Westpac defends bank industry

The Reserve Bank has accused major banks of not lowering their mortgage rates, despite changes to the OCR. Photo / Richard Robinson

The four big banks reported a return on assets of 1 per cent last year, which is the global benchmark. Westpac economists yesterday defended the banking industry against accusations it is insulating itself from the recession by marshalling data to support claims that funding costs remain high, net interest margins are narrowing and profits are falling.

Responding to criticism of the big four banks from the Reserve Bank, politicians and commentators for their muted pass-through of official cash rate cuts to borrowers, Westpac's chief economist Brendan O'Donovan and markets economist Michael Gordon said their commentary was "a detailed look at bank funding costs".

They said that while the average OCR fell by 440 basis points from the June 2008 quarter to the March 2009 quarter, funding costs were down just 240 basis points. The banks said their funding costs remained under pressure from still-high offshore wholesale rates and competition for domestic retail deposits.

The average rates for floating mortgages, which have been the focus of much of the criticism, fell by about 395 basis points over the same time. These numbers do not, however, capture April's 50 basis point cut to the OCR and much of the RBNZ's criticism has been about the lack of pass-through of that cut to variable-rate mortgages.

O'Donovan and Gordon noted that net interest margins, the difference between what banks earned and paid out in interest as a proportion of their assets, had on average fallen from 2.28 per cent in December 2007 to 2.17 per cent in December last year.

The pair then cited "timelier" monthly RBNZ information which showed an apparent increase in interest margins from below 2 per cent late last year to almost 3 per cent in March.

But Westpac pointed out that the data only included NZ dollar funding, and did not show the impact of hedging where banks used interest rate swaps to manage interest rate risk.

The RBNZ's aggressive cuts had resulted in large "revaluation liabilities" related to these instruments. Although banks' real net interest margins had narrowed, loan losses were rising and would continue to do so for some time.

In its last Financial Stability Report last month, the RBNZ had encouraged banks to increase their provisioning or cash they set aside to cover these losses.

"Since banks have not been able to claw back loan losses by increasing their lending margins, their profits have taken a hit," the Westpac commentary said.

The four big banks reported a return on assets of 1 per cent last year, which is the global benchmark for the industry, but is the lowest return they had enjoyed in at least eight years.

O'Donovan and Gordon estimated that pre-tax profits for the big four's core retail banking operations during the March year were down 40 per cent on the previous 12 months, a drop offset by higher profits for their institutional divisions.

Westpac's commentary came as ratings agency Moody's said the industry outlook for banking systems in Australia and New Zealand was negative, reflecting the impact of the slowdowns in global and domestic economies, "but both systems also remain robust".

Moody's Asia Pacific managing director Jerry Chien noted that while funding costs had risen as a result of the crisis and competition for deposits, "pre-provision bank margins are improving as the banks are better able to price for risk".