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Why big bank stocks are caught between a rock and a hard place after Macquarie Group Ltd (ASX:MQG) lifted mortgage rates

Make no mistake Fools! The outlook on profitability for the big banks is getting worse, not better!

This probably explains why the share prices of the big banks are underperforming the market this morning as they face increasing pressure to lift mortgage rates after Macquarie Group Ltd (ASX: MQG) joined a host of second-tier lenders to increase rates on their loans.

Shares in Commonwealth Bank of Australia (ASX: CBA), Westpac Banking Corp (ASX: WBC), Australia and New Zealand Banking Group (ASX: ANZ) and National Australia Bank Ltd. (ASX: NAB) are trading between 0.1% and 0.6% lower at the time of writing when the S&P/ASX 200 (Index:^AXJO) (ASX: XJO) index is flat.

The big four are facing an increasingly hostile environment that could threaten their profitability as their boards remain nervous about passing on rising funding costs to customers at a time when the community is smarting from revelations of their predatory behaviour from the Banking Royal Commission.

This is preventing the big boys from raising mortgage rates for borrowers when Macquarie, AMP Limited (ASX: AMP) and other non-bank lenders have moved to increase their rates to protect their precious profit margin.

If the profit squeeze on the big four isn’t bad enough, their top-line is also under pressure as credit growth is slowing while the falling property market and record household debt could force them to increase their bad debt provisioning.

The banks had bolstered their profits by lowering the level of provisioning over the past several reporting seasons (including the most recent one in February), but I think they won’t get such a free-kick going forward.

What this means is that even if our property market doesn’t suffer a hard landing, bank profitability is likely to deteriorate over the next year or two.

However, the risks of a hard landing are actually building due to a potential credit crunch where there isn’t enough liquidity (loans) to meet demand.

While some experts have played down this risk due to the rise of non-bank lenders, UBS pointed out that these non-traditional and smaller lenders cannot fill the gap left by any retreat in the big four who control 80% of the mortgage market.

The fact that second-tier and non-bank lenders are lifting interests charged on their loans adds to UBS’ case, in my opinion.

A credit crunch will not only spark a meltdown for the banking and property sectors. It will also take down our market.

Despite the air of optimism on our market since the new financial year kicked off, equity investors will have to climb a much higher wall of worry in FY19 than they did last year.

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Motley Fool contributor Brendon Lau owns shares of Australia & New Zealand Banking Group Limited, Macquarie Group Limited, National Australia Bank Limited, and Westpac Banking. The Motley Fool Australia owns shares of National Australia Bank Limited. 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 Scott Phillips.

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