Australia’s big four banks – forecast to post a combined $16.2bn six-month cash profit when they release their results over the next week – have motored through a cost-of-living crisis, increasing margins as they lift lending rates.
The dynamic reflects that the rapid-fire rises in the official cash rate, used by the Reserve Bank to combat high inflation, created a highly profitable period for the biggest lenders to charge borrowers more for loans than what they pay savers.
While some analysts believe the windfall period of bank profitability is passing, Australia’s biggest financial institutions are not expected to give up their fatter margins any time soon.
Citi analysts said in an investment note that while margins may have peaked “they will likely defy downward expectations and plateau in coming halves”.
Kevin Davis, emeritus professor at the University of Melbourne, said as long as most people had jobs, banks would print strong profits.
“It’s more about the potential of an increase in unemployment that I would worry about in terms of the impact on bank profits through loan defaults,” said Davis, noting that the jobless rate was near historic lows.
Davis said banks were adept at passing on rises in official borrowing rates.
“Banks are meant to be really good risk managers and they manage that risk by passing on those costs to customers,” he said.
The Reserve Bank will announce on Tuesday whether it will add to the 10 rate rises recorded from May last year or pause the cash rate at 3.6% as it did in April. Most analysts believe the central bank is at or near the end of its rate hiking cycle.
While Australian banks have issued warnings about economic headwinds, they are still forecast to produce record profits, or very close to it.
National Australia Bank, ANZ and Westpac are forecast to deliver $11bn in cash profit for the six-month period to March when they announce results from Thursday, according to UBS.
Commonwealth Bank, which reported a $5.2bn half-year result earlier this year, is due to provide a trading update next week.
The strong profit figures have been accompanied by healthy margins, which is the preferred gauge of bank profitability along with return on equity, a measurement of how efficiently a company uses shareholder money to generate returns.
The strong metrics enjoyed by the banks contrast with inflation-fuelled cost-of-living pressures that have dramatically increased household expenses, such as food, electricity, rents and mortgages.
Concerns over how banks price their loans and deposits has prompted a government-ordered inquiry by the competition regulator.
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Given banks draw the majority of their funding from deposits, the difference between the rates offered to depositors and borrowers drives profitability.
Rising rates, however, don’t necessarily translate to increased profits. At some as yet undetermined point, rising interest rates could trigger enough bad debts, and business failures, that bank profits get squeezed.
The banking sector has said funding costs were increasing significantly at the same time as home loan competition heated up, creating financial pressures.
But Paul Kofman, business and economics faculty dean at the University of Melbourne, said the limited competition in Australia’s banking sector meant they would not suffer greatly when competing for customers.
“They have enough market power that typically means they’ve got some wriggle room in not going overboard in giving significant benefits to new borrowers,” Kofman said.
While the level of bad debts is still modest, there is concern over the cohort of home buyers that may have stretched themselves to secure low borrowing rates during the initial years of the pandemic.
Research by financial comparison site Canstar shows that many recent borrowers are in mortgage stress, which is defined as those making repayments that exceed 30% of a borrower’s before-tax income.
Banks rely on mortgages as their main money-spinner, which means a wave of defaults would pressure their businesses should conditions deteriorate.
“Borrowers who jumped into the market with loan repayments up to their income capacity in April 2022 are now spending more than 40% of their income on repayments and are likely to be struggling with normal living costs after paying the mortgage,” Canstar group executive, Steve Mickenbecker, said.