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Implications Of Credit Growth - Major Banks’s Facing Headwinds

Jordan Baird

Jordan Baird is the head ASR Wealth Advisers client services desk and has been with the organisation since 2017. He first started investing in his early years. While he believes that investors should leave no stone unturned he has a particular interest in trading based on broad macroeconomic trends along with specific analysis of innovative up-and-coming companies.

Overview of the Australian economy, interest rates and the banking sector

The Australian economy has been growing on average below-trend growth over the past decade. In particular, annual growth was reported at 1.4 per cent per to the June Quarter 2019, while trend growth is around 3.1 per cent per annum. In light of the below-average level of economic growth and given the inflation rate has been very subdued, the Reserve Bank of Australia (RBA) has over time been undertaking an expansionary monetary policy, with the cash rate steadily decreasing since 5 October 2011 from 4.75 per cent to the current level of 0.75 per cent (see Figure 1).

Implecation Growth - fig 1

Over the last decade, profits of the major banks have been stagnated. In addition to modest growth in the Australian economy, there are two other factors that have caused this stagnation in profitability. Firstly, credit growth in the housing, business and personal sectors has been relatively low and falling since around 2015 (see Figure 2). The most recent figures released by the RBA on the 2 October 2019 show that credit growth is continuing to slow following the trend.

Implication Growth - fig 2

Secondly, the net interest margin for the major banks has fallen from around 2010 to current levels (see Figure 3). The main driver for this occurring is that as interest rates have been steadily decreasing, this has caused net interest margin to squeeze as the banks lower lending rates while deposit rates and the cost of other funding has not fallen by as much. It also reflects competitive pressures in the industry.

Implication Growth - fig 3

Recent reductions in the RBA’s cash rate cut and are the banks passing it?

An important consideration is how the lower interest rate environment is influencing banks’ net interest margin. Over the last few years, movements in interest rates and the net interest margin have been slightly correlated. As shown from Figures 1 and 3, from 2011, as the cash rate has fallen, so has the net interest margin. The banks’ capacity to reduce lending rates further without causing the net interest margin to fall is now constrained by the fact there is minimal scope for the banks to reduce deposit rates.

It was announced yesterday (2 October 2019) that the major banks will not pass the full 25 basis point rate cut from the most recent rate cut on the (1 October 2019). The major banks announced that they will lower their variable housing rate by between 0.13 and 0.15 percentage points. That is, none of the major banks passed on the reduction in the cash rate in full, possibly reflecting a preference limit the negative impact on the net interest margin.

What are the recent regulatory developments impacting on the Australian banking sector?

The first recent key development is that the Australian Prudential Regulation Authority (APRA) has eased regulation requirements on lending. On 5 June 2019, APRA announced that banks have to test a borrower’s ability to repay a loan at 2.5 percentage points above the standard variable rate instead of at 7.25 per cent made in 2014. This is positive news for the major banks, as it should allow them to provide additional credit for the housing sector.

The second key development is that APRA announced on 9 July 2019 an easing of future capital requirements for the major banks. The original proposal was for the major banks to increase their capital requirement by 4 to 5 percentage points over a few years mainly by raising additional Tier 2 capital. Following a consultation period with the industry, APRA has relaxed this proposed requirement with the major banks now required to increase their capital requirements by 3 percentage points by 1 January 2024 mainly by issuing additional Tier 2 capital. This is a positive development for the major banks as it provides them with a smaller constraint on increasing lending (ie, credit growth) relative to APRA’s original proposal. However, the fact that the major banks still have to raise substantial capital over the next five years places a constraint on credit growth and a willingness to take the risk. In addition to APRA’s capital requirements, the New Zealand regulatory authority may require the major Australian banks to hold additional Tier 1 to support the New Zealand based banks they own.

The above two developments are positive for the industry. However, the banks continue to face issues arising out of the Hayne royal commission into financial services. Yesterday NAB announced additional customer remediation costs (around $832 million after-tax) and the other banks may announce further costs in coming months. In addition, ASIC is an appealing decision against them relating Westpac’s lending practices and the responsible lending requirements. Further, ASIC is undertaking a consultation process on the regulatory requirements around responsible lending. The outcome of this consultation process is uncertain, but it could result in additional regulatory requirements.

Overall assessment

Australia’s banking sector is on a double-edged sword. On one edge, availability of credit to consumers and businesses should increase due to low-interest rates and an easing in lending regulations and capital requirements. However, on the other edge, the net interest margins for each bank could be squeezed even more.

The major banks are trading in PE ratios in the low to mid-teens and dividend yields of more than five per cent. This means that the major banks are priced more cheaply relative to some other sectors of the market. However, the major banks face significant headwinds of slow credit growth (also reflecting weak economic growth), pressures on net interest margins (which could lower profitability) and increased regulatory requirements (both capital and lending requirements). That is, in the short term at least, the major banks may have lower growth prospects than other sectors of the market.




This article has been prepared by the Australian Stock Report Pty Ltd (AFSL: 301 682. ABN: 94 106 863 978)

(“ASR”). ASR is part of Amalgamated Australian Investment Group Limited (AAIG) (ABN: 81 140 208 288 Level 13, 130 Pitt Street, Sydney NSW 2000).

This article is provided for informational purpose only and does not purport to contain all matters relevant to any particular investment or financial instrument. Any market commentary in this communication is not intended to constitute “research” as defined by applicable regulations. Whilst information published on or accessed via this website is believed to be reliable, as far as permitted by law we make no representations as to its ongoing availability, accuracy or completeness. Any quotes or prices used herein are current at the time of preparation. This document and its contents are proprietary information and products of our firm and may not be reproduced or otherwise disseminated in whole or in part without our written consent unless required to by judicial or administrative proceeding. The ultimate decision to proceed with any transaction rests solely with you. We are not acting as your advisor in relation to any information contained herein. Any projections are estimates only and may not be realised in the future.

ASR has no position in any of the stocks mentioned.

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