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Banking Industry Country Risk Assessment: Australia

Major Factors


S&P Global Ratings classifies the banking sector of Australia (AAA/Negative/A-1+) in group '3' under its Banking Industry Country Risk Assessment (BICRA). Other countries in group '3' include Denmark, France, Korea, Netherlands, Chile, Czech Republic, the U.K., and the U.S. (see chart 1).

Chart 1


Our bank criteria use our BICRA economic risk and industry risk scores to determine a bank's anchor stand-alone credit profile (SACP), the starting point in assigning an issuer credit rating. The anchor SACP for banks operating only in Australia is 'bbb+'.

Australia benefits from being a wealthy and diverse economy. The country has performed relatively well during and following negative cycles and external shocks. Australia has to date successfully contained the spread of COVID-19 after a second wave in the second most populous state of Victoria. We believe the national economy has commenced its recovery. This follows the first recession in the country in almost 30 years, triggered by the COVID-19 outbreak and containment measures. We expect credit growth to remain muted despite an accommodative monetary policy. We believe credit losses will ease to levels close to our expected long-term average by 2023 after a significant rise from a historical low in 2019. Following a modest correction in property prices during 2020, growth has resumed on the back of an expected economic recovery. We believe economic growth and low interest rates will continue to drive property price appreciation in the next two years. Nevertheless, high house prices and household debt, and Australia's external weaknesses--against the backdrop of global economic uncertainty--expose the banks to elevated risk of a substantial rise in credit losses in the next two years.

We consider that Australia's prudential regulatory standards are conservative. We also believe that the structure of the banking industry supports stability--a small number of strong retail and commercial banks dominate the sector. Low interest rates, weak credit growth, and a drop in fee income will curtail bank earnings. Still, bank earnings should remain sufficient to absorb higher credit losses. Substantial monetary support from the Reserve Bank of Australia (RBA) has alleviated funding and liquidity risks for the Australian banks. Nevertheless, the Australian banking system's material dependence on external borrowings exposes the banks to a disruption in access to funding as well as a rise in borrowing costs.

Economic And Industry Risk Trends

In our view, the economic risk trend for banks operating in Australia is negative, notwithstanding early signs of recovery after COVID-19 infections have been brought under control. We consider that there is a one-in-three possibility in the next two years that the economic risks facing the banks operating in Australia could rise. This could occur if we foresee the economic downturn (or its impact on the banking sector) becoming significantly more prolonged or severe than our current forecasts. In such a scenario, credit losses could rise substantially above our current forecasts and for more than just one year.

We assess the Australian banking system's industry risk trend as stable. In our view, the Australian banks are likely to work toward strengthening their governance standards following the highlighting of lapses in their conduct and risk management in recent years. In addition, the decisive funding support from the RBA should allay fears that the Australian banks face an imminent funding or liquidity crisis due to the COVID-19 outbreak. The well-coordinated action by the authorities seems positive for financial system stability. Nevertheless, industry risk could increase if, contrary to our expectations, Australian banks' earnings capacity materially deteriorates. Banking system stability could also weaken if the banks' risk-appetites become more aggressive in response to weaker earnings metrics than those seen in the past several years.

Economic Risk  |  3

In our opinion, economic risks that banks in Australia face are relatively low, reflecting a high-income, flexible, and resilient economy, conservative underwriting standard and a creditor friendly legal and institutional framework. However, the COVID-19 outbreak and containment measures have led to economic weakening. This, in turn, would very likely drive a significant increase in credit losses before they ease to levels close to our expected long-term average by 2023. Economic risks are also heightened by the buildup of property prices and private sector debt over several years, in addition to persistent current account deficits and high level of external debt.

Economic resilience: Economy is recovering following first recession in nearly 30 years

Economic structure and stability:  We believe Australia's economy remains structurally wealthy and diversified, with a high GDP per capita (see table 1). Australia appears to have brought COVID-19 infections under control after a second wave in the second most populous state of Victoria. We believe the national economy has commenced its recovery after the first recession in the country in almost 30 years. We estimate GDP to have grown by 0.7% in the September 2020 quarter, officially ending the recession. We expect growth to rebound strongly in the next two years. Large fiscal stimulus and accommodative monetary policy will support the economy in the immediate future. Australia's economy was hit hard by the global COVID-19 pandemic, which forced state governments to close large parts of their economies to contain the virus outbreak.

Australia's GDP growth will suffer over the next 12 months, reflecting lockdowns and the collapse in population growth due to international border closures. The government expects negative net migration for the first time since 1946. Migration has contributed about 60% of Australia's population growth over the past 15 years. We believe it will rebound strongly once borders open.

S&P Global Ratings believes there remains a high degree of uncertainty about the evolution of the coronavirus pandemic. Reports that at least one experimental vaccine is highly effective and might gain initial approval by the end of the year are promising, but this is merely the first step toward a return to social and economic normality; equally critical is the widespread availability of effective immunization, which could come by the middle of next year. We use this assumption in assessing the economic and credit implications associated with the pandemic (see our research here: As the situation evolves, we will update our assumptions and estimates accordingly.

