Australian banks’ profit growth is likely to slow in 2018 as global monetary tightening pushes up funding costs, loan-impairment charges rise, and tighter regulation has an impact on business volumes and compliance costs. Fitch Ratings maintains its negative sector outlook to reflect these pressures.
Australian banks are more reliant on offshore wholesale funding than global peers, as the superannuation scheme has created a lack of domestic customer deposits. Global monetary tightening could therefore push up banks’ funding costs. That said, the impact is likely to be contained by banks’ hedging of foreign-currency borrowing back to Australian dollars, while only a portion of the wholesale funding is refinanced each year. Meanwhile, improved liquidity should mitigate the risks associated with dependence on wholesale funding.
Loan-impairment charges fell close to record lows in 2017, which is one reason why profit growth held up better than we had expected. However, impairment charges are likely to increase this year, with asset quality still being challenged in some sectors and regions. At the same time, write-backs from previously impaired assets are likely to fall. Implementation of the Australian equivalent of IFRS9 might also result in higher provisioning charges.
Despite the headwinds, the major Australian banks are likely to remain more profitable than most international peers, owing largely to dominant domestic market positions that give them strong pricing power.
The main risks to banks’ performance stem from high property prices and household debt. We forecast house prices to rise modestly this year. Moreover, the proactive approach by regulators to address household debt risks – such as a tightening of underwriting standards and restrictions on investment mortgages and interest-only loans – should offer some protection to banks’ asset quality in the event of a housing market downturn.
Nevertheless, Australian banks are more highly exposed to residential mortgages than international peers, while households could be sensitive to an eventual increase in interest rates or a rise in unemployment, given that their debt is nearly 200% of disposable income. A significant deterioration in asset quality in the mortgage sector could undermine bank profitability and weaken capitalisation, although this is not our base case.
