Australia and New Zealand Banking Group (ASX: ANZ) – or ANZ to the rest of us – last week made good on its promise to break with tradition and review its interest rates on a timetable of its own choosing (the second Friday of each month) and by a measure that reflected the change in its overall cost of funding, not a merely as a function of the change in the RBA cash rate.
For many years, our banks have sweated on the Reserve Bank's interest rate decision – to increase, decrease or hold the official cash rate – and then played a cat and mouse game with each other, seeing who would move first and by how much, and then how the other banks would respond.
Ringing the interest rate bell
There was nothing official or necessary about this timetable, but years of immediate responses to changing rates created something of a Pavlovian response among banks, commentators and consumers. Our banks were happy to propagate (or at least allow to run unchallenged) the myth that their funding costs were linked inextricably – and wholly – to the cash rate.
It's true that the cash rate has a significant bearing on bank costs. However, the rate paid to depositors and the rates at which each bank borrows money from overseas are also significant factors. A change in one component (in this case the RBA cash rate) has no bearing on the others. In fact, the other costs are forever moving, as overseas lenders become more or less willing to lend money to our banks, and as consumer demand for deposit products waxes and wanes.
While it was easy to extrapolate the decision from the first Tuesday of each month to our mortgage rates, it was never (or at least not for many years) thus, in terms of bank funding costs.
Now or never?
So why are the banks making this move now? Clearly, they've been stung by the higher funding costs over the past couple of years, predominantly from overseas. At the same time, the RBA is probably only part-way through a rate-lowering phase (though who can forecast these things, as last Tuesday's decision showed), but overseas rates are probably already at a low point in the current cycle. With consumers (and our bank-bashing politicians) expecting banks to follow the RBA down, ANZ likely saw a range of only bad outcomes ranging from bad press to significant margin erosion over time.
Humans have notoriously short attention spans. My guess is that by putting 10 days between the RBA's decision and its own response, the ANZ figured it could more easily change its own rates in keeping with its cost changes.
The least popular paragraphs I'll write this year…
It has become fashionable to take a swing at our banks, given their billions of dollars in profit and planned staff cuts. I think the criticism is largely unfair – on a purely pragmatic basis I'd rather have a profitable, lower risk banking system rather than the risk-laden, growth-at-any-cost culture that developed in the United States and Europe in the first 7 or 8 years of this century.
If the cost of a stable economy (and remember, our unemployment rate still has a 5 in front of the decimal point, compared to the US at 8.3 per cent and the Euro area at 10.4 per cent) is a couple of extra dollars in bank profits, that's not an unreasonable price to pay, even if it does stick in the craw.
What does it mean for investors?
Investors in the banks should, on balance, be happy with the change (other banks seem content to follow ANZ's lead and tweak their rates accordingly). Being more able to move rates in line with true funding costs puts less pressure on margins in the short term, so should be a positive.
Any margin benefit is likely to be short-lived, however. While banking in Australia may be benefitting from a small number of sizeable competitors, and many have called their competition a 'phony war', NAB (ASX: NAB) has made a concerted pitch recently to 'break up with the other banks'.
The competition may not be as cut-throat here as elsewhere, but banking is not so unlike other industries in its competitive dynamics. When top-line growth is easy to come by, competition becomes less aggressive because profits come easily. However, as organic market growth stalls, banks are increasingly turning to market share gains to fuel bottom-line growth.
In that environment, I'm not sure our banks can deliver sustained profit growth to the extent that makes them likely to beat the market from here. I'm not prepared to write them off either – so for now I'm content to watch from the sidelines.
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Scott Phillips Is The Motley Fool's feature columnist. Scott doesn't own shares in any company mentioned in this article. You can follow him on Twitter @TMFGilla. The Motley Fool's purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.