Perspective needed on banks

AUSTRALIA'S major banks have copped a hammering over the past fortnight but it seems to me that the critics have very selective memories, both in the short term and long term.

The latest bout of bank bashing was triggered by the Commonwealth Bank's recent decision to lift its standard housing loan rate by 10 basis points, independent of any move by the Reserve Bank on official interest rates.

Treasurer Wayne Swan responded by labelling this a selfish decision, and went on to characterise the bank as almost unpatriotic.

"I think Australians rightly will be furious with the Commonwealth Bank for hindering the effort of the commonwealth government, the Reserve Bank and the community to support our economy during this global recession," he told reporters earlier this month.

Never mind that the Commonwealth Bank had been the market leader and was bringing its lending rate back into line with competitors. In fact, the bank's new housing loan rate is equal to, or lower than any of its major competitors.

The initial attack was followed by a spate of ignorant commentary that confused variable rate mortgages and fixed rate mortgages.

The former have traditionally been linked to movements in official interest rates whereas the latter are tied to term funding costs in the professional money market and have always fluctuated independently of Reserve Bank moves.

Against this backdrop, the Reserve Bank did the market a big favour by releasing earlier this month detailed research on the banks' funding costs; ie the amount they have to pay to attract everything from retail deposits to professional money market deposits.

The Reserve Bank found that, for much of the past decade, banks' funding costs have tended to move in line with the official cash rate.

As a result, the rates on variable-rate small business and household loans closely tracked the cash rate.

This has changed over the past year, as a result of the global financial turbulence.

While the cash rate remains a key influence on banks' funding costs, the cost of other funding sources have not fallen as much "due to an increase in term premia and credit and liquidity spreads".

How have the banks' responded to these changing conditions?

"Banks have cut variable housing loan rates more than the fall in their cost of funds, but reductions in business lending rates have been less," the Reserve Bank said.

In other words, homebuyers should be happy; small business customers not so.

"Overall, banks' net interest margins have risen a little recently, offsetting the fall that occurred in the early part of the financial crisis," the bank concluded.

It is instructive to look at longer-term trends in interest margins, which are the difference between average funding costs and average lending rates.

The four major banks - which account for about 75 per cent of total banking assets in Australia - have seen their net interest margin decline from about 3 per cent in the year 2000 to a low of 2.13 per cent last year, before rising to 2.27 per cent currently.

The banks were able to increase profits, despite this long-term decline in interest margins, by increasing their lending volumes and achieving greater economies of scale.

The banks' financial performance was also aided by prudent lending and investment activity.

That is the fundamental reason why Australia's banks came through the global financial crisis in remarkably good health compared to most of their counterparts overseas.

The government has put in place a contentious guarantee, which enables Australia's banks to borrow funds overseas, but otherwise Australian taxpayers have not had to fund the massive bailouts that occurred in many other countries.

Australia's banks are the envy of most banks - and finance ministers or treasurers - around the world.

Despite all of his bluster, Treasurer Wayne Swan knows there is little he can do, judging by the following exchange with Lateline host Tony Jones.

"And have you got any further options to use against banks which raise interest rates against the interests of the government and you say against the interests of the economy?"

"Well, what we can do is ensure that our system is operating in a competitive way."

Exactly, that is the key to better outcomes.