• The Reserve Bank has given a clean bill of health for the Australian financial system, highlighting the strength of domestic banks compared with their overseas peers.
• The Reserve Bank has indicated that the natural disasters earlier this year is unlikely to significantly impair bank assets and profitability. However the central bank did highlight that growth amongst domestic banks is likely to be more limited when compared to pre-crisis levels due to regulation.
• The central bank also commented on the improvement in wholesale bank funding, however it did note that banks have been less reliant on wholesale markets largely due to the increase in household deposits.

What does it mean?

• The Reserve Bank has effectively given Australia’s financial system the tick of approval highlighting that the recent natural disasters are unlikely to significantly hurt bank asset quality or significantly impair overall performance. Importantly the Reserve Bank believes that the underlying resilience of the domestic economy has kept the banking system in good stead. In fact the latest financial stability review goes so far as to suggest that domestic banks are still outperforming overseas peers.
• Even throughout and subsequent to the global financial crisis, Australia’s financial system remained in good stead. And looking forward it is likely that the banking will continue to be well ahead of its international peers. However the central bank did comment that nonperforming assets remain higher than a few years ago, but still low on comparison with international counterparts.
• The near term weakness in the domestic economy has largely been as a result of the rapid fire rate hikes and the resulting lift in consumer conservatism. However the string of natural disasters has also sapped momentum from the economy and it is likely to have a marginal impact on the banking sector. Also the Reserve Bank did warn that banks are unlikely to be able to grow at pre-crisis levels, largely due to tighter regulation and attempts to grow at those levels could induce risks.
• The central bank did once again weigh into the topic surrounding bank funding costs, commenting on the improvement in access to wholesale funding. However given the fact that consumers have been saving rather than spending, banks have been less reliant on the wholesale market, and “as a result their liquidity positions have improved further”. The central bank also did highlight that looking forward Australian banks are well placed to meet the new capital standards to be introduced under Basel III.
• Interestingly the Reserve Bank has once again highlighted that the level of conservatism being shown by households has resulted in improving household balance sheets. Additional savings and low unemployment should be beneficial in the longer run, resulting in stronger future spending. At the same time the Reserve Bank believes that the level of household debt remains historically high, and it would be helpful for borrowers to show further restraint.

• In the near term it is looking less likely that the Reserve Bank will need to raise interest rates. Inflation remains well contained, while several sectors of the economy including housing, construction and retail are showing signs of weakness. Monetary policy is already mildly restrictive and as such the Reserve Bank can afford to wait a few more months to assess data flow before once again moving on rates.
• Overall CommSec believes that the longer term fundamentals for the domestic economy remain sound. Employment growth is likely to remain healthy, while activity levels will pick up in the second half of the year. More importantly the Asian region continues to grow at a steady clip and as such the demand for commodities should ensure that the “once in a century” terms of trade boost remains part of the economic landscape. The additional flow of income which is currently being saved by businesses and consumers will drive up future spending adding further momentum to the domestic economic growth story.

Key points from the Reserve Bank Financial Stability Review:

Global banking System: “Confidence in the banking systems of major countries has generally improved since the previous Financial Stability Review.”

“The major international banks have continued to report profits and strengthen their balance sheets. Some banking systems are still under considerable strain, however, notably in parts of Europe, where recovery is being undermined by market concerns about sovereign debt sustainability.”

Banking system: “The Australian banking system has continued to perform better than those in many other countries, consistent with the relative strength of the domestic economy over recent years. Non-performing asset levels remain higher than a few years ago, though they are low in comparison with those in the major economies. Their largest component – nonperforming business loans – was beginning to show slight signs of improvement towards the end of last year, and the flow of loan loss provisions has already fallen significantly.”

“Australian banks are well placed to meet the new capital standards, particularly given the significant bolstering of their capital positions in recent years.”

Funding costs: “Australian banks have maintained ready access to wholesale funding markets in the past six months, but they have also had less need to raise wholesale funds over this period as growth in deposits continues to outpace growth in credit. This shift towards deposit funding has enabled banks to further reduce their reliance on short-term wholesale debt. As a result, their liquidity positions have improved further. Banks’ capital positions have also been substantially bolstered in recent years”.

Household balance sheets: Households “continue to exhibit a more cautious approach to their borrowing… reducing the growth in their debt outstanding to a rate more in line with income growth. Household indebtedness remains historically high, however, and recent increases in interest rates have lifted the aggregate debt servicing requirement. While indicators of financial stress are relatively subdued, a continuation of this recent borrowing restraint would help build additional resilience into households’ balance sheets.””

What is the importance of the economic data?

• The Reserve Bank issues its Financial Stability Review half-yearly. The RBA says that “these Reviews assess the current condition of the financial system and potential risks to financial stability, and survey policy developments designed to improve financial stability.”

What are the implications for interest rates and investors?

• A strong financial system is crucial for sustained economic growth. And the Reserve Bank’s positive assessment of Australian banks should provide investors with further confidence in the economic recovery currently underway.
• The financial stability review suggests that the Reserve Bank is more comfortable with the position of the domestic banking sector and the state of household and business balance sheets. But we continue to expect that the next hike is unlikely to take place before mid year.
• Our equity analysts have Westpac, ANZ, and National Australia Bank on a HOLD rating. This reflects the expectations of earning stability and fair valuations at present.

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