The Reserve Bank has warned that Australia’s banking system is about to be tested like it hasn’t been tested for some time.
But this test will come at a time when our banks are among the strongest, best capitalised, and most profitable banks in the world.
Unemployment will be a problem as the year goes on for the banks (and the community as a whole), but dud corporate and commercial property loans look like being a bigger concern, with higher default rates already being seen.
At the same time a senior bank executive says its unlikely Australia will suffer a US style subprime mortgage crisis in housing, like that still damaging the US economy. (see next story)
In first of two financial stability reports for 2009, the RBA says in spite of all the current positives, the country’s banking system is "facing a more difficult environment than it has for some years. "
"While the overall level of profitability is high, it has declined recently and problem loans have increased from the very low levels of recent years.
"Notwithstanding weaker wealth management income, the recent decline in bank profits has been mainly due to a rise in provisioning charges.
"The five largest banks reported charges for bad and doubtful debts of $5.3 billion over the latest half year, compared to $1.4 billion in the same period a year earlier.
"Banks’ trading updates and analysts’ expectations suggest that the charges for bad and doubtful debts are likely to rise further, to be equivalent to around 0.5 per cent of their assets for the 2009 financial year.
"This is up from the unusually low charges over recent years – when both specific and general provisions fell to very low levels – but well below the expense for bad and doubtful debts incurred in the early 1990s."
"Provisioning expenses have also increased at the regional banks, with these banks reporting a $360 million rise in provisioning charges over the past year.
"These higher charges are likely to see the banking system’s aggregate post-tax profits decline in the near term, with analysts generally anticipating that aggregate profits for the largest banks will be around 10 per cent lower in the 2009 financial year than in 2008.
"If this were to occur, the post-tax return on equity would be around 14 per cent which, while lower than the average return over the past decade, would still be higher than that being earned in many other banking systems around the world."
"Banks’ lending growth has also slowed recently, although banks generally continue to make credit available to good quality borrowers, albeit on less accommodating terms than in the recent past.
The RBA singled out unemployment as the main "downside risk for the banks, but even there, the problems of corporate loans going sour has been a greater concern in the past.
"The rise in non-performing loans has been evident across each of the main segments of the domestic loan portfolio, though it has been most pronounced in lending to businesses, with the non-performing business loan ratio increasing from 0.6 per cent to 2.1 per cent over the year to December 2008.
"This increase partly reflects the general downturn in economic conditions, but it is also due to a small number of exposures to highly geared companies with complicated financial structures and/or exposures to the commercial property sector.
"In banks’ commercial property loan portfolios, the impaired assets ratio stood at 3.3 per cent as at December 2008, compared to around 1½ per cent in early 2008.
"This ratio is now higher than it has been for around a decade or so, but is much lower than the levels reached in the early 1990s.
"Much of the recent rise is accounted for by loans for retail property and, to a lesser extent, residential development, with only a small rise in the arrears rate on loans for office property.
"In the mortgage and personal loan portfolios – which together account for over half of on-balance sheet loans – non-performing loan ratios have also risen, but remain low by the standards of many other countries.
"As at December 2008, non-performing housing loans accounted for 0.48 per cent of Australian banks’ outstanding on-balance sheet housing loans, compared to 0.32 per cent a year earlier.
"Housing loan arrears rates for Australian credit unions and building societies are lower than for banks and are around the same levels as in 2005."
"An issue that has also drawn some attention recently is the Australian banks’ exposures arising from their overseas assets, particularly in New Zealand and the United Kingdom, where economic conditions have weakened significantly.
"As at December 2008, the Australian banks’ overseas exposures accounted for around 30 per cent of their total assets, with New Zealand and the United Kingdom together accounting for about two thirds of these foreign exposures.
"The recent deterioration in conditions in these two countries, including falls in house prices, has been associated with a sharp decline in lending growth, and an increase in non-performing loans and provisions.
"Looking ahead, the main downside risk to the performance of banks’ housing portfolios is from a rise in unemployment as the economy slows, with the recent declines in interest
