Banks will not pass on rate cuts in full

The pressure is on from the property adoring press:

Experts expect the major banks to pass on most, if not all, of a one-quarter of a percentage point drop in the official cash rate to 1.25 per cent at Tuesday’s meeting, which financial markets estimate is an 86 per cent chance.

“They should pass it through,” said Jason Kururangi, a portfolio manager at Aberdeen Standard Investments. “I think that their licence to operate has probably come into question in the last few years.”

Lenders have already moved to slash fixed rates in the past two months, according to RateCity’s director of research, Sally Tindall. With 16.2 per cent of the market opting for locked-in rates, the lowest fixed rate is now 3.48 per cent for three years from Loans.com.au. “Variable is the big ticket item,” Ms Tindall said…

Yes it is. But brace for disappointment. ING just led off, via Banking Day:

ING last night confirmed that it will cut variable rates for new owner-occupiers, but appears to be backing away from extending relief to existing borrowers and new investors.

In an email sent to mortgage brokers last night, ING said it was lowering rates on principal and interest home loans to new owner-occupiers by 0.17 per cent from today.

While the repricing might be viewed by some commentators as the bank moving ahead of the RBA’s flagged official rate next week, the announcement is potentially controversial given that ING has not signalled it intends providing similar rate relief to borrowers glued to its A$50 billion back book.

Goldman neatly summarised the problem a few years ago:

…if the cash rate was to fall below 1.50%, every additional rate cut thereafter would shave about 5 bp off sector margins. The sensitivity of margins to falling rates accelerates once the cash rate falls below 1.50% because the various levers the banks have at their disposal become less flexible as the cash rate approaches zero and we would particularly highlight the following:

Our expectation is that term deposit (and cash management to a lesser degree) pricing will become quite sticky as the cash rate falls below 2.0%, as was the experience in the both the United Kingdom and Canada in 2008/09. This will particularly be the case as the domestic banking regulator, APRA, shifts its focus in 2016 towards the Net Stable Funding Ratio (NSFR), which is likely to place pressure on the banks to both term out and improve the quality of their funding (i.e. preference for deposits over wholesale). Furthermore, we note that the recent move out in funding costs has historically correlated with higher rates being paid by the banks on deposits (Exhibit 2).

We estimate that the replicating portfolio represents about a 5bp p.a. margin headwind for the banks over the next 2-3 years.

Once you can’t reprice deposits, which are 60% of funding, then you can’t reprice mortgages, either. Not unless you’ve got some Godawful volume boom and we don’t.

This will only get worse as we go lower. Expect banks to hold back some of all future rate cuts.

Eventually, this leads inevitably to RBA QE as it turns to crushing the spreads on the other 40% of bank funding costs in RMBS, covered bonds and wholesale debt.

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