. This has eased funding pressure on banks. Although CLSA banking analyst Brian Johnson warned me yesterday this could quickly change, as soon as today, if market expectations shifted to expecting no more rate cuts.

The theatrics of the political election cycle have a lot to do with it.

Punters hate seeing big banks raking in multi-billion dollar record profits. Yes, they are large companies, and yes you would therefore expect their profits to grow and hit new records each year, and be large in dollar terms.

But no, banks are not worth their high returns on equity of 15 per cent and above.

Banks are the plumbing of the financial system, essentially an infrastructure play. Utilities companies typically have returns on equity of 5 per cent or so.

Investment returns are supposed to reflect the risk return trade off – the higher the risk the higher the return. But which other sector can you think of that is essentially government guaranteed not to fail?

Already the Opposition has tapped into this anti-bank sentiment promising a 'son of Wallis' inquiry upon election. Banks will be hoping the Labor party doesn’t come to the party with policies that – unlike an inquiry – might actually affect their business.

UBS’s Mott sees banks coming under increased pressure this election year to cut mortgage lending rates. Johnson agrees that net interest margins are unlikely to rise in an election year, meaning that if funding costs ease, it is only a matter of time before banks are forced to come to the party with cuts.

The other reason to expect a discounting war – even a small one – is also intuitive.

It’s a pretty standard business strategy that when demand for your product falls, you may consider discounting its price.

Banks have been incredibly successful at passing on higher funding costs to customers, in their entirety. It speaks volumes about the level of competition in the banking sector that they have been able to do so. What other business is able to pass on higher costs dollar for dollar?

The strong arm of the big four banks has never been stronger.

But the ground has shifted beneath them.

Nobody but nobody wants mortgage debt at the moment. Growth in mortgage debt has slowed from a clip of 20 per cent plus during the mid noughties, to just 4.4 per cent on the Reserve Bank’s latest figures. Even in the wake of the early 1990s recession, housing credit growth did not dip between 10 per cent.

The great deleveraging is underway. Households are saving more of their income and using lower interest rates to pay off their mortgage faster. How much further this has to run is unclear. But it’s obviously one of the reasons why retail and housing construction have been slow to recover despite the Reserve Bank’s 1.75 percentage points of rate relief delivered in quick succession over the past year and a bit.

As old mortgages roll off the books, banks will need to replace them with new loans to maintain the same or increased levels of revenue.

The question is whether they accept some shrinkage as the natural product of a new era of lower credit growth and appetite for debt. Or whether they make a bold bid to rekindle in Australia’s lost love affair with mortgage debt.

Banks have already increased their discounts offered on their standard variable rates to new borrowers. If you do nothing else today, it’s worth a phone call to your bank manager to ask for a discount on your mortgage.

But nothing captures the headlines like a cut to the standard variable rate.

It’s just a question of which of the big four is most keen to make a splash.