Australian banks' NIMs to be hit by prolonged period of low interest rates

Multiple headwinds put pressure on the banks' credit profiles.

Moody's Investors Service says that Australian banks are facing a growing number of headwinds due to increasing household leverage and persistently low interest rates, which are increasing the banks' sensitivity to shocks.

"These headwinds could, over time, put pressure on the credit profiles of Australia's major banks, particularly in the context of their very high ratings," says Frank Mirenzi, a Moody's Vice President and Senior Analyst.

"Whilst solvency and liquidity buffers have improved in recent years, the path of future balance sheet strengthening is likely to be slower than in previous years -- at a time when risks continue to rise," adds Mirenzi.

Moody's conclusions were contained in a just-released report on Australian banks, titled, "Australian Banks: Rising Leverage And Cyclical Challenges Pose Risks".

Moody's says that the weak state of the operating environment is reflected in Australia's accommodative monetary policy, characterized by a historical low in the Reserve Bank of Australia's (RBA) policy rate. This is likely to persist over the next 12 months.

The prolonged period of low interest rates will over time negatively impact the banks' net interest margins. Australia's major banks have to date managed to preserve margins through strong pricing power. However, they may be increasingly challenged to maintain them in the face of further interest rate cuts.

The need to meet the requirements of the Net Stable Funding Ratio is likely to increase price competition for retail deposits. If, at the same time, tighter housing loan underwriting criteria increase price competition for lower-risk loans, then bank margins may be squeezed and become increasingly sensitive to volatility in wholesale market funding costs.

This would come at a time when tail risks in the housing market have been rising. A combination of low nominal income growth and buoyant housing conditions in the key Sydney and Melbourne markets have led to an increase in household debt and overall credit-to-GDP ratios. Coupled with bank portfolios that have unusually high levels of concentration to residential mortgages, Moody's believes that risks to Australian banks are increasingly skewed to the downside.

At the same time, Australian bank asset quality is coming off a cyclical high, as the unwinding of the global commodities cycle is placing some segments of banks' loan portfolios.

Against the backdrop of these challenges, the major banks' solvency and liquidity buffers have improved in recent years. Regulation has strengthened major banks' capital positions.

Their funding and liquidity profiles have also improved, with a lower reliance on short-term wholesale funding and higher holdings of liquid assets. These improvements have, to date, supported major bank ratings. However, Moody's anticipates that the path of future balance sheet strengthening is likely to be slower than in previous years -- at a time when risks continue to rise.