Forget pitchforks and flaming torches, banks won't pass on cuts

The angry mob, usually led by the Treasurer of the day, that gathers whenever one of this nation's banks does something wrong is soon to face a crisis of its own making.

Yep, it's difficult to feel any sympathy for the nation's banks. The next run of blockbuster films are surely going to feature Australian bankers as the black-hatted and black-hearted villains that would Cruella de Vil a run for her money.

But the way official interest rates are falling means the national economy may be about to answer that great philosophical question; what happens when an unstoppable force meets an immovable object?

The unstoppable force here is the fall in official interest rates.

At 1.25 per cent, the official cash rate has never been lower and Reserve Bank of Australia governor Philip Lowe has made it pretty clear it is going to keep on falling. The aim is to get the economy moving along at such a clip that the unemployment rate sinks somewhere south of 4.5 per cent.

Hence the headlines and TV bulletins with stories about it being such a great time to borrow and how the house market will stop falling.

Forgotten is the other side of the banking ledger. Those who have money in the bank, squeaking out a bit of interest (of which there are far more than those lining up for another $750,000 to buy their little piece over over-priced suburban paradise).

In the wake of the global financial crisis, Australian banks rediscovered the importance of deposits.

Interest rates on all deposit products rose as banks jostled to get extra customers through the door. From accounting for about 45 per cent of funding base of the big four banks, deposits went close to 65 per cent.

It made sense then and it continues to make sense. But it's pretty darn hard to offer enticing interest rates on deposits if the cost of money keeps falling.

Remember, banks survive by lending out cash at a rate slightly higher than what they pay their depositors.

So what happens when the Reserve Bank takes the official cost of money down to an all-time low? Well, as a bank you cut deposit rates.

Comparison website Mozo reckons the average rate on ongoing at-call savings accounts is now just 1.46 per cent.

All the major banks sliced their at-call rates by a quarter percentage point last week with none of them above 1 per cent. In real, inflation-adjusted terms, people are already losing money on these type of savings.

The Commonwealth Bank, the biggest holder of deposits, along with the NAB are offering just 0.3 per cent.

If you've got a lazy $50,000 or more on hand, you could put it in a term deposit. The best rate going for locking up your money for a year is 2.5 per cent.

In other words, you could earn the princely sum of $1250 (before tax) on your $50,000.

Through last week, rates on many term deposits quietly fell another 0.1 percentage point and they are going to keep on falling if official interest rates drop.

Of course, the large banks could slice their deposit rates to zero or even into negative territory.

So what would a rational customer do if their bank was offering nothing? Of course, they'd take their money out and look somewhere else. Great for them, but not so good for our major banks which would then have to cover that loss of custom by lifting rates on lenders.

That's why it's highly unlikely the majors will go to zero. But it also means that the chances of them passing on in full any further cuts in official interest rates is rapidly diminishing.

The angry mob brigade could argue that our highly profitable, molly-coddled and generally dodgy banking sector should just suck it up.

Of course, that's the same highly profitable and dodgy banking sector that pays the largest share of corporate income tax to Canberra and which pays out billions in dividends to shareholders (while boosting our superannuation accounts).

A pitchfork could be put up the nose of a banker in an effort to persuade them into cutting costs to help protect depositors. But "cutting costs" is just a euphemism for "cutting staff" or "cutting wages" which, given banks are large employers, would have an impact on the broader economy.

Given those sort of choices, will Treasurer Josh Frydenberg demand banks pass on in full the next round of rate cuts if it leads to banks offering zero deposit rates, or slashing their dividends, or cutting their staff or reducing how much tax they pay the federal government?

The angry mob might have to find a new target.