Westpac defends NZ bank lending rates

Major banks' cuts in key mortgage rates have been criticised as too low to reflect the fall in the Reserve Bank's benchmark interest rate, but that was justified by higher funding costs, Westpac says.

In a select committee report this month, MPs lashed out at banks for failing to reduce mortgage rates, for protecting their profits, and, in the case of Australian institutions, for treating New Zealand firms differently.

Reserve Bank Governor Alan Bollard announced recently that the official cash rate (OCR) would stay at 2.5 per cent, after cutting it by 575 basis points since last July. Dr Bollard has also said banks had room to cut their lending rates.

Standard floating mortgage rates currently range between 5.99 per cent and 6.45 per cent, while two-year fixed rates range between 6.09 per cent and 6.50 per cent.

Key mortgage rates have lagged the fall in the OCR from its peak by between 140 basis points and 340 basis points since July 2007.

However, funding costs have lagged the OCR by an estimated 200 points, Westpac said, noting that the OCR was a benchmark for short-term lending but less relevant for long-term lending.

In Australia, banks' funding costs have lagged the cash rate's fall by just 95 points.

The Reserve Bank of Australia found that despite a small rise in funding costs, Australian banks modestly increased their margins in the last year in contrast with their New Zealand subsidiaries.

Westpac estimated that New Zealand's four major banks' return on assets fell from 1 per cent in 2008 to 0.85 per cent in the March 2009 quarter, compared with the international benchmark return of 1 per cent.

Pre-tax profits for banks' retail businesses fell an estimated 40 per cent in the year to March 2009, larger than a 17 per cent decline in total profits, Westpac chief economist Brendan O'Donovan said.

New Zealand banks are profitable, well-capitalised and have high credit ratings, but they are not well known internationally and fund in New Zealand dollars, which is a relatively minor currency with few natural overseas investors, said O'Donovan.

Before the credit crisis, the premium that New Zealand banks paid for short-term offshore funding was as little as 10 points above the expected OCR, rising to 50 points in August 2007 as the crisis hit and as high as 300 points in September 2008 after the Lehman Brothers bankruptcy in the United States.

"In recent months the premium has narrowed, but it remains well above pre-crisis levels," said O'Donovan.

Longer-term overseas funding tended to be 40 to 50 points above that sourced by Australian banks.

"Contrary to what some have claimed, the major banks draw very little funding from their Australian parent banks -- they are locally incorporated subsidiaries and operate at arms' length," he said.

Banks also sourced domestic wholesale funding, on-call deposits and term deposits for long-term lending needs.

Pushing up the cost of funding from deposits were government retail deposit guarantees introduced last year, which increased competition for deposits from finance companies.

In addition, the Reserve Bank wanted banks to reduce their vulnerability to a loss of access to international money markets, and will require them to draw more funding from stable, and expensive, sources such as retail deposits and long-term wholesale borrowing.

The Government has said it was concerned about the gap between interest rates and the OCR, but believed a more important objective was to promote stability and continued lending by the banks.

- NZPA