The challenge came as Westpac and St George received approval for an $18 billion merger, which will create Australia's biggest bank.

Reserve Bank assistant governor Philip Lowe told a conference in Sydney that Australia's banks are "highly profitable by international standards" and are making double what they did five years ago.

Prime Minister Kevin Rudd backed up the Reserve Bank's assessment, saying that passing on interest rate cuts is the "right and reasonable thing" for the banks to do.

"If you are a bank generating significant profits … those banks owe it to working Australians who are under financial pressure that when official interest rates move that those moves should be passed on to consumers," Mr Rudd said in Perth.

Coincidentally the Commonwealth Bank yesterday announced a 7pc jump in profits to $4.48 billion - and refused to guarantee it would pass on rate cuts to customers.

Commonwealth Bank chief executive Ralph Norris would say only that the bank would "assess what our average cost of funds is" and then make a decision.

In a statement released earlier in the day, the bank said it expected volatility in global credit markets to continue to put upwards pressure on its funding costs - although the Reserve Bank said the cost of borrowing funds had already fallen.

Although profits were up, the Commonwealth's mortgage arm fell 5pc, wiping $279 million from its bottom line.

ACTU president Sharan Burrow said the banks have lifted their lending rates four times, independently of the Reserve this year, which she labelled "profit gouging", adding an extra $100 a fortnight to the typical mortgage repayment.

Westpac, meanwhile, when combined with St George, would have a market worth of about $62 billion, eclipsing the Commonwealth Bank's value of $58 billion and leaving National Australia a distant third at $43 billion.

Westpac would also become the nation's biggest mortgage lender.

Australian Competition and Consumer Commission chief Graeme Samuel said there are no significant concerns that the enlarged Westpac would dominate the market.

The Finance Sector Union, however, is warning that up to 5000 jobs could be lost from the merging of the two banks.

It has been lobbying against the merger.

The union estimates, the two banks employ about 38,000 people in total, of which more than 30,000 are in Australia.