Concerns Mount for Australian Banks

Consumers might have been forgiven for thinking that a timely boost was set to come their way in time for Christmas.

It is widely predicted that central interest rates, which had remained untouched since April 2009, will fall for the second consecutive month when the Federal Bank’s committee convenes next week for the final time in 2011.

But the untimely downgrading of Australian banks by credit ratings agencies this week has put a new complexion on the immediate forecast for bank funding, irrespective of whether a central rate cut is announced or not. Consumers are set to lose out when they may have expected to benefit.

Downgrading

Standard & Poor’s have downgraded a number of major banks worldwide, including Barclays, HSBC, Goldman Sachs, UBS in Switzerland and the Bank of America. In Australia, the Commonwealth Bank, ANZ, National Australia Bank and Westpac all fell by one grade to AA[-], the agency’s fourth-highest rating. Macquarie Group was cut by two levels to BBB, a grade which anticipates a level of risk from adverse economic conditions.

What these reductions do is heighten insecurity for banks to lend to one another. This, in turn, raises the cost of lending as banks insure themselves from that elevated level of risk.

Such costs will no doubt be absorbed by consumers through less competitive savings and loan rates. A central interest rate cut may prove welcome only insofar as it prevents loan rates from rising.

Crucial Challenges

Fellow ratings agency Moody’s warned that Australian banks faced ‘various crucial challenges over the next 12-18 months’ as the costs of bank funding begin to rise.

Moody’s announcement declared the Australian banking system as stable, but warned that profitability would depend on ‘how severe and how protracted any contagion from the European sovereign crisis may be’. A continuation of the ensuing Eurozone crisis could result in a reduction in overseas investor demand and increased bank funding costs.

However, despite S&P’s moves to downgrade Australian banks, Moody’s senior vice-president, Patrick Winsbury, highlighted a number of core strengths that would benefit Australian banks as they prepared for a rougher journey ahead.

Australia’s banks have built sizeable capital buffers to absorb possible weakness in asset quality, and they have a good measure of flexibility to deal with the challenging conditions.

The stable outlook also reflects our analysis that Australia has good monetary and fiscal policy flexibility to deal with weaker economic conditions.

Winsbury also praised banks’ attempts to reduce their reliance on offshore funding.

While we continue to view the Australian banking system’s relatively high proportion of offshore wholesale funding to be a structural sensitivity, customer deposits have been growing faster than loans as deleveraging continues, allowing the major banks to reduce their reliance on offshore wholesale funding.

Weathering a Storm

Australian banks would appear to be as well positioned as any to withstand the storm. National Australia Bank suffered an additional blow, however, as its UK based operations, Yorkshire Bank and Clydesdale Bank, both had their ratings slashed for the third time in three months.

Cameron Clyne, chief executive of NAB, defended the ratings cuts against assumptions made by the agencies through their tighter evaluation criteria which account for parent company support.

While S&P has changed its assumptions, in substance, the nature of NAB’s support for Clydesdale Bank is unchanged.

The UK and New Zealand are both currently weaker banking territories than Australia, S&P have noted, and these weaknesses are inherent in individual banks’ credit profiles.

So, as the noose begins to tighten, Australian banks, on average, have positioned themselves well. Consumers will no doubt feel the pinch, but they might be consoled by the (sobering) thought that they are only likely to encounter a light shower rather than the torrent many other nations are facing.

With bank rates likely to worsen in relation to the central interest rate, could you use a better savings account while the opportunity is there? Visit Which4U’s savings account listings today and see what deals are available.

Keith McDonald

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