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Australian banks face challenging 2023 as inflation stays elevated – S&P Global

Australian banks face challenging 2023 as inflation stays elevated
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Falling mortgage demand and rising interest rates will be top concerns for Australian banks in 2023, as the risk of persistent inflation could impact borrowers’ ability to repay loans.
The four major Australian banks Australia and New Zealand Banking Group Ltd., Westpac Banking Corp., National Australia Bank Ltd. and Commonwealth Bank of Australia — gained from the eight successive interest rate increases of the Reserve Bank of Australia, or RBA, in 2022. The banks’ net interest margins grew in the second half, bolstered by the rate increases and the economy’s stability in the wake of the COVID-19 pandemic.
While the higher interest rate environment will still support margin recovery, banks face a potential economic downturn, inflationary pressures and house price declines in the new year.
The more the RBA raises rates, the more pressure it puts on households and corporations. And until the RBA stops hiking rates, lending and property prices could continue to further bite banks’ bottom lines,” Jessica Amir, market strategist at Saxo, told S&P Global Market Intelligence in a Dec. 2 email before RBA’s Dec. 6 policy meeting.
Rising rates
The central bank raised its benchmark cash rate target for the eighth time in 2022 to 3.10% on Dec. 6. Gross domestic product rose 0.6% in the September quarter compared to a 1.9% contraction a year earlier, according to a Dec. 7 release from the Australian Bureau of Statistics. Inflation, however, remained high at 6.9% year over year in October.
“A further increase in inflation is expected over the months ahead, with inflation forecast to peak at around 8% over the year to the December quarter,” RBA Governor Philip Lowe said in the policy statement.
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If inflation stays elevated, it may force the central bank to keep a tightening bias.
“We think lending will continue to fall, and property prices will continue to pull back as they traditionally do when a central bank is raising rates,” Saxo’s Amir said. “We think householders have not yet felt the full impact of rate rises, and some households are under financial duress with our nation having one of the highest debt-to-income ratios in the world.”
“This means banks will be concerned their margins will likely continue to fall, perhaps across 2023, as the lag effects of rate hikes and inflation bite. I also see bad debts (provisions) continuing to rise, and that could be a dominant theme of the earnings season in February and August next year,” Amir added.
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Property prices
National house prices fell 1% in November from the previous month, according to property data firm CoreLogic. The total value of dwelling units in Australia dropped to A$9.674 trillion from A$10.033 trillion in the June quarter, according to data released Dec. 6 by the Australian Bureau of Statistics. It was the largest quarterly fall since the bureau started tracking the total value of residential homes in September 2011.
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“Focus of the banks will be margin control and cost control in a low growth but higher rate environment,” said Martin North, principal at Digital Finance Analytics, told S&P Global Market Intelligence. “They are highly exposed to a property downturn and rising international funding costs. I expect to see higher provisions from bad loans in the higher rate environment, and I expect profit will be hit. They will try to save on the cost side especially with accelerated branch closures and staff reductions,” North said.
The easing of prices could come as a shot in the arm for Australian households.
“A potential upshot is that the RBA is correct; inflation will retreat, and concerns over debt serviceability have been overstated. This could see demand for housing pick up, and banks outperform the broader market next year after a lackluster (yet volatile) 2022,” said Matt Simpson, senior market analyst at City Index, told Market Intelligence.
Banks may be forced to squeeze their lending margins and the Australian Prudential Regulation Authority may ease lending standards for home loans. However, that would raise banks’ risks that the regulator is trying to reduce, Simpson said.
Banks squeezed
A Bank of Queensland Ltd. spokesperson said all Australian banks feel the effects of rising rates and falling house prices. “The changing market dynamics are already being seen in reductions in customers borrowing power and slowing market demand for new credit,” the spokesperson said. Although house prices are falling, this has been preceded by a period of rapid house price appreciation. House prices peaked in April 2022 and have since fallen to levels seen in mid-2021.
Other major banks did not respond to queries from Market Intelligence.
“Banks are entering this period in a stronger position in terms of capital, liquidity and strength and quality of credit than they’ve been in for a very long time, thanks to the regulatory reform agenda and also to conservatism that was applied through the global pandemic,” Doug Nixon, EY Oceania banking and capital markets leader, told Market Intelligence in an email. “This means that banks have a much broader suite of levers to pull and position for in this turbulent period than they’ve had in living memory.”
“Competition and a constrained market will continue to drive focused strategy for market share and liquidity. More than ever, we’ve got non-traditional players vying for space in the market that may not be a level playing field. This not only creates a complex, competitive environment but also has the ancillary effect of pushing risk into less illuminated parts of the financial system,” Nixon said.
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Joseph Muongi

Financial.co.ke was founded by Mr. Joseph Muongi Kamau. He holds a Master of Science in Finance, Bachelors of Science in Actuarial Science and a Certificate of proficiencty in insurance. He's also the lead financial consultant.