Last Tuesday, the RBA decided once again to cut interest rates. From 1.75% to 1.50%, a historic low for Australia.
The RBA gave several reasons for their decision. A lower than expected inflation, which in June came at a low 1%, much lower than the expected 2–3%. Warnings of a slowdown in China. The unemployment market. You name it.
Bottom line, they are cutting interest rates because the economy is not doing well.
The RBA is hoping that this move will place a downward pressure on the Aussie dollar, and spur activity in a slowing economy.
But as rates go lower, bank profit margins are getting squeezed.
After the last rate cut in May, most banks passed on the full cut to their customers.
Not this time.
This time banks have refused to pass the full cut on. Instead, they are holding back some of if to shield their bulky margins.
As debt gets cheaper, their basic business is being squeezed. That is, borrowing money and then lending it at a higher price. And as margins get lower, banks will need to find other sources of profits.
‘That’s what’s happening: they have to reprice. It’s not like they’re repricing to expand their profit margins; they’re repricing to keep their net interest margins stable,’ said Andrew Martin, a fund manager at Alphinity Investment Management during an interview with The Australian.
How long until rate cuts get too low and the big four are forced to decrease their profits? 1%? 0%?
Further rate cuts will cut into their profitability even farther. We could soon see a hike in bank fees, much like we’re seeing in Europe.
Low and negative rates in Europe have seen a decline in bank earnings.
Many European banks have taken a new strategy to combat low profitability. More commissions to counteract the low interest rates. That is, from your pocket right into theirs.
Before, with higher rates, European banks could afford to provide some services at no charge. Now it seems that they are charging for everything.
Don’t get me wrong, fees have always been part of the banking industry. But fees have been climbing as interest rates have been decreasing.
And increasing bank fees is a profitable practice. Banks in Spain are taking 20 billion Euros a year in charges. Fees now make up 30% of their profits.
In Australia we are already seeing an increase of bank fees. In 2015, banking fee income increased by 3.5%. Around $12.5 billion.
The largest source of fee income from households was credit cards. Another significant source is charges on small business customers.
Fees are still below the 2009 high. But, as interest rates and profits lower, we may see more increases.
After all, aren’t banks are in the business of making money?
For The Daily Reckoning
PS: Selva recently joined the Port Phillip Publishing team as our macroeconomic analyst. She works closely with The Daily Reckoning editor Vern Gowdie on his advisory service,The Gowdie Letter.