Will banks choose profit or customer popularity?

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Australian banks will soon decide whether or not to increase interest rates and choose between profits or popularity. Recently, the banks’ wholesale cost of borrowing funds has increased to a level that would cost the biggest ones up to an extra $500 million a year. The banks hope that the three-month bank bill rate will drop again.

If it does not, the banks could wear the higher costs that will reduce their profit or reduce the interest paid on deposits. They could also increase interest rates on customer loans and mortgages but all of these aren’t quite palatable.

The banks will likely wear the current margin squeeze for about a month before it reduces their profits too much. The pressure on profit has fallen their share prices last month. The question is which of the major banks will first increase rates in the middle of a royal commission?

Once one bank increases its rates, the others are expected to follow. The banks are suffering because of the royal commission, regulators, consumer groups, politicians and the media. The RBA has kept the official cash rate on hold again and might continue to do so until 2019. So banks could also lower deposit rates instead.

The laps of big U.S. technology companies may be to blame for the current spike in rates as they have been big buyers of corporate bonds issued by Australian banks as they are now allowed to repatriate profits instead of parking cash in offshore corporate bonds. It could also be because of the increase in U.S. interest rates which led investors to demand a higher rate when lending to big corporations and Australian banks hope this is just a temporary situation.

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Some are worried that the banks cannot afford any more negative sentiment. The royal commission has focused on responsible lending, particularly in car loans and mortgages. If this forces banks to increase their scrutiny of borrowers’ income or expenditure, there would be lower credit growth which could damage banks while credit tightening may lead to larger and sustained price falls.

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