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Banks margins under pressure

Low interest rates are having a negative effect on bank margins, with ANZ Bank (ASX:ANZ) revealing that its net interest margin had fallen and was likely to narrow even further.

Net interest margin is a critical measure for banks, determining the difference between what it has to pay to borrow funds against what it charges on its loans. ANZ has reported that its net interest margin contract by 2 basis points in the June quarter, and was expected to fall by several more basis points during the September quarter.

ANZ management have blamed low interest rates for the majority of the contraction. As the Reserve Bank cuts official cash rates to historical lows of 2.5%, banks can cut their loan rates to remain competitive, but their funding costs may not come down, or down as much. Additionally, the banks can’t cut interest rates on deposit accounts that already have zero or very low interest rates.

Commonwealth Bank (ASX:CBA) on the other hand, said its net interest margin had improved over the six months to June, although it may have deteriorated since.

The fall in net interest margin for ANZ seemed to spook the market, with ANZ shares down 3.1% in mid-afternoon trading. All the banks are trading down, with National Australia Bank (ASX:NAB) and the Commonwealth  Bank losing 0.9%, while Westpac Banking Corporation (ASX:WBC) had slipped 0.6%.

Foolish takeaway

The big four banks aren’t bulletproof, despite what many investors may think. Highly leveraged, and exposed to the vagaries of the economy, a sudden downturn or rising unemployment could see their earnings hit hard – along with their share prices. More interest rate cuts could also be on the way, adding further downward pressure to their margins.

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Motley Fool writer/analyst Mike King doesn’t own shares in any companies mentioned.

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