Banks under pressure to pass on rate cuts

Wholesale funding costs dropping

a woman

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Cheaper wholesale funding costs suggest the banks should be able to pass on any future cuts to the official cash rate in full.

Borrowing costs in wholesale markets are estimated to have fallen to about 70 basis points over the swap rate, compared to 190 basis points in June 2012, and 242 points in at its peak in October 2011, according to The Australian. The swap rate is the key benchmark investors use to price borrowings.

Last month, ANZ Bank (ASX: ANZ), Westpac Banking Corp (ASX: WBC), National Australia Bank (ASX: NAB) and Commonwealth Bank (ASX: CBA) all entered the wholesale market to take advantage of the cheap rates.

With central banks around the world flooding the market with cash and banks in struggling economies reducing their lending, wholesale market rates have been dropping.

Banks have usually cited wholesale funding costs as the primary reason for not passing on the full cut in official cash rates to consumers. RateCity estimates the banks have passed on 1.33% of the RBA’s 1.75% cuts to the cash rate since November 2011.

However, with deposits now making up around 60% of the banks’ funding, they could still struggle to pass on rate cuts in full. Competition for deposits has intensified after global debt markets dried up following the GFC, and deposit interest rates have jumped to around 2% higher than the cash rate. While debt markets have thawed, banks have come to rely on deposits as their major source of funding.

Analysts have suggested that deposit rates would need to fall, before the banks were in a position to pass on in full any future interest rate cuts by the RBA.

Foolish takeaway

The banks are likely to find themselves between a rock and a hard place, in an election year the pressure from politicians to pass on the full cut to consumers will be higher than normal, while trying to please retirees, many of whom rely on the interest income from deposits to survive. (Yet another reason for investors to consider high-yielding stocks).

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