Big bank customers are predicted to face higher borrowing costs due to regulatory changes unveiled on Monday, but it is expected to happen gradually as lenders quietly tweak their mortgage pricing.

The Australian Prudential Regulation Authority on Monday unveiled measures that will make mortgage lending less profitable for the big four banks and Macquarie.

These giants of our financial system will be forced to set aside more capital – funds for absorbing losses – for every dollar they lend out in home loans.

Experts predict the banks will pass on some of this extra $12 billion cost to customers, especially those with home loans.

But rather than suddenly raising home loans interest rates, banks will tighten the screws gradually: removing a discount here, tweaking a deposit rate there.

Morningstar analyst David Ellis said that if the Reserve Bank cuts interest rates – something that is seen as possible but unlikely over the coming months – banks would recoup some of their higher capital costs by not passing on the reduction to borrowers in full.

This is what Westpac, National Australia Bank and Commonwealth Bank did in May.

If the RBA does not cut rates, Mr Ellis said banks would claw back the cost “quietly” such as by reducing mortgage discounts, rather than raising their advertised rates.

“You might not see it in the headline rates.. but I think discounts will be reduced and you will see it in deposit rates,” he said.

Credit Suisse analyst Jarrod Martin said the extra cost to the big four banks and Macquarie Group from Monday’s changes was equal to about a 20 basis point increase in mortgage rates.

However, he said the major banks were only likely to claw back “some” of this cost, not the full amount, as competition would restrict the big banks’ ability to push up prices.

“In order to claw back half of the impact on return on equity, you are looking at a 10 basis point increase in mortgage pricing,” he said. “There will be some competitive considerations – the regionals will not be impacted by this change.”

Westpac, which has previously warned that forcing banks to hold more capital may push up borrowing costs, also said that customers would feel some of the cost.

“While Westpac is well-placed to meet these changes, increased capital does come at a cost,” chief financial officer Peter King said in a statement to the Australian Securities Exchange.

“The cost of holding higher capital will inevitably be borne by customers and shareholders,” he said. More competition

The changes, which were recommended by last year’s financial system inquiry, are aimed at making the banking system safer and helping smaller lenders compete.

By tightening the financial models used by banks to asses risk, known as “risk weightings,” the regulator is ratcheting up banks’ capital requirements by about $12 billion by July 2016.

While banks have warned the extra costs may be passed on to borrowers, the change has been welcomed by smaller rivals, who argue it will level the playing field with the major banks.

The Customer-Owned Banking Association said the changes would allow smaller rivals to maintain pressure on the major banks.

“If the major banks seek to increase home loan interest rates in response to APRA’s new, fairer capital settings, customer-owned banking institutions look forward to taking market share from the major banks,” chief executive Mark Degotardi said.

Nonetheless, analysts said that given their dominant position in the market, it was likely banks would be able to pass on some of the extra cost to their customers.

Macquarie analyst Mike Wiblin said in a note that banks had a “clear mandate to reprice mortgages as funding costs rise due to the use of more (costly) equity to fund mortgages.”

Mr Wiblin said he believed banks would meet the target through a mixture of retained earnings and issuing share through the dividends.

Posted by Clancy Yeates – The Age on 20th July, 2015