RC and PC scrutiny could undermine banks’ pricing power

In its Banking Sector Outlook, Moody’s Investors Service has noted that it expects potential recommendations from the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, and the Productivity Commission (PC) to “weaken banks’ pricing power and the sector’s profitability”.

Moody’s noted that slowing credit conditions spurred by macro-prudential measures, combined with falling property prices, rising wholesale funding costs, an increase in regulatory and compliance costs, and a need to invest in technology for “efficiency gains” are set to place net interest margins “under pressure”, as reflected in the 2018 full-year financial results of several lenders.

The credit ratings agency added that banks would try and offset profit pressures through “adjustments to loan and deposit rates”, but it claimed that such measures would only “partially alleviate pressures on revenue and profit”.

Moody’s said that it also expects traditional banks to face stiffer competition from “technology-driven financial firms”, which it said would benefit from the Australian Securities and Investments Commission’s move to ease barriers to entry for fintechs.

However, Moody’s has said that the “royal commission’s recommendations alone are unlikely to alter the concentrated structure of the banking system”, which it claimed “offers favourable competitive dynamics for incumbent banks”.

Risks to asset quality to “remain high”

Moody’s has also reported that it expects “problem mortgages” to rise as borrowers transition from paying interest-only to principal and interest, and added that it expects out-of-cycle interest rate increases to “contribute to growth in problem mortgages”.

Echoing comments made by RBA assistant governor Michele Bullock, the credit ratings agency noted that while it expects asset quality to “remain strong” over the next 12 to 18 months, “tail risks” would “remain high” as the “resilience of household balance sheets and bank portfolios to a serious economic downturn has not been tested at the current level of private sector indebtedness”.

However, Moody’s claimed that “slowing credit growth and strong economic growth” would “ease the risks associated with high household leverage” and “underpin asset quality”.

Reflecting on falling property prices, Moody’s said that it does not expect the decline, which it said follows a “prolonged period of rapid appreciation”, to lead to an increase in “problem mortgage loans”.

Further Moody’s noted that it believes the “banks’ collateral quality will remain very strong despite house price declines”.

Slowing credit to ease funding burden

Moreover, Moody’s claimed that slowed loan growth would lead to a “marginal narrowing of banks’ funding gap and ease their wholesale funding needs”.

Moody’s stated that it expects credit to slow further amid tighter underwriting standards and falling property prices, which it said is likely to result in a “modest further narrowing of the funding gap over the next 12 to 18 months.

However, Moody’s stated that it expects Australian banks’ overall cost of funding to “continue to rise over the next two years as banks replace older and less costly wholesale market funding matures with higher-cost debt”.

Moody’s concluded that despite its forecast of a sustained rise in funding costs, “Australian banks will continue to enjoy strong access to global debt capital markets, with their credit-default swap spreads remaining at very low levels”.

[Related: Arrears fall, rate rises unlikely to affect credit quality: Fitch]