Australian banks face a challenging new year as they contend with record-low interest rates, tighter lending requirements and the risk of the housing market cooling.
Net interest margins may remain under pressure because the central bank will likely hold its benchmark cash rate at 0.1% until 2023, even after scrapping support measures for lenders in June last year. Regulators have also imposed tougher capital rules on riskier housing loans, which may deter banks from making higher-margin deals.
"[The] next couple of years will be tricky," said Martin North, principal at Digital Finance Analytics. "Profitability will be under pressure."
Authorities are dialing back on stimulus and the central bank is preparing to implement stricter capital adequacy requirements on banks from 2023 as the nation prepares to restore normalcy after the pandemic has abated. The Australian Prudential Regulation Authority, or APRA, in November overhauled its bank capital requirement rules, allowing banks to set their own capital benchmarks from 2023, based on how risky their lending is.
Still, the regulator expects banks to operate with Tier 1 ratios above 11% when the rules come into effect in January 2023. Currently, APRA requires Australia's big four banks to maintain their core capital above 10.5%. The big four lenders — Commonwealth Bank of Australia, Australia and New Zealand Banking Group Ltd., National Australia Bank Ltd. and Westpac Banking Corp. — are all comfortably above the requirement.
Housing peak
The big four also face a potentially overheated housing market, which could crash once rates eventually go up. Commonwealth Bank of Australia, or CBA, has predicted property prices to fall 10% in 2023 once the central bank starts pushing up cash rates for the first time in more than decade.
A buoyant housing market in 2021 helped banks grow their mortgage books. Housing prices rose 22.2% in the first 11 months of the year, according to CoreLogic, a property data analytics provider.
Banks' total residential mortgage lending rose 5.7% year over year as of Sept. 30 to A$1.962 trillion, from A$1.856 trillion, according to data released Dec. 7 by APRA.
The risk is that home prices may be nearing a peak. Australian and New Zealand Banking Group, or ANZ, predicts prices will only rise 6% in 2022 and then fall 4% in 2023.
"Affordability constraints are biting, new listings have lifted strongly and macroprudential tightening and higher mortgage rates are set to constrain lending over the coming year," ANZ senior economists Felicity Emmett and Adelaide Timbrell said in a report in November.
National Australia Bank, or NAB, said in its Q3 residential property survey that house prices will see a sharp slowing in 2022 as the impact of lower interest rates fades. CBA expects house prices to peak around the middle of the year.
"If housing prices decline sharply it will impact the value of collateral, which may result in losses for banks," said Matthew Barry, senior analyst at IBISWorld, an industry research and consulting firm.
Tighter rules
Regulators also tightened lending rules in October 2021 due to an increase in the share of heavily indebted borrowers. APRA ordered banks to assess new borrowers' ability to meet loan repayments at an interest rate at least 3 percentage points above the loan product rate versus 2.5 percentage points previously, after it observed an increase in the share of heavily indebted borrowers.
"At an aggregate level the expectation is that housing credit growth will run ahead of household income growth in the period ahead," APRA said Oct. 6. More than one in five new loans approved in the June quarter was at more than six times the borrowers’ income, it said.
Under new capital rules released in November 2021, APRA will also require banks to hold more capital for riskier loans. One of the objectives of the new framework is to strengthen the amount of capital held by banks for residential mortgage lending, given the industry concentration in the asset class, according to the regulator.
The big banks expect margins to be under pressure in the current fiscal year as record-low interest rates persist. CBA, the country's biggest bank by assets, said in its full-year results in August, that its margins will be impacted by the low-rate environment, increased competition and higher deposit rates. CBA's NIM slipped to 2.03% in the 12 months ended June 30, from 2.07% in the previous year.
"Margins are unlikely to recover until the Reserve Bank of Australia lifts the cash rate, allowing banks to increase rates on existing loan books," said Nathan Zaia, an equity analyst at Morningstar. The biggest challenges for the big banks include balancing the desire to grow loan books and managing the downside to margins, Zaia added.