Australian banks' stable profitability to offset risks for the next 12-18 months

What factors are behind the stable outlook for Australian banks?

Moody's Investors Service says that its stable outlook for the Australian banking system reflects the banks' increasing capital buffers and stable profitability that will offset the risks that they face over the next 12-18 months.

"Our stable outlook for Australian banks is underpinned by favorable domestic economic trends, as well as the banks' strengthening capital positions and stable profitability, which offset heightened risks from the housing market," says Frank Mirenzi, a Moody's Vice President and Senior Credit Officer.

Here's more from Moody's:

Moody's explains that the ratings for most Moody's-rated banks in Australia carry stable outlooks, after Moody's downgraded the banks' ratings on 19 June 2017, on concerns over rising tail risks in the domestic housing sector. The banks' lower ratings now adequately capture the balance of risks in the system.

The stable outlook is based on Moody's assessment of five drivers: operating environment (stable); asset quality and capital (deteriorating/improving); funding and liquidity (stable); profitability and efficiency (stable); and government support (stable).

With the operating environment, Moody's says that the Australian economy will continue to perform well and Moody's forecasts real GDP growth of 2.8% in 2018, with the unemployment rate holding steady at 5.6% over the period. While housing market-related risks remain high, such risks will not likely significantly undermine the stability of the banking system over the next 12-18 months.

On asset quality and capitalization, Moody's says that the banks' asset quality may worsen slightly, but their capitalization will improve.

While asset quality remains very strong, levels of problem loans could begin to rise from cyclical lows. Consequently, system-wide asset quality could deteriorate modestly. Risks in the housing market, however, will not likely increase further, due to regulatory measures to curb growth in riskier housing loans.

As for capitalization, Moody's expects that Australian banks will strengthen capital to meet higher minimum capital requirements.

The banks' funding and liquidity levels will stay stable. Moody's says that the banking system's funding requirements will not likely increase materially because loan growth should moderate, due to regulatory curbs on residential mortgages. And, growth in credit demand by businesses should remain moderate.

On profitability and efficiency, Moody's says that home loan repricing will prop-up net interest margins and profitability. Australian banks have raised interest rates charged on some of their existing loans, which will support net interest margins into next year. This situation, together with low bad debt charges and efficiency gains, will enable the banks to maintain their healthy profits.

However, profit growth could be pressured by intense competition for lending assets and moderate loan growth.

And on the issue of government support, Moody's says such support should stay strong. In particular, the Australian authorities have taken a cautious public stance on creditor bail-in. As a result, the introduction of a framework for total loss absorbing capital is possible, but unlikely before 2021.

Moody's rates 21 authorized deposit-taking institutions in Australia, comprising 18 banks, two credit unions and one building society. The 18 banks accounted for 90% of total gross loans and advances in the Australian banking system as of end-August 2017.