The government is leaning on the might of Australia’s banking sector to get through the COVID-19 crisis, and it’s better prepared now to weather the storm than during the Global Financial Crisis (GFC).
The major banks are entering the economic downturn in very strong financial positions. Their capital, asset quality and earnings positions are a standout globally, even after facing headwinds in recent years.1
It’s important to remember that, though there is a rough road ahead, we believe the sector is better placed to handle this now than it ever has been.
The stimulus cushion
The push by the Australian Banking Association (ABA) and government that banks should allow their business and mortgage borrowers to delay repayment of loans for up to six months is credit negative, as it will hurt asset quality, earnings and capital positions in the long-term, even though APRA allows the banks to not classify those loans as impaired or non-performing loans.
As such, we expect the asset side of the banks’ balance sheet to deteriorate. In saying that, the degree of asset quality deterioration is likely to be cushioned by more government support and stimulus packages, as the extent and duration of this health crisis becomes clearer.
The government support packages are crucial to support households and businesses which ultimately mitigates the deterioration in the banks’ credit profiles. As at March 31, our estimates are that total fiscal and monetary support is equal to a huge 16% of GDP, including a third stimulus package which subsidises wages.
The major banks’ current credit profiles are strong, benefiting from capital and liquidity positions that are nearly twice as strong than prior to the GFC in 2008. At the financial year-ends in 2008, the banks’ regulatory Tier-1 ratios stood between 7.35% and 8.17% which compares to the latest reported Tier-1 ratios of 12.36% to 15.84%.2 Since the GFC, global regulators have implemented tougher bank capital rules which are now being loosened to allow the banks to absorb losses, but to also continue lending to businesses and consumers in this crucial period.
At the same time, the banks’ funding positions are less reliant from wholesale funding markets, as customer deposit positions have strengthened. This is reflected in customer deposits accounting for between 66% to 74% of non-equity funding, or in other words customer deposits fund 78% to 89% of the current loan books. This compares to 2008’s position of 37% to 56% and 36% to 62% respectively.3
Whilst these positions have improved, Australia’s banking system remains an importer of capital from offshore investors. Hence, maintaining a strong banking system which then receives a AA- rating by the rating agencies is crucial. A downgrade in the rating could result in higher funding costs.
It's important to remember there are some mitigating factors if wholesale funding costs were to increase:
a) We believe the Australian dollar is likely to play a stabilising role; and
b) the RBA has already proven its commitment to keep funding costs as low as possible by lowering the cash rate to historical low levels of 0.25% and by providing the banks with the recently announced three-year term funding scheme. The funding facility limits the banks’ need to accessing capital markets in the next three years as it will cover a large part of maturing debt. In addition, we believe that credit growth is likely to sharply decline from already weak levels.
The road ahead
In a very short time, we have come to understand that Australia is in for a recession like we’ve never known before. That is, of course, troubling and nerve-wracking, and everyone will feel its impact. But we believe that sectors, like banking, are going into this with heavy armour and strong foundations, prepared for the fight and the recovery.
3Banks’ Annual Reports
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