Public scrutiny of the sector's shortcomings via the banking royal commission and a separate inquiry by the competition watchdog into mortgage pricing make it a particularly difficult moment for the banks to pass on higher costs to mortgage holders, especially in the absence of an RBA rate hike, experts say. That will force lenders to swallow the higher costs.

Pressure on banks

Those pressures were already apparent in the Bank of Queensland's half-year earnings update on Tuesday. BoQ flagged higher hedging costs could weigh on the bank's profitability in the second half of the financial year.

"It will become a headwind in the periods ahead if current bank bill rates are sustained," BoQ chief financial officer Anthony Rose told shareholders. "This could hit [net interest margins] by between five to seven basis points over the next two periods, with a drag of three basis points likely in the second half of 2018 if rates remain at current levels."

Bank of Queensland is more exposed to higher wholesale funding costs than its peers, but even so Mr Joshi estimated the potential hit on the major banks' interest margins could run to three to five basis points.

"In an environment where there are few tailwinds, it is material; it does start to hurt your earnings growth," Mr Joshi said.

Should funding costs remain high into the start of bank reporting season at the end of this month, then management will be obliged to factor that into their outlook statements


"The longer it [the BBSW] holds here, the greater the pressure on the banks," DNR Capital portfolio manager Jamie Nicol said. "It might pass, but when the market decides it's a structural headwind and it will stick, then you get the downgrades."

Rise in funding costs

The sharp moves in money markets have also claimed the Reserve Bank's attention. At its most recent meeting, the RBA discussed how "developments in US money markets had flowed through to higher short-term borrowing costs" in Australia. But the minutes, released Tuesday, suggested board members remained of the view that the recent spike in funding costs could prove transitory – a view that has largely appeared to reflect the consensus.

Jamie Nicol of DNR Capital believes the banks face downgrades if higher funding costs persist. Lisa Maree Williams

"Futures pricing suggested that these pressures in US money markets were expected to abate somewhat over the coming months," the minutes, released on Tuesday, said.

But in a note to clients, Westpac chief economist Bill Evans said the RBA minutes provide "no opinion on whether these tight conditions will be sustained and therefore offers no implications for the economy and monetary policy".

"We can only note that Australian companies which rely on BBSW pricing for their loans will have seen around a 25bps [basis points] increase in funding costs, while banks' funding costs for their mortgage books will also have increased," Mr Evans said.