Australian banks face elevated risk of credit losses: S&P

Whilst losses are projected to remain low, a sudden price drop in the housing market spell trouble for banks.

Australian banks remain exposed to elevated risk of credit losses due to high household debt, rising interest rates, and uncertain economic conditions, reports S&P Global Ratings.

Credit losses over the next two years are projected to remain low, and dwell close to pre-pandemic levels even as rate hikes erode debt serviceability for highly leveraged borrowers, the ratings agency said in a report.

An orderly fall in house prices is expected over the next year or two. Higher borrowing costs and the roll off of lower fixed rate mortgages to higher variable rate mortgages should further keep house prices under check. 

Despite this, banks in Australia remain exposed to risk of higher credit losses, especially if a sharp fall in housing prices occurs.

“A sharp fall in property prices, pronounced economic downturn with a jump in unemployment, or financial market dislocation could set off a spurt in credit losses,” S&P warned.

Risks facing banks in Australia could increase if house prices plunge or sharply rise in the next two years. A persistent gap in housing supply, population growth through immigration, and a benign economic outlook could refuel a surge in house prices, it added.

Industry structure supports stability
Local banks have the advantage of Australia’s regulatory standards supporting stability, meaning that earnings should remain sound on the back of low credit losses and solid interest margins.

“We see limited downside to economic risks facing Australian banks in the next two years, including when stronger credit and house price growth resumes on the back of resurgent immigration and limited housing supply,” S&P reported.

“Furthermore, an upside could emerge if uncertainties around the economic outlook ease and we gain confidence that credit and asset price growth will remain muted,” it said.

Overall, S&P estimates that there is a one-in-three likelihood that Australian banks will face reduced risks in the next two years. 

“This could occur if we see a reduction in the industry's risk appetite or a lower possibility of significant regulatory lapses--for example, due to the simplification of business models of the larger Australian banks,” it said.

Industry risks could also diminish if the financial sector's net external liabilities remain well below 20% of domestic customer loans.