Sharply higher funding costs yesterday sparked a 2.4 per cent fall in Westpac shares, as market volatility in cash markets crunched the bank's profit margins, adding to pressure on Australia's biggest banks to raise mortgage rates.

Numerous small lenders have already moved to hit borrowers with rate rises, but the major banks that control 75 per cent of the $1.6 trillion mortgage market have not yet moved because of political pressure on the lenders arising from the revelations at the Royal Commission.

Westpac, the nation's second largest bank, said it's net interest margin fell 11 basis points in the quarter to the end of June compared with the preceding three months. 

The net interest margin is the difference between what the bank pays for funding and what it charges borrowers, and is the key measure of it's profitability.

Westpac attributed almost half of the net interest margin decline to rising funding costs, after the bank bill swap rate rose 24 basis points over the period from mid-2017 to mid-2018. Westpac also said its profits were hit by a poorer performance by its treasury division and falling sales of more lucrative interest-only loans. 

Westpac said the number borrowers falling behind on mortgage repayments rose slightly over the period, with regular delinquencies up three basis points to 0.72 per cent of mortgages and "unsecured" consumer borrowers more than three months behind up five basis points to 1.76 per cent. 

"Credit quality metrics remain near cyclical lows," Westpac said. The bank, which has the greatest number of investor borrowers and interest-only loans on its books, said interest-only loans made up 37 per cent of its portfolio at the end of June, down from 40 per cent three months earlier. 

Borrowers holding up to $240 billion in mortgage debt have been hit with higher interest rates, as banks push through rate rises on owner-occupiers and investors.

On top of this, higher funding costs are starting to leak through to the unregulated shadow banking sector, where many more loans worth tens of billions of dollars - often held by riskier "nonconforming" borrowers - are also facing dramatic rate increases.

Non-bank lenders, outside the scope of the Australian Prudential Regulation Authority's supervision, are forcing through rate rises as so-called warehousing finance costs skyrocket.

Along with Macquarie, other regulated lenders that have increased rates recently include AMP Bank, Bendigo Bank, Bank of Queensland, ING Direct, ME Bank, Suncorp and Citigroup, along with small lenders including Beyond Bank, Auswide Bank, MyState and QBank.

Borrowers who have bought loans from unregulated lenders such as Yellow Brick Road, Pepper Group, State Custodians, Homeloans and Loans.com, Resi Mortgage Corporation, Vow Financial and others are now facing rising mortgage repayments. 

Courtesy: Michael Roddan - AFR