Opinion: The fixed to floating switch has boosted NZ bank profits by over NZ$300 mln. Time to donate some back to NZ with rate cuts?

By Bernard Hickey

In the wake of the earthquake some bank economists have called on the Reserve Bank to cut the Official Cash Rate (OCR) to help revive an economy in crisis.

ANZ New Zealand, which owns both ANZ and National Bank, is New Zealand's biggest bank. Its economists have called for an emergency cut of up to 50 basis points to 2.5%. So has ASB's economists, who argued that inflation pressures were light and credit growth was weak. Westpac also sees a good chance of a cut on March 10 when the Reserve Bank releases its monetary policy statement, saying national confidence needs the boost. See more here from Alex Tarrant on bank economists calling for an OCR cut.

BNZ is the only bank to say a cut is not justified, saying it was a blunt instrument and other more targeted spending was needed.

The assumption, of course, is that the banks would pass on such an OCR to their customers, almost half of whom are now on floating rate mortgages and would see the benefit almost immediately.

However, there is the politically explosive risk that the banks would not pass on all of any cut in the OCR. In Australia last year the parents of these same banks added extra interest rate hikes to the one made by the Reserve Bank, sparking a political storm. It seems unthinkable that the banks would not pass on cuts in the OCR here after the earthquake.

So it's worth looking more closely at what has happened to the big banks' profit margins over the last year and how much 'fat' is in their accounts upon which to rely when deciding what to do when or if the OCR is cut.

It turns out the banks have quietly been lifting their profit margins over the last year by sitting still as the market has changed around them.

PricewaterhouseCoopers reported earlier this month that in the second half of the financial year to last September the big five banks (ASB, ANZ, BNZ, Westpac and Kiwibank) increased their net interest margin by 8 basis points on average or 9%. That doesn't sound like much, but it amounts to an extra NZ$300 million profit in six months to NZ$3.3 billion. This was largely possible because most of the banks customers are moving to floating mortgages, where profit margins are slightly higher, from fixed rate mortgages. See more here from Gareth Vaughan from the PwC report and the chances of tougher regulation to control bank profits.

This 8 basis point increase in New Zealand was actually higher than the 5 basis point increase seen for their parents in Australia over the same period.

The increase in the banks' profit margins have continued since the end of September. ANZ reported its New Zealand net interest margins rose a further 7 basis points in the December quarter. On lending of NZ$97 billion, that's an extra NZ$68 million in profit for New Zealand's largest bank inside 3 months. See more here in Gareth Vaughan's article on ANZ's net interest margin rise.

ASB reported its net interest margin rose by 40 basis points to 200 basis points in the year to December 31, again largely because of the shift from fixed to floating. Even Kiwibank reported its net interest margin rose 23 basis points to 142 basis points in the year to December 31, helping to increase net interest income by NZ$23 million. See more from Gareth Vaughan on ASB's profit growth.

To be fair to the banks, their fee incomes from transactions have fallen around NZ$165 million in the last year because of lower transaction volumes in a slower economy, but that's less than half of the increase from net interest margins.

But it's still worth asking why the banks have increased their profit margins when their customers are doing it much tougher and lending growth has stalled.

So one way for the banks to help boost the economy would be to give back the profit growth they have experienced over the last year, including Kiwibank. That might spark some activity and help stressed consumers.

A cut in their floating mortgage rates of around 10 basis points would do the trick.