Why not all bank bashing is justified

Banks have always been an easy target and after the raft of misbehaviour and downright thievery that was uncovered by the Hayne Royal Commission, they have brought a lot of the condemnation upon themselves.

Politicians are particularly pleased to find a convenient whipping boy that is even less popular than they are, which is why the banks have endured a welter of criticism from all sides after failing to “pass on’’ in full the Reserve Bank’s cut in official interest rates.

Prime Minister Scott Morrison was quick out of the gates, saying: “They never learn. They honestly never learn and it’s disappointing.”

His Treasurer Josh Frydenberg was also in on the act, claiming that the banks were putting profits before customers.

That led to the inevitable retort from the Opposition leader Anthony Albanese, who said the Government needed to act and should not let the banks get away with it.

His suggestion – an increase in the levies charged to banks.

RBA is not a direct money wholesaler

All of these politicians and some of the more breathless critics of the big banks, should know that this concept of the banks “passing on’’ RBA cuts in a linear fashion has always been a myth.

The RBA is not a straightforward money wholesaler, passing cash to the banks that they can then add a margin to and lend to families and businesses.

To lend money, all of the banks first have to raise it and to do that they need deposits, which are their main source of loan funds.

To raise deposits, you need to offer attractive interest rates, something that is getting increasingly difficult to do when so many banks accounts are at or almost at zero interest and even term deposit rates are throwing off increasingly minimal interest.

One person I know who is always shopping around to get the best possible term deposit rate recently gave up when he realised the amount of money he would earn between the two term deposits was so tiny as to be not worth the bother of walking across the road to the other bank.

Dangerous environment for banks

This sort of environment is actually very difficult and dangerous for banks because balancing the needs of borrowers and depositors is measured in tiny differences such as 0.01%.

Already the banks are justifiably suffering a compression in their profits due to the large amount of customer remediation they need to pay for past misdeeds and the general economic environment of subdued borrowing and fickle depositors.

Traditionally bank profits fall in a falling interest rate environment – they make much better profits when rates are rising and there is more lending activity.

They are also coming out of an environment in which their bad loans fell to record lows, something that may not be the case for much longer as the economy worsens.

And they are investing heavily in risk, compliance and technology to meet competitive and regulatory pressures.

It is certainly not as simple as “passing on the rate cut in full’’ – given that passing on the rate cut in full to depositors would see many bank accounts offering no interest or even negative interest.

It is still important to offer some incentive to depositors to leave their money in the bank, otherwise lending really will be rationed.

None of this is to suggest that we should all be rattling tins to raise cash for the banks – they are big enough and ugly enough to look after themselves and over time there is little doubt they might get up to their dirty old high fees tricks if given half a chance.

Margins and profits are already contracting

It is rather to realise that bank profitability and their net interest margins (NIM) are contracting and look set to do so for some time as low rates persist.

The RBA itself pointed out this in its Financial Stability Report, saying that underlying bank profits have declined and aren’t expected to improve.

“Interest income growth has been limited amid slowing housing credit and a persistent narrowing in the NIM,” the RBA commented.

That narrowing of the net interest margin also points to the fact that competition between the banks and other financial institutions is actually working to reduce their profits and narrow the gap between where they borrow and lend.

This is a good thing for both us and them – the banks need to learn to live off leaner margins if they are to successfully compete with the new fintech entrants that are disrupting their business models and consumers need to be vigilant to get the best deal and ensure a strong and competitive market for financial products.

An unprofitable banking sector would be a real problem

However, there is one thing worse than a profitable banking sector should the world economy really turn sour – an unprofitable or barely profitable banking sector.

In times of real stress such as the GFC, having a solid banking sector that can raise capital from its shareholders and deposits from its customers is a really important factor in having the ability to keep going.

A weak and unprofitable banking sector would be a massive burden on everyone and significantly impede a recovery.

There are lots of justifiable reasons for giving the banks a good bashing – charging dead people for giving financial advice is one that sticks in the memory.

However, not passing on rate cuts “in full’’ as official rates approach zero is not one of those reasons and our political leaders should really know better.