Australia’s big four banks Australia and New Zealand Banking Group (ASX: ANZ), Commonwealth Bank of Australia (ASX: CBA), National Australia Bank Ltd (ASX: NAB) and Westpac Banking Corp (ASX: WBC) are tipped to raise mortgage rates again in 2016.

The big four raised interest rates controversially last year – outside of the official moves by the Reserve Bank of Australia (RBA) – to recoup costs imposed by additional capital requirements.

Rising headwinds in the form of higher wholesale funding costs and fierce competition from smaller home loan lenders including AMP Limited (ASX: AMP) and Suncorp Group Ltd (ASX: SUN) is crimping banks’ margins – and they may have no choice but to raise mortgage rates.

That’s a double-edged sword though – with several smaller lenders offering mortgage rates as low as 3.69%, compared to the big four banks’ average variable home loan rate of 5.7%. Most big four bank mortgage customers will receive better rates than their advertised standard variable rates, but even a 1% discount means the big four banks’ interest rates are still well above their competitors.

Raising rates even further could see more of their customers switch to smaller lenders, leading to negative credit growth and even more pressure on their margins.

But the banks are stuck between a rock and a hard place. If they don’t raise interest rates, their margins will likely suffer and profit growth could evaporate. The problem is that with a large lending exposure to Australia’s property market, any other moves to raise margins, such as commercial banking rates or cut deposit interest rates is unlikely to have such a significant effect.

An additional issue is the prospect of the big four being forced to raise even more capital, which is likely to see share prices hammered and potential for dividends to be slashed.

The RBA might not be pleased, though. Two official rate cuts last year were designed to help the economy grow, but if the big four banks begin raising rates, the RBA could be forced to cut the cash rate below 2% in the hope the banks follow suit.

Foolish takeaway

Don’t be surprised if the big four raise their mortgage rates this year – whatever the RBA does with the official cash rate. Headwinds are rising for the big four – although it may not seem like it for retail investors obsessed with their fully franked dividends.

 

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Motley Fool writer/analyst Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.