Australian banks relatively better positioned for lower rates says RBA 

Summary

  • Economic recovery is underway in Australia, and loan deferrals are down significantly from the peak. 
  • Large capital buffers and Term Funding Facility from the RBA would ensure lending support in the economy. 

Recently, Reserve Bank Australia’s Head of Financial Stability Jonathan Kearns spoke at a conference.  

In contract to the global financial crisis (GFC), the pandemic-led crisis has been a large external shock to the financial system.

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Banks have been resilient during the pandemic and have continued to support economic activity with lending and loan deferrals. Mr Kearns noted that loans were deferred in at least 55 jurisdictions. 

After the GFC, the reforms implemented by banking regulators have enabled to evade a larger financial downturn. Now banks hold more capital, more liquid assets, have less risky operations, and lending standards have increased.

The magnitude of fall in global economic activity is largest since the Great Depression. As a result, some borrower’s ability to repay loans would be impaired to some extent. 

Australian banks 

Since the global financial crisis, the resilience of Australian banks has improved significantly. Now Australian banks have a tier 1 capital ratio of 14% compared to 7½% in 2007. 

Aussie banks not only have a strong capital buffer, but they are also profitable. He said the Australian banking industry generated $34 billion of profits in 2019 with return on equity at 11% - higher than the cost of equity. 

More importantly, since March 2013, the increase in capital buffers of banks has been largely sourced internally (retained earnings) and from dividend reinvestment plans.

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Now only around 3% of housing and SME loans are on deferral. This is compared to 10% of housing loans and 17% of SME loans in deferral at the peak. 

While there has been a lot of debate on the impact of lower rates on banks, Mr Kearns said that lower rates indirectly help banks by improving economic activity. 

In the absence of lower interest rates, the economic downturn would have been larger, causing stress on the borrowers and banks. 

He said Australian banks have 3/4th of assets in variable rate loans, which suggests movement in interest rates would have less influence on profits. After the GFC, interest rates in Australia have remained relatively higher compared to other developed economies. 

Australian big four bank source one-third of their funding needs from wholesale markets, meaning that the cost of funding could turn negative as well. Meanwhile, smaller banks have a large share of deposit fund at 80%. 

In addition, Reserve Bank’s Term Funding Facility is giving funding to banks at cash rate, which also allows aids funding constraints of Aussie banks.

He concluded that impact lower interest rates on Australian banks would be lesser compared to other jurisdictions.


 


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