Westpac's interest rate margins have slumped over the past few months, sending its share price sliding and putting pressure on the bank to lift home loan interest rates.

A bank's net interest margin (NIM) is the gap between what it pays to borrow money and the interest rates it is lending at, and is the main source of profits.

Westpac's NIM fell from 2.17 per cent in the first half of its financial year (October 1 to March 31) to 2.06 per cent in the most recent quarter to June 30.

Around half of this came from higher wholesale funding costs, 4 basis points from its internal financial operations (treasury) and 2 basis points due to people switching from higher-rate interest-only mortgages to lower-rate principal and interest loans.

The major banks have traditionally used their 80+ per cent mortgage market dominance to increase interest rates on their home loans to recover any decline in NIM.

However, UBS bank analyst Jonathan Mott wrote that the scale of the margin decline and the current anti-bank climate would make that difficult to do.

This would mean the falling NIM will hurt profits, leading Mr Mott to lower his earnings forecasts for the next two years by about 5 per cent.

Biggest margin hit since early 1990s

He believes it is the largest quarterly fall in Westpac's NIM since the early 1990s — a very different period from the present, when the bank was perilously close to collapse following the 1990s recession.

While the scale of the NIM decline is unusual, Mr Mott said it had been affecting all the major banks periodically as funding costs had fluctuated with global interest rates and market conditions.

"During these episodes they have repriced their variable rate mortgage books to pass on higher funding costs to customers," he said.

"However, given renewed competition for new mortgages, criticism from the royal commission, ACCC and Productivity Commission, and a challenging political environment, we believe this is less likely.

"As a result, we expect higher funding costs will need to be borne by shareholders."

Shareholders seemed to agree, with Westpac falling 1.7 per cent to $27.87 by 2:40pm (AEST), in contrast to gains for its main rivals — ANZ (0.1 per cent), NAB (0.5 per cent) and CBA (1.2 per cent).

Mr Mott further lowered his price target for the bank, from $26.50 to $26.

Westpac has underperformed the other major banks over the past few months.

Westpac has underperformed the other big banks over the past three months, falling back to where it was at the end of May. ( Supplied: Thomson Reuters )

The bank was hit hardest by revelations of poor mortgage-lending practices released as part of the first round of royal commission hearings earlier this year.

Westpac's latest update revealed another small, 3-basis-point rise in mortgage delinquencies to 0.72 per cent.

Westpac is also facing a lawsuit from the corporate regulator, ASIC, over an alleged failure to properly assess borrowers' expenses during the home-loan-approval processes.

Earlier this year, the bank moved to significantly tighten lending standards by more thoroughly assessing borrowers' expenses, among other changes.

The bank noted it had raised $31 billion in term wholesale funding with an average duration of six years, which the bank said largely fulfilled its full-year 2018 funding requirements.