Earnings prospects for Australian banks are stable and supported by a favourable interest rate outlook

An unquestionably strong banking industry

It can be argued that Australian banks are the most resilient in the world. The underlying tenet supporting this assertion is that Australia’s four major banks are the best capitalised major financial institutions globally. Regulatory capital is the cornerstone of depositor protection, and Australia’s four major banks, based on their Common Equity Tier 1 (CET 1) ratio, are capitalised at an average of 12 percent. This capital adequacy ratio is above internationally accepted capital ratios for major banks and comfortably above the prescribed minimum regulatory requirements established by the international Basel III Accord. In short, Australia’s four major banks maintain sufficient capital buffers to continue providing critical functions within the economy such as housing and SME loans and credit card payment services during periods of financial distress and even catastrophe.

It has been said that the world is a global village, and this is especially the case in the banking industry where capital markets are interconnected 24/7/365. In other words, money never sleeps! Investor anxiety is quickly transmitted around the globe during times of widespread financial distress or economic uncertainty. This is often the case despite overseas problems and issues not necessarily related to Australia and where ‘Information’ and misinformation can rapidly spread through social media. App-based banking allows entire balances to be instantly transferred away from a bank at the click of a button and so well-capitalised Australian banks are the defence against this type of customer behaviour.

Importantly, maintaining the capital ratio above their international peers explains the relative attractiveness of Australian banks to global investors. Around 20 percent of the total funding requirements of Australian banks are met by overseas investors.

The prosperity of Australian banks is assured

The Australian Prudential Regulatory Authority (APRA) is responsible for the prudential supervision of Australian banks and maintains the regulatory architecture that keeps Australian depositors and international financiers at ease.

One way it achieves this outcome is to prescribe and maintain a banking regulatory system that has different and often more stringent prudential standards and requirements than many peer jurisdictions.

It has been stated that as a relatively small nation as measured in terms of global GDP and given Australian banks’ concentration risk in residential mortgage lending, that Australia’s major banks should maintain higher capital adequacy ratios than their global peers. Australia has gone beyond the Basel III global banking regulatory and prudential requirements in prescribing higher levels of regulatory capital reflecting such concentration risk. Examples where APRA imposes other more stringent prudential standards on Australian banks compared to overseas jurisdictions include:

• A narrower range of “high-quality liquid assets” (HQLA) when determining the Liquidity Coverage Ratio, ensuring banks can manage 30 days of higher-than-usual deposit outflows. Furthermore, corporate bonds and residential mortgage-backed securities (RMBS), which in times of financial distress, may not be readily liquidated or sold, are excluded from the HQLA calculation. This strengthens the quality of Australian bank liquidity. Furthermore, RMBS and corporate bonds are valued at market prices and must be hedged.
• Unique to Australian banks is the requirement to hold extra capital to protect depositors from “interest rate risk in the banking book”. Australia is the only jurisdiction in the world that mandates large banks carry capital to address the risk of rising interest rates as part of their core capital requirements.

These self-imposed regulatory initiatives make it easier for Australia’s big four banks to attract deposits, especially from offshore investors, at times of capital market volatility. In making Australia’s four major banks more attractive to overseas investors, APRA is also assuring Australian bank depositors of the soundness of their bank deposits which maintains depositor confidence and underpins the ongoing prosperity of Australian banks given their privileged position within Australia’s financial system.

Maintaining a capital adequacy ratio above minimum prescribed prudential standards that enhance depositor protection also provides Australian bank shareholders with the benefit of receiving dependable and consistent dividends. This is because the regulatory capital buffer maintained by Australian banks provides the flexibility to Increase the dividend payout ratio if required to maintain dividend growth consistent with shareholder expectations.

Looking to the future

Regardless of the current economic challenges and financial turbulence that may lay ahead, Australia’s four major banks are well placed to address these challenges because they have in place the prudential buffers to withstand any economic turbulence that may arise. The prospect of domestic and global inflation easing in the months ahead enhances the likelihood of official interest rate cuts later in 2024. This should reduce the potential of economic recession. These short-term factors support a positive earnings outlook for Australia’s big four banks. Over the long-term the oligopoly market structure of the Australian banking system should also preserve their market share and underpin earnings and dividend consistency.

Australia’s four major banks are essential to the Australian economy, and the APRA prudential supervision standards that are in place in putting bank depositors’ minds at ease in terms of depositor protection are a critical factor that underwrites the stability of Australian bank profits and dividends.