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Bank profits at risk

The RBA’s decision to cut interest rates yesterday confirmed what the markets were expecting: the central bank is concerned over growth and unemployment.

When rates are cut, it puts our biggest lenders’ profits at risk for a number of reasons but most importantly it puts a squeeze on transaction and deposit accounts that return little interest to depositors. Unlike mortgage rates that can move up or down with the cash rate, deposit accounts that pay no or very little interest cannot, and this makes them unappealing to investors and drags on profits.

Banks also use surplus capital to invest in fixed-income investments like bonds, which suffer when interest rates are low. In the Sydney Morning Herald, Credit Suisse analyst Jarrod Martin said that, “Falling interest rates in general are negative for bank earnings”.

Banks will not only face competition for depositors, but Westpac’s (ASX: WBC) move to pass on 0.28 percentage points highlights the need to sign up new customers. Westpac needed to do something, as it has been losing market share for some time and another cut to its mortgage rate may even be necessary.

Another massive issue that could present itself to the banks is unemployment. If job losses continue, the government predicted the unemployment rate could jump to 6.25% this financial year. Although some analysts have played it down, job losses will put pressure on mortgage repayments and could lead to a rising number of bad loans.

Foolish takeaway

Commonwealth Bank (ASX: CBA), Westpac, NAB (ASX: NAB) and perhaps even ANZ (ASX: ANZ) could be lucrative investments for traders expecting the market to push up yield plays, but for serious long-term investors who buy and hold, ANZ is the only big four bank that is in this Fool’s portfolio. New investors looking to make a quick return from buying bank stocks should be very careful. After May’s rate cut we saw yield plays like bank stocks push to unsustainable levels then drop upwards of 15%.

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Motley Fool contributor Owen Raszkiewicz owns shares in ANZ. 

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