Why did profit-hungry banks act so quickly to cut interest rates?

“It’s become a lot harder for banks to dilly-dally and take time with their decisions,” he says.

Then there’s the state of the home loan market, in which banks are still competing quite hard to attract and retain customers. This level of competition probably also put a flame under the backsides of banks when deciding whether to cut their interest rates.

The rapid movements were also partly a reflection of the banks’ size. Australia’s banking sector has had some new smaller and digital banks enter the equation, but it’s still what’s called an “oligopoly”: a handful of businesses with control over rather large slices of the market.

They’re not supposed to be able to collude (for example, by all agreeing to move prices by the same amount) because our competition laws prohibit that. But as John Storey, head of Australian bank research at UBS, points out, the nearly simultaneous movement is indicative of a fairly cosy oligopoly, where once one business breaks from the pack, others tend to follow quite quickly.

In a more competitive market (with more banks), Storey says, it’s possible the banks would act more independently. They might be more incentivised to break further away from their peers by, for example, cutting their rates by a deeper amount.

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But in a market with only a few big competitors, each business closely watches the others, and their pricing decisions heavily influence the actions of competitors. A bank cutting its rates too much, for instance, might be met with retaliatory price cuts that just lead to lower profits for everyone.

As Morningstar banking analyst Nathan Zaia puts it, banks don’t want to unnecessarily drive down profit margins for the entire industry.

So, while there was pressure from consumers (and politicians) to pass on the full interest rate cut from the Reserve Bank, and all four banks quickly fell into line, there wasn’t as much incentive to slash rates any further.

There is bad news for savers. The banks will also almost certainly try to minimise lost profit by making similar cuts to interest rates on deposits. That means that although mortgage holders will be breathing a sigh of relief, savers will probably see a fall in interest they earn on their bank balances.

Finally, it’s worth understanding what exactly the “cash rate” targeted by the Reserve Bank is. It’s essentially the interest rate for banks borrowing from – and lending to – each other overnight. You might ask, what’s this mysterious nocturnal activity?

Basically, banks need enough cash every day to serve their customers – and a bit extra (called the “reserve requirement”) in case they suddenly face a wave of withdrawals they weren’t expecting. Depending on the amount of lending, depositing and withdrawing their customers do on any given day, banks might end up with more (or less) cash than they need.

So, at the end of every business day, the banks with more money than they need lend to banks facing a shortage. The Reserve Bank pushes banks to lend and borrow to each other at (or very close to) its cash rate target. How does it do this? By being a bank for the banks.

What seems like a dent to the banks’ profits, and a win for customers, was almost certainly a calculated decision by the banks.

Basically, the Reserve Bank can hold onto deposits from the banks (called “exchange settlement balances”). The interest rate that banks can earn on these deposits is a bit lower than the cash rate target. That makes banks a lot keener to lend to each other, rather than depositing their extra cash with the Reserve Bank.

Meanwhile, borrowing from the Reserve Bank costs banks a bit more than the cash rate. So any banks needing money are much keener to borrow from their banking peers, which, remember, would rather lend their money out than leave it with the Reserve Bank.

By putting these parameters into place, the Reserve Bank basically creates a narrow “corridor” around the cash rate that determines the cost of banks moving their money around. These costs are then typically passed on to consumers. A lower cash rate for banks usually means lower interest rates for consumers, and vice versa.

The rapid response from the banks this week is certainly no promise of what we’ll see following future Reserve Bank decisions. What seems like a dent to the banks’ profits, and a win for customers, was almost certainly a calculated decision by the banks. They just weighed up the political, social and economic costs of dilly-dallying.