How will banks tackle the next rate cut?
While the major banks moved swiftly in response to the Reserve Bank of Australia’s decision to cut rates, the problem for the majors now is how to respond to the next potential 0.25 per cent rate cut, possibly as early as August.
It’s an issue that Morningstar bank analyst David Ellis tackles in his latest client note on the sector.
Although both the Commonwealth Bank and National Australia Bank passed on the full 0.25 per cent reduction in the cash rate, Westpac cut 0.20 per cent and ANZ 0.18 per cent – the latter drawing widespread criticism.
Ellis notes that short-term wholesale funding costs have fallen sharply – a view also shared by RBA governor Philip Lowe.
The Morningstar analyst estimates that the cuts to the variable home loan interest rates announced by the banks will put some pressure on margins despite t the banks benefiting from lower short-term funding costs.
Despite this pressure, Ellis said the move by the major banks to follow the RBA rate cuts was appropriate – particularly that the political pressures were “not worth the pain”.
However, going forward, Ellis does not see the banks making a similar move.
“Despite considerable political pressure, we think the major banks could – or should- only pass on about half of the next 0.25 per cent cut in the cash rate.
To support their margins, Ellis said banks will have to withhold most of the subsequent cash rate decreases.
“If the RBA was to implement one or more rate cuts during the next 12 months, there will be pressure on bank margins as lower interest rates on assets cannot be fully offset by lower rates on liabilities,” Ellis said.
“Some deposit account interest rates are already at or close to zero and cannot be lowered.”
Ellis also forecasts credit growth to continue to slide but the post-election rebound has been welcome.
According to RBA data, housing credit growth continues its downward slide with year-on-year growth of 3.9 per cent.
Owner-occupier growth was a solid 5.5 per cent offset by weak investor lending growth of just 0.6 per cent.
Business credit growth is around 4.5 per cent and personal credit growth negative – contracting 2.8 per cent for the year to April.
“We expect the decline in credit growth to continue for several months, but at a reduced pace, with some improvement starting in the December quarter 2019.”
Anecdotally, Ellis notes that the Coalition victory triggered a surge in home loan finance inquiries at banks and mortgage brokers.
If the RBA was to implement one or more rate cuts during the next 12 months, there will be pressure on bank margins as lower interest rates on assets cannot be fully offset by lower rates on liabilities
He sees the victory also as removing a “raft of potential negative political, structural and taxation concerns from the banking system and the housing market”.
Added to the “property-friendly political outcome”, Ellis acknowledges APRA’s move to change its mortgage serviceability benchmarks as another positive.
“Despite the post-election hype, the property market is still soft and tough lending underwriting standards continue to slow the flow of housing credit.
“It is too early to adjust our home loan credit growth forecasts for the major banks, and we will be watching future ABS housing finance approval data for early signs of a recovery in the home loan market.”
Nevertheless. Ellis is positive over the long-term outlook for the major banks and sees an upside to his forecasts if the housing market starts to recover sooner-than-expected.
“We are confident major bank management actions to restructure wealth management businesses, invest in technology, maintain loan quality, manage margins and improve productivity will deliver modest earnings growth, assuming demand for housing credit stages a good recovery.”