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Banks are on a collision course with reality

The collective sigh of relief was almost audible across the various capital city mortgage belts during the week, with the news that ANZ was cutting its variable home loan interest rate by a whopping 0.34 percentage points, to a new low of 3.65 per cent.

Oh sure, there were conditions. It’s only for new loans, and you need to have at least 20 per cent deposit, as the loan can only be for a maximum 80% of the property’s value.

But still. On a $500,000 loan, over 30 years, that’s a saving of almost exactly $100 each month. (That assumes borrowers don’t just choose to borrow more, instead. That couldn’t happen, could it? But I digress…)

Putting that saving in a longer term context, it’s a saving of $35,000 over the life of the loan. Or, if you maintain the repayments at the higher level, you can cut two years off your loan… all on the bank’s dime.

The move, by ANZ, is widely considered — rightly — to be a drive for market share. And, by requiring a 20% deposit, the bank is able to both trumpet the cheapness of the loan while still doing its best to minimise risk — there’s plenty of equity there to protect its downside.

So we’re in for a period of lower rates and freer money? A path that’ll restore faith in faltering house prices? Crisis averted?

Not so fast on the former, I have no view on house prices, and only the permabears see a crisis (a variation of the same one, every time, as it happens).

ANZ’s rate cut is either brave, crazy brave or carefully calculated. To the extent it’s the later, ANZ is making hay while the sun shines (an awful and awfully apt metaphor in the current drought, and the way the farmers have been treated by some banks, as it happens).

Because even Blind Freddy can see what’s coming down the pike. Short of a local economic slump, the RBA is done cutting rates. The US Federal Reserve and the Bank of England, the respective central banks in those countries, are raising rates. And while our local retail banks are cutting deposit rates as fast as they dare, funding costs are only going one way.

Because our banks get a large minority of their funding from overseas. And if funding costs here are stable, or even slightly declining (thanks to term deposit rates being squeezed, as retirees know only too well), the increase in official cash rates overseas mean that banks are — and will be — paying more in interest.

So, unless bank shareholders are prepared to give their companies a free pass (and cop falling dividends), their CEOs have little choice. They’ll continue to cut costs, of course, but that’s a sideshow. In the face of rising funding costs, they’ll have to pass them on.

They do their best to hide, them, of course. The number and mix of loan products available these days is truly dizzying. Standard rates, discount rates, investor rates, small business rates, offset rates, first-home-buyer rates… the list goes on. Divide and conquer has long been a successful strategy, and the banks are past masters. Then there’s fees, charges, wraps, platforms…

And all in the service of one particular goal: the famed ‘net interest margin’ (NIM), which is the banks’ version of gross profit. If they’re going to keep shareholders happy (and keep their jobs) the bank bosses need to make sure the NIM doesn’t fall.

And as any good retailer knows, if your costs go up and you want to hold profits steady, you have to raise your prices. Of course, most retailers operate in fiercely competitive markets, where the opportunities for price increases are small, lest they lose business to the guy across the street.

Of course, our banking sector is fiercely competitive and the banks won’t be able to raise rates, right? Sorry, I couldn’t even type that with a straight face.

Foolish takeaway

Kudos to ANZ. It has scored a very valuable win in the PR stakes: it paints itself as an attractive place to get a low-cost home loan in the public’s mind, and I dare say will gain a good amount of business by doing so.

But in the event, it puts off the inevitable. Hopefully, for ANZ shareholders, the business it wins now will be kept once rates go up. But go up they will, and talk of lower rates will be shelved, perhaps for years, as overseas funding costs keep rising.

Let’s just hope borrowers pocket the savings, rather than succumbing to the temptation to borrow more. Because otherwise, when rates rise, they’ll find out just how friendly our banks can be.

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Motley Fool contributor Scott Phillips has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. 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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