The banking game has taken a surprise twist. This month big banks have more money to lend than they ever dreamed of, which is a hidden force behind the banking price war.

Why are banks flush with funds? First, last year they lifted deposit rates and attracted a lot of self-managed superannuation fund deposit money. Second, although the $130 billion required by banks from the overseas wholesale markets for the current financial year was high, they met their requirements.

Thirdly, with the Australian economic recovery the banks expected medium-sized business to come running through the bank manager’s door looking for loans. Instead, the borrowers are absent. There are many reasons. Some are nervous about the government or others, such as retailers, are frightened at their outlook given consumer nervousness; others were burnt so badly by banks during the global financial crisis that they are looking for other sources of money; still another group believe bank charges for business loans are too high.

For whatever reason, the borrowers are not coming through the door so the banks have more money than they need. Interestingly one area where there is demand comes from dwelling and dwelling land developers. Yet the banks are still pulling the rug under residential property developers and remain cautious about lending money for new developments.

The extra funding is also an ingredient (not the main one) in the banks’ mortgage price war.

Treasurer Wayne Swan might be under carbon tax pressure but he must smile every time he reads about the antics of the big four banks. Most analysts laughed at last year’s Swan banking measures but they were cleverly designed to make home mortgage banking a commodity product with much lower margins.

And they are achieving exactly that. NAB might have started the war but the CBA is taking the commoditisation trend a significant step further by making a lower cost commodity product available to all.

It’s important to remember that house financing is very lucrative for the banks because they are able to leverage their housing loans much more than, say, a small-to-medium business loan. As a result return on equity is high.

And Australia has enjoyed a magnificent housing boom, which has virtually eliminated significant bank debts in home mortgages.

The biggest beneficiary from the boom has been the CBA. Not surprisingly the CBA showed that when the NAB challenged it to retain market share. NAB will have to go one step further. In due course it will.

Westpac, which lead the bank deposit market with 8% 5-year deposit rates at the start of 2010, has cut its five-year rate from 7.2% to 6.8% over the past couple of months. Banks will want depositors to pay for their price wars.

*This originally appeared on Business Spectator.

Peter Fray

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