Bank margins and pass through

The RBA adjusts official interest rates knowing that some banks may not pass it on. And pass it on to whom is a difficult question - mortgages, small business, big business, credit cards, deposits? No one seems to report the fact or give two hoots that all banks are offering 3 to 12 month terms deposits 100 to 150 basis points above the cash rate. That windfall margin to savers does not attract the rage of Wayne Swan or Joe Hockey.

In any event, the interest rate cut yesterday will have one of two issues attached to it: If it is passed on in full, the RBA gets maximum bang for its buck and borrowers with variable loans will see an improvement in their cash flow; they will be encouraged to spend and borrow more; supporting growth and so on. Great.

If the banks pocket some of it - for arguments sake, 10 basis points and pass on only 15 basis points - the RBA will have given a bit to borrowers and a bit to the banks. Both benefit. When funding issues are becoming more acute as they are now, it may not be a bad thing for the banks to hold on to some of the cut. Frankly, it matters little if banks do or don't pass it on because it will be the behaviour of the economy which is determined by much much more than interest rates and bank margins that will determine future monetary policy moves. If banks don't pass any on, and the economy is weak, then the RBA will cut some more. Obviously.

And finally, it is a completely free way of supporting the banks. It costs nothing to do. There are no extensions of government guarantees, no quantitative easing requirements which screw up your bond and currency markets, no need for the government to write a cheque as the odds of a bank failure shorten. It's a free lunch.

The RBA cut hard during the GFC knowing banks needed support and most other major central banks are doing some form or other of the same policy right now. While key macro data will determine future changes in official interest rates, so too will the health of the banking sector, its access to money and the price it pays to get money to lend to you and me.

It's very simple.

Bank competition and efficiency in that sector is a different question that I might cover another day. Maybe.