The Outlook For Australia's Big Four Banks

by: Colin Reed

Australia, like Canada, has some of the world's safest banks. In fact, all of the 'big four' Australian banks are listed in the top 20 of Global Finance's 'World's 50 Safest Banks Report 2011.' Australia & New Zealand Bank (OTCPK:ANZBY), Commonwealth Bank of Australia (OTCPK:CMWAY), National Bank of Australia (OTCPK:NABZY), and Westpac (NYSE:WBK) account for around 75% of total banking sector assets in Australia.

Again, like Canada, they are strictly regulated. The Australian government has a "four pillars" policy that prevents mergers between the four major banks. Simply put, this prevents the systemic risk of an individual financial institution becoming so large that its failure could destabilize the financial markets - and the wider economy. In contrast is the Glass-Steagall Act in the U.S., which previously had prevented banks, insurance companies, and brokerage firms from merging. It was repealed in 1999, allowing the creation of Financial Holding Companies. The sheer size of the resulting 'too big to fail' institutions is widely seen as a major contributor to the 2008 Financial Crisis.

Australian Banks weathered the 2008/09 crisis well. No individual Australian bank had to be explicitly rescued during the crisis. In response to bank guarantees issued by governments in 19 countries supporting their own banking systems, the Australian government did however make an A$8 billion fund available for asset purchases in October 2008. This not only signaled that the Australian government would guarantee bank debt, but also ensured Australian institutions were not placed at a disadvantage vs. their international competitors. All four of the big banks raised capital in 2008/09, raising about A$30 billion through a combination of new share issuance and dividend reinvestment plans.

Tier 1 Capital Ratios and Basel III

A bank's capital, in its simplest form, represents its ability to withstand losses without becoming insolvent. Tier 1 capital ratio is the ratio of a bank's core equity capital to its total risk-weighted assets (RWA). Tier 1 capital ratio for all four Australian banks increased in 2011. See table below.

Australia & New Zealand Bank



Comm. Bank of Australia



National Bank of Australia









The Basel III accord requires banks to hold 4.5% of common equity (up from 2% in Basel II) and 6% of Tier I capital (up from 4% in Basel II) of risk-weighted assets (RWA). Basel III will also require banks to hold 4.5% of common equity (up from 2% in Basel II) and 6% of Tier I capital (up from 4% in Basel II) of RWA. However, the Australian Prudential Regulatory Authority's (APRA) strict interpretation of current Basel II rules means that all four of the largest banks are already in compliance with the Tier 1 common equity requirements of Basel III. In September 2011, the APRA recommended Australian banks meet the Basel III minimum capital requirements by January 2013, two years ahead of the 2015 deadline set by global regulators. A recent independent study released by the IMF 'Bank Capital Adequacy in Australia confirmed: 'The four major Australian banks are well-positioned to meet the higher capital requirements under Basel III.'

Higher Funding Costs and Ratings Downgrade

Conservative oversight from the APRA and early compliance with Basel III were not enough to escape the global ratings clampdown by S&P in 2011, with all four being reduced from AA to AA-. In addition, Fitch put out a negative ratings watch on all four in January 2012 'based on their weaker funding profiles than similarly rated peers'. Australia's 'Big Four' banks are set to raise around $100 billion this year to help meet a shortfall between deposits and lending. Australia's banks have seen their debt funding costs rise since 2007. Competition for deposits in Australia has intensified since around mid 2008, resulting in a significant increase in deposit rates relative to market benchmark rates. And although wholesale funding costs have fallen with improved capital market conditions, this has been largely offset as the major banks lengthened the average maturity of their bond funding.

Although lowering their credit rating by a notch will also slightly increase their wholesale borrowing costs, the market has largely shrugged it off in similar fashion to S&P's downgrade of U.S. government debt last year. Risk is relative. Australian bank debt is still safe relative to other global banks as U.S. Treasuries are considered safe relative to other sovereign debt. My own view is Australian banks are more secure than would appear - and for one very good reason: Their very low exposure to EU Sovereign debt.

Foreign Bank Claims on Euro Area Countries* (as % of lending country's total bank assets)

Euro area Banks


UK Banks


US Banks


Japanese Banks


Swiss Banks


Australian Banks


* Based on 24 countries reporting to the BIS.

Challenges Ahead
The above analysis is a look in the rear view mirror of how the 'Big Four' performed during the GFC up until now. I think it confirms a bank sector which is secure. Strict regulatory oversight by the APRA, coupled with conservative lending practices, helped Australian lenders largely avoid the crisis which hit Anglo/U.S. banks in 2008. Low EU Sovereign debt on their books will largely immunize them from any EU fallout. The challenges ahead are regional and domestic. They include:

  • Weak home lending - lowest since 1977

  • Two-tier economy - booming mining industry/slumping domestic economy

  • Rise in wholesale funding costs - narrowing margins

  • Exposure to slowing growth in China - Australia's biggest trading partner

A slowdown in domestic demand for bank loans and mortgages is their biggest post crisis challenge - and will mean cost cutting at all four banks. Labor is responsible for 58% of all costs. Australia & New Zealand Bank announced February 13 plans to eliminate about 1,000 jobs. Westpac announced the loss of 400 jobs February 2nd. UBS AG forecast last month that Australian banks may need to eliminate 7,000 jobs in the next two years. These cost cutting measures will probably continue until the domestic and global economy is fully recovered. The question for investors right now is: Are the 'Big Four' attractive as investments at their current levels? This I will discuss in a follow up article.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in OTCPK:ANZBY, OTCPK:CMWAY, OTCPK:NABZY, WBK over the next 72 hours.