If Australia is an economic miracle -- the so-called Lucky Country, beneficiary of more than a quarter century of uninterrupted growth -- then its banks are its most visible sign of strength.
Australia's Banks are glittery but maybe not gold
(Bloomberg View) -- Satyajit Das
If Australia is an economic miracle -- the so-called Lucky Country, beneficiary of more than a quarter century of uninterrupted growth -- then its banks are its most visible sign of strength. After a near-death experience in the 1990s, they’ve reformed and bounced back dramatically: Returns on equity now average around 15 percent, compared to single digits in the U.S. Share prices and dividends have risen strongly over the past decade. At around twice book value, market valuations are well above global levels.
In fact, though, this ruddy good health masks some deeply worrying trends. The balance sheets of Australia’s biggest banks are far more vulnerable than they may seem on the surface -- and that means Australia is, too.
To most observers, this might sound alarmist. Scared straight after a mountain of bad loans nearly brought them down at the beginning of the 1990s, the banks reformed and minimized their international exposure, which meant they were insulated from the worst effects of the Asian financial crisis and the 2009 crash. Today they face little competition in their home market and have benefited tremendously from Australia’s strong growth, underpinned by China's seemingly insatiable demand for the country’s gas, coal, iron ore and other raw materials. During the 2012 European debt crisis, Australia's banks were worth more than all of Europe's.
But Australian financial institutions have made the same fundamental mistake the rest of the country has, assuming that growth based on “houses and holes” -- rising property prices and resources buried underground -- can continue indefinitely. In fact, despite a recent rebound in Chinese demand, commodities prices look set to remain weak for the foreseeable future. Banks’ exposure to the slowing natural resources sector has reached nearly $50 billion in loans outstanding -- worryingly large relative to their capital resources.
If anything, their exposure to the property sector is even more dangerous. Mortgages make up a much bigger proportion of bank portfolios than before -- more than half, double the level in the 1990s. And they’re riskier than they used to be: Many loans are interest-only, while around 80 percent have variable rates. With a downturn likely -- everything from price-to-income to price-to-rent ratios suggests houses are massively overvalued -- losses are likely to rise, especially if economy activity weakens.
Australian banks are also more vulnerable to outside shocks than they may first appear. Their loan-to-deposit ratio is around 110 percent. Domestic deposits fund only around 60 percent of bank assets; the rest of their financing has to come from overseas. While that hasn’t been a problem recently, Australia’s external position is deteriorating. The current account deficit is expected to grow to 4.75 percent in the current financial year. Weak terms of trade, a rising budget deficit, slower growth and a falling currency are likely to drive up the cost of funds. If Australia’s economy or the financial sector’s performance falters, or international markets are disrupted, banks’ access to external funds could be threatened.
(Bloomberg View) -- Satyajit Das
If Australia is an economic miracle -- the so-called Lucky Country, beneficiary of more than a quarter century of uninterrupted growth -- then its banks are its most visible sign of strength. After a near-death experience in the 1990s, they’ve reformed and bounced back dramatically: Returns on equity now average around 15 percent, compared to single digits in the U.S. Share prices and dividends have risen strongly over the past decade. At around twice book value, market valuations are well above global levels.
In fact, though, this ruddy good health masks some deeply worrying trends. The balance sheets of Australia’s biggest banks are far more vulnerable than they may seem on the surface -- and that means Australia is, too.
To most observers, this might sound alarmist. Scared straight after a mountain of bad loans nearly brought them down at the beginning of the 1990s, the banks reformed and minimized their international exposure, which meant they were insulated from the worst effects of the Asian financial crisis and the 2009 crash. Today they face little competition in their home market and have benefited tremendously from Australia’s strong growth, underpinned by China's seemingly insatiable demand for the country’s gas, coal, iron ore and other raw materials. During the 2012 European debt crisis, Australia's banks were worth more than all of Europe's.
But Australian financial institutions have made the same fundamental mistake the rest of the country has, assuming that growth based on “houses and holes” -- rising property prices and resources buried underground -- can continue indefinitely. In fact, despite a recent rebound in Chinese demand, commodities prices look set to remain weak for the foreseeable future. Banks’ exposure to the slowing natural resources sector has reached nearly $50 billion in loans outstanding -- worryingly large relative to their capital resources.
If anything, their exposure to the property sector is even more dangerous. Mortgages make up a much bigger proportion of bank portfolios than before -- more than half, double the level in the 1990s. And they’re riskier than they used to be: Many loans are interest-only, while around 80 percent have variable rates. With a downturn likely -- everything from price-to-income to price-to-rent ratios suggests houses are massively overvalued -- losses are likely to rise, especially if economy activity weakens.
Australian banks are also more vulnerable to outside shocks than they may first appear. Their loan-to-deposit ratio is around 110 percent. Domestic deposits fund only around 60 percent of bank assets; the rest of their financing has to come from overseas. While that hasn’t been a problem recently, Australia’s external position is deteriorating. The current account deficit is expected to grow to 4.75 percent in the current financial year. Weak terms of trade, a rising budget deficit, slower growth and a falling currency are likely to drive up the cost of funds. If Australia’s economy or the financial sector’s performance falters, or international markets are disrupted, banks’ access to external funds could be threatened.