Table 1

Australia -- Economic Resilience
(%) 2017 2018 2019 2020 2021f 2022f
Nominal GDP (bil. US$) 1,330 1,434 1,394 1,328 1,419 1,539
Per capita GDP (US$) 54,070 57,401 54,946 51,778 55,000 59,034
Real GDP growth (%) 2.4 2.9 2.0 (0.2) (2.2) 5.7
Inflation (CPI) rate (%) 1.7 1.9 1.6 1.3 3.0 1.5
Monetary policy steering rate (%) 1.5 1.5 0.8 0.3 0.3 0.3
Net general government debt as % of GDP 15.9 17.2 15.9 22.2 36.2 40.0
f-- Forecast. Year ending June 30. Source: S&P Global Ratings.

Macroeconomic policy flexibility:  We believe that the Australian government continues to benefit from high fiscal flexibility by international standards, underpinned by low public debt and strong fiscal discipline. Large COVID-19-related budget deficits do not represent a structural weakening of fiscal performance, with deficits forecast to narrow substantially by 2023. Net government debt nevertheless will remain elevated in the next few years. Monetary policy and a flexible exchange-rate regime remain key strengths for Australia. The central bank continues to purchase government bonds to ensure the market functions.

In response to the COVID-19 pandemic, the government revised its economic and fiscal strategy in its 2020-21 budget. It no longer aims to achieve budget surpluses, on average, over the course of the economic cycle. Instead, it is aiming to promote employment growth as well as business and consumer confidence until unemployment is comfortably below 6%. Once achieved, the government will shift its strategy to grow the economy to stabilize growth in net debt. The government's medium-term projections indicate the budget will remain in deficit for more than a decade.

Political risk:  Australia is characterized by effective policymaking, as well as transparent and accountable institutions. The fiscal and monetary policy frameworks are well established, and policymakers have maintained growth on a sustainable path and responded in a timely manner to shocks. Australian governments have a history of proactive policymaking to address structural budget pressures. In our view, there are no significant or immediate external geopolitical or security risks and organizations external to the national infrastructure have minimal effect on policy setting. Also, we regard public finance data and statistical information as comprehensive, reliable, and timely. Importantly, there is strong bipartisan support in parliament during economic and financial crises and there is strong respect for the rule of law, and a free flow of information and open public debate of policy issues.

Economic imbalances: Property prices are set to recover following a modest correction

We forecast that property price growth will resume with economic recovery and low interest rates, following a modest correction. Nevertheless, we expect a weak economy, elevated unemployment, and weak consumer and business sentiment to drive a significant rise in credit losses from the historical low in 2019. We consider that imbalances built up over several years of growth in house prices and private debt expose the banks in Australia to a scenario of a sharp fall in property prices, and its severe consequences.

Table 2

Australia -- Economic Imbalances
2017 2018 2019 2020 2021f 2022f
Annual change in claims of resident depository institutions in the resident nongovernment sector in % points of GDP (1.0) (1.1) (3.3) 2.7 0.4 (3.0)
Annual change in key index for national residential house prices (real) (%) 8.4 (2.5) (9.0) 4.9 2.0 5.5
Annual change in inflation-adjusted equity prices (%) 7.6 6.3 5.2 (12.2) N.M. N.M.
Current account balance/GDP (2.2) (2.8) (0.7) 1.8 1.9 (0.3)
Net external debt / GDP (%) 44.5 46.8 49.5 46.2 44.1 41.0
f-- Forecast. N.M: Not measurable. Year ending June 30. Source: Australian Bureau of Statistics, Australian Prudential Regulation Authority, Reserve Bank of Australia, S&P Global Ratings.

Private sector credit growth:  Australia's private sector credit (as a percentage of GDP) has marginally contracted since 2016 following macro prudential measures by the prudential regulator. We expect a further reduction in private sector debt to GDP by fiscal 2022 as GDP growth resumes. We forecast minimal credit growth (in nominal terms) in fiscal 2021; we expect growth in household debt during this period to offset a fall in corporate debt as unemployment is likely to remain elevated and investment sentiment weak. Nevertheless, we expect credit growth to resume in fiscal 2022 as the economy starts to grow, interest rates remain low, and a degree of monetary, fiscal, and policy stimulus from the government is likely to continue.

Real estate prices:  We expect modest growth in house prices to resume soon on the back of the economic recovery. Travel restrictions continue to impede immigration-driven population growth and consumer sentiment remains weak. These factors should rein in house-price appreciation in the next few months. However, low interest rates, easing of responsible lending rules, and housing supply shortages could reignite house prices over the next two years. We expect immigration-driven population growth to resume by fiscal 2022. Reduced construction of new homes in recent months is likely to persist in the next year, which should also amplify the persistent gap between demand and supply for housing--especially in Melbourne and Sydney, which attract most of the migrants.

