A change in rhetoric required

The banks have done a bad job articulating why changes in official interest rates are a moderate and declining driver of their lending and deposit rates. It has opened then to criticism and derision which is not a good thing. Much of that criticism has come from Treasurer Wayne Swan and his shadow, Joe Hockey who would be well advised to change their rhetoric when it comes to future moves in official rates and changes in retail interest rates.

While it varies from bank to bank, the official cash rate would closely influence not much more than half of their funding. Banks get about 50% their funding from deposits, 40% from debt raising in capital markets both on and offshore and 10% from other odds and sods.

In recent times, term deposit interest rates have gone from being below the cash rate to well above it. That obviously increases funding costs or in other words, the cost of doing business. In the wholesale market, both on and offshore, global credit issues means banks have to pay a lot more - relative to the cash rate - for that funding as global investors judge such investments as increasingly risky. If we want our banks to remain profitable, it is only natural that the higher cost of opening the doors each morning at your local bank branch is passed through to customers.

While the banana milkshake analogy may have been poorly articulated a few years ago, no one seems to have the same outrage when the local barista hikes the price of coffee by 50c when a frost in Brazil raises the cost of inputs. Nor has there been the same yodelling when a hamburger price rises $1 because beef (and the off cuts) prices rise. And no one (that I am aware of) has praised the banks in recent years for offering deposit rates 150 basis points or more above the cash rate, reversing the practise of paying lower interest rates.

They also forget that the RBA is more or less targeting the mortgage rate and if for whatever reason those mortgage rates move higher against the RBA's preferred option, it would cut official rates. If mortgage rates fell due to lower funding costs, for example, the RBA would hold off cutting the official rate, knowing the banks were doing some of the work for them.

The tail is wagging the dog.

Mr Swan would be wise to stop bank bashing. He will not win any more arguments when the banks almost inevitably fail to match any future moves in the RBA cash rate. Credit conditions don't look like they will be easier any time soon. And Mr Swan should also remember that the banks holding margins to maintain profitability is free - it costs nothing to the budget and lessens the need for government guarantees for the banks. One only has to look at current debacle in the UK, US and much of Europe to see the consequences of government funded bank bailouts. It is depression like in its consequences. We do not want Australia to go anywhere near that.