Will the banks choose to use their profit 'fat' to help the New Zealand economy cope with the European crisis over the next year?

That's the big question arising from the Reserve Bank's Monetary Policy Statement (MPS) today, which highlighted the risk that higher funding costs for the banks' foreign borrowings may push up retail interest rates.

The Reserve Bank seems willing to let the banks pass it on and even soften the blow by cutting the Official Cash Rate to compensate, leaving mortgage rates and retail deposit rates unchanged.

This is the key section in the MPS:


"Although New Zealand banks are currently well funded, bank funding costs are likely to increase to some degree over the coming year. This is likely to put some upward pressure on retail interest rates relative to the OCR. Monetary policy will need to take account of these pressures."

But why is the central bank helping the banks support their record high profits?

The Reserve Bank's own figures on the banks' net interest margins show they have increased by about 50 basis points over the last 18 months as borrowers have shifted from fixed rates to floating rates, which are more profitable for the banks.

Why don't the banks use some of that profit 'fat' to soak up the pain of higher international funding costs linked to the European Financial Crisis?

And why is the Reserve Bank enabling them to keep those profits high by further keeping the OCR low, or even cutting it? The Reserve Bank has already eased up on the banks by delaying a deadline for them to increase their Core Funding Ratios by a month.

This is shaping up as the main economic and political battle of the next year or two.

Will the banks support the New Zealand economy by using that profit fat to keep interest rates flat, in line with the Reserve Bank's OCR?

Who will force them to use that fat if the Reserve Bank won't?


A sneak preview of this battle is playing out across the Tasman where an official cash rate cut on Tuesday has yet to be passed on by the same four banks that dominate our banking market.

There's fat there for the banks to burn. They need to build up a sweat to help our economy.