Why CBA and Westpac were so quick to cut

Now that's something you don't see too often! Less than 24 hours after the Reserve Bank cut official interest rates the major banks were scrambling to pass the reduction through to home loan rates.

The big banks have always been quick to pass on rate increases and slow to move in the opposite direction. The alacrity with which Commonwealth Bank and Westpac moved is unusual, which may be a function of both the competitive and economic settings.

In cutting the cash rate to a historical low, the RBA was responding to an economy that is slowing at a greater rate than it had previously anticipated, as well as to the growing number of central banks now engaged in the global currency wars.

The last thing it would want as the commodities crunch continues to batter the terms of trade is for the interest rate differential to attract a deluge of carry trade capital that pushes up the Australian dollar.

The banks may, from a somewhat narrower perspective, be signalling their own concerns about the slowdown in the economy.

It says something telling (and disconcerting) that the cuts to their headline rates (28 basis points for Westpac, 25 basis points for CBA) have lowered their standard variable rate mortgages to their lowest levels since early 2009, in the immediate aftermath of the global financial crisis.

The problem confronting the major banks is their outlook. In recent years much of the momentum in their earnings that has under-pinned their extraordinary share price levels has been generated by a continual fall in bad and doubtful debt charges and cost-cutting.

Those forces, which are waning, have offset credit growth numbers that by historical standards have been quite modest. Lending for housing has been solid -- it is running at about 7 per cent annualised -- but that growth is less than half that which was generated pre-crisis. Business demand for credit has also picked up from negligible post-crisis levels, but is still running at less than 5 per cent.

Factor in a deteriorating economy and the outlook for volume growth to offset the declining impact of reducing bad debt charges and cost reductions isn't encouraging.

The other factor colouring the outlook for lending volumes (and the economy) is that neither households nor businesses have been using the windfall gains to household income of the historically low interest rates to go on spending or borrowing sprees. Instead they have been using it to deleverage.

Westpac said today that about 67 per cent of its customers are ahead in their mortgage payments.

The story is the same for the other banks. CBA, the biggest lender for housing, has around 75 per cent of its customers paying down their mortgages faster than required. NAB has had a similar experience to Westpac, while ANZ has about half its customer base reducing their mortgages faster than required.

Essentially, borrowers are maintaining their repayments even though their interest rates have fallen dramatically. While that's good for the customers, who are reducing their risk and increasing their equity, it's a mixed blessing for the banks. It does help reduce the risk in their home loan books, although that tends to be overstated, but it means their balance sheet footings are shrinking.

To maintain or increase their balance sheets and drive the volume growth to offset the fading momentum from lower bad debt charges and cost reductions they need to drive new lending.

There were some interesting trends in lending last year.

CBA and Westpac backed off a bit on mortgage lending, with the two biggest home loan providers growing their mortgage books at rates lower than the growth in the system. NAB grew its book at slightly more than the rate of system growth, as did ANZ.

In business lending, Westpac went on something of a spree, which is continuing. Its loans to businesses were growing at around twice the system's rate. While its peers picked up the rates of growth in their lending towards the end of the year, generating something of a tussle for new business loans, they all grew below the system's growth rate.

The relative appeal of business loans relative to housing loans ought to improve if the Murray inquiry recommendations on the majors' capital requirements for home loans are implemented, but in the current environment it is unlikely there is going to be a surge in new lending.

There is likely to be a battle for market share, with winners and losers, one made more intense by the determination of new NAB chief executive, Andrew Thorburn, to reassert NAB's former dominance of business lending.

The tightening environment, the gloomy outlook and the way households and businesses have been responding to rate cuts ought to mean that the banks will need to fight for whatever demand for new loans there might be. That might explain why CBA and Westpac, with by far the biggest exposures to the mortgage segment, were so quick off the mark today.