Why Moody's is confident that Aussie banks are robust against challenges

Despite economic transition soon.

Moody's Investors Service says that its stable outlook for the Australian banking system reflects its view that the banks are well-positioned to meet the challenges from a period of economic transition in the coming 12-18 months, as the investment boom in the resources sector moderates and the decline in the terms of trade weighs on national income.

Here's more from Moody's:

"We believe that the banks can manage the transition with little risk of disruption to their credit standing, because of their improved balance sheet strength, funding profiles and financial flexibility," says Patrick Winsbury, a Moody's Senior Vice President.

Winsbury was speaking on the release of Moody's Banking System Outlook Australia, and which looks at the sector's operating environment; asset quality and capital; funding and liquidity; profitability and efficiency; and systemic support.

"Headline economic growth should remain sound, in the mid-2% range for all of 2013, and again in 2014, although somewhat below the long-term trend of 3%. While housing activity has picked up and there are some tentative signs of an associated wealth effect in improving discretionary retail sales, pockets of weakness in the labour market will nevertheless remain a feature," says Winsbury.

"At the same time, while the low interest rate environment should continue to support asset quality there is nonetheless a risk that, over the course of this outlook, net credit costs will rise moderately from their current low levels, as the period of economic transition will inevitably create some weakness, and as recoveries from impairments related to the 2008-09 global financial crisis tail off," says Winsbury.

The report notes that the banks' solid capitalisation levels have allowed for the early implementation of Basel III capital requirements in Australia in 2013 and underpin their strong performance in Moody's stress tests.

And while the banks have increased dividends, they have done so on the back of their strong profits and slow growth in risk-weighted assets (RWA). In this context, Moody's expects the banks to readily revert to a strategy of capital preservation, if needed.

There are also signs that the low credit-growth environment is raising competition in lending, but the impact on profit is somewhat offset by an easing of competition in deposit gathering.

Moody's stable credit outlook for the banking sector is also underpinned by the significant improvements the banks have made in their funding and liquidity profiles since the global financial crisis.

While the larger banks are unlikely to be able to reduce their reliance on wholesale funding much further, the need to meet the Basel III liquidity coverage ratio (LCR) requirement -- which will be implemented in January 2015, with no phased introduction -- will continue to drive them to improve the stability of their funding.

Moody's stable outlook for the banking system is consistent with the overwhelmingly stable outlooks for the banks' size-weighted, average standalone bank financial strength of C+ (which equates to a baseline credit assessment of a2) and long-term issuer ratings of Aa3. The outlook also echoes Moody's stable outlook on the Aaa-rated Australian sovereign.

Moody's rates 12 of Australia's 21 domestic banks, and four of the eight foreign bank subsidiaries operating in the country. At end-September 2013, the 16 rated banks accounted for 94% of total banking system loans.