As Saul Eslake from ANZ bank points out, despite the current turbulence,
"Australian banks are still profitable and still adding to their capital and therefore to their capacity to lend. However, the Australian banking system has at least one point of vulnerability – we don't save enough in the form of bank deposits to finance all our loans. This means the banks rely on "wholesale funding" for the difference. This difference is reflected in Australia's large current account deficit that requires overseas borrowings by Australian banks to finance it."That overseas borrowing has become more expensive since the financial crisis began to unfold in August last year and dramatically so over the past two weeks as the crisis has deepened. This upward pressure on funding costs is the reason banks have raised their rates on top of the increases that were handed down by the Reserve Bank in recent months. If things continue as they are and the Reserve leaves its cash rate at the current 7 per cent, its quite concievable the retail banks would have to begin putting their rates up if they want to contine lending at their current levels. To leave their lending rates where they are would mean, in the short term, they would have to restrict their already reduced levels of lending. Either outcome would have catastrophic consequences for our economy as credit for business investment, housing and consumer goods either dried up or was priced beyond reach of most borrowers and crippled those already in debt.
However, this is not going to happen. The reason the RBA cut rates last month is because they see a slow down in the economy as potentially more damaging than any lingering threat of inflation that last caused it to raise rates back in March. Inflation will still be on the RBA's radar but the onset of recessionary conditions in the US and elsewhere globaly (New Zealand is already in a technical recession) will help to kill off any immediate inflation worries. We are already seeing markets forecast lower global demand in the falling price of oil. The reason the Australian Dollar has gone from US$0.96 to $US0.78 in just a few weeks is because of the expectation that commodities like coal and iron ore are going to be affected by lower global demand.
The Reserve will want to see retail interest rates continue to fall in an effort to stimulate a faltering economy and it will cut the official cash rate when its board meets next Tuesday. If they want to see retail banks pass the rate cut onto customers, then the cut will need to be a generous half of one per cent because the cut given to customers by the retail banks will definately be more modest.
(References: Saul Eslake, ANZ Bank. Cited in The Sydney Morning Herald, 30 September 2008)