KEY POINTS:
Discontent is growing among the business and farming communities about slow and small cuts in their bank overdraft rates despite a massive fall in the official cash rate (OCR).
Federated Farmers has accused the banks of profiteering, and this week Reserve Bank Governor Alan Bollard asked the banks nicely to pass on lower wholesale interest rates to their customers.
Both Federated Farmers and Bollard are right to point out that the banks have not passed on all the OCR cuts to business customers in particular. They are also right to say banks are increasing their profit margins from lending. Mortgage borrowers have fared much better, but business borrowers are understandably frustrated and angry.
Reserve Bank statistics show the combined profit margin on lending has risen from a record low of 1.63 per cent in January last year to a three-year high of 2.17 per cent in November.
This figure measures the difference between what it costs the banks for their money (funding costs) and what they receive in interest payments from their customers. This figure takes into account the total cost of funding, including cost of retail deposits, local wholesale deposits and foreign wholesale deposits.
The difference between how much business overdraft rates have fallen and how much the OCR and wholesale rates have fallen also appears to support the criticism that the banks are profiteering.
The weighted average base lending rate charged by the banks to businesses has fallen just 65 basis points to 13.25 per cent since July last year. Yet over that time the OCR was cut 325 basis points to 5 per cent and the 90-day bill rate fell 444 basis points to 4 per cent.
This means that less than a fifth of the cut in wholesale rates has been passed on to most businesses. No wonder the Reserve Bank Governor is concerned. His one tool to revive business investment appears to have been blunted by slow banks trying to hike their profits.
This accusation is less easy to level for mortgage rates. Reserve Bank figures show that since July the variable mortgage rate (a weighted average compiled from the banks) has fallen from 10.90 per cent to 8.05 per cent as at the end of December. This week they fell further to around 6.9 per cent. That implies the banks have passed on 400 basis points of the 475 basis points of OCR cuts since July.
But how do the banks answer the criticism on business rates?
They would argue they are simply adjusting their margins to reflect the greater risk of lending to businesses during the worst recession since at least the early 1990s. More businesses are likely to go bankrupt. Banks will have to make provisions for extra losses. Businesses are riskier than home owners because their profits are much more volatile than salaries.
There is also the difficult area of access to cheap funding. In the past our banks obtained around 30-40 per cent of their funding from overseas financial markets, which have been either shut down or have become prohibitively expensive.
Banks report having to pay 150 basis points or more above baseline wholesale rates to issue longer term bank bonds, even when they are government guaranteed.
It is debateable that banks are profiteering once their increased actual funding costs and the increased provisions for losses are taken into account.
However, Bollard and Federated Farmers are right to keep the pressure on. It would be disappointing to see businesses which have not taken on too much debt in recent years punished for the profligacy of consumers over the same period. Yet that appears to be what is happening.
* Bernard Hickey is the managing editor of www.interest.co.nz, a website for investors and borrowers wanting free and independent news and information about interest rates, banks, finance companies and the economy.