The retail and office segments of commercial real estate prices and income are likely to be affected by low demand for such assets. Nevertheless, we note that Australian banks have limited direct lending exposure to commercial real estate (at about 6% of their lending), especially to real estate development and construction.

Equity prices:  In our view, the trend in equity prices does not indicate any significant additional buildup of economic imbalances. Along with global financial markets, the Australian equity market also fell sharply early this year followed by a strong rebound fueled by low interest rates. We believe that the banking sector's direct exposure to equities is manageable, although it has indirect exposures via corporate customers dependent on equity capital markets as well as through funds management and insurance subsidiaries of some banks.

Current account and external debt position:  External imbalances pose a relatively unique risk for banks operating in Australia compared with those in many other countries, in our view. We consider that Australia's economy remains vulnerable to major shifts in international capital flows. We believe the economy carries a high level of net external debt, at 250% of current account receipts (CARs), and a large stock of short-term external debt.

While these vulnerabilities are a structural feature of Australia's economic landscape, they are improving. The stock of short-term external debt, which is mostly borrowings by the Australian banks, has fallen to about 150% of CARs from more than 200% in fiscal 2016. Further, the current account recently moved into surplus for the first time in more than 40 years. This compares with an average current account deficit of about 20% of CARs during the past two decades. This improvement is also helping to reduce the volatility in the terms of trade associated with the country's reliance on commodity exports.

We believe external risks are somewhat ameliorated by the flexibility of monetary policy and Australia's actively traded and free-floating currency, which would help mitigate the negative economic impacts of a major external shock. Australia's domestic bond market is deep, and although external borrowing is high, it is mostly denominated in the nation's own currency or hedged.

Credit risk in the economy: Sound underwriting standards, government support, and loan repayment moratoriums should limit the rise in credit losses

Private-sector debt capacity and leverage:  With GDP per capita of about US$52,000 in 2019, we consider that the Australian economy's debt capacity remains strong. We expect private sector debt in Australia to remain relatively high at about 150%-155% of GDP in the next two years, but lower than that for a number of countries that we consider otherwise similar, such as Japan, Norway, Sweden, and Switzerland (see table 3). We consider that high income and wealth levels support the private sector's debt-bearing capacity. Financial assets held by the household sector are strong at about 290% of GDP, compared with household debt of about 100% of GDP. Superannuation (or pension fund) balances form a large part of Australia's financial assets, with households showing healthy levels of retirement savings compared with many other advanced economies.

Australia's household debt remains high, but there are factors that reduce the credit risks, in our view. The tightening in lending standards for residential mortgages in recent years has improved the quality of new lending and reduced risks emanating from wealth distribution. A good part of household financial assets is held in the mandatory superannuation schemes. Many workers affected by the COVID-19 outbreak and containment measures have benefitted from wage subsidies and superannuation balances to compensate for lost income. Loan repayment deferrals will also provide a safety net for those households that would otherwise struggle to service their obligations. These factors will help households manage their debt during this difficult period, in our opinion.

Corporate debt is relatively low by international comparison. We also consider that the corporate sector has entered the economic downturn from a relative position of strength. Firms have generally reduced their leverage in recent years and improved their liquidity. Furthermore, the large fiscal, monetary, and policy support measures should help them in managing their cash flows and financial obligations, in our view. Nevertheless, we expect that businesses will face sizeable stress due to reduced economic activity and restrictions applied by the authorities to contain the pandemic. Manufacturing supply chains, retail, travel, tourism, hospitality and education related businesses will be amongst the most impacted in our view.

Lending and underwriting standards.   In our view, lending and underwriting standards in Australia are well developed and conservative. The banking sector's average loan-to-value (LTV) ratio for newly approved residential mortgage loans remains below 60%, which is reasonably low by global standards. While this level could be partially attributable to elevated property valuations, the progressively stringent LTV and debt-servicing requirements that the prudential regulator introduced as cooling measures have also played a part in constraining LTV ratios for new housing loans. We believe that lending criteria include generally rigorous serviceability tests and security valuations, and most lending policies, including those concerning loan-to-valuation, appear sound. Australia's robust credit data sharing system, which includes both positive and negative data, supports effective implementation of underwriting standards. We believe, the Australian banking sector's lending and underwriting practices will remain moderately conservative and much stricter than prior to the global financial crisis of 2008.

The banking system's largest lending concentration by sector is toward low-risk residential property at about 60% of the total loan book. These exposures are generally well managed and loss rates have remained low. Otherwise, lending concentrations generally are not large--whether to higher-risk sectors, single names, or foreign currencies--and are generally well managed.

Australian Prudential Regulation Authority (APRA) prudential guidance requiring tighter lending standards by banks, which was introduced in late 2014 and has since been progressively further strengthened, has curtailed growth in riskier mortgage loans. We believe that risks associated with securitization, derivatives, and higher-risk lending activities such as property construction, are not significant, and reasonably well managed. Further, the regulatory authorities have been working closely together to minimize the economic harm caused by the pandemic, to avoid the impairment of household and business balance sheets and to support financial market functioning. We believe these measures, along with the strong starting position of the banking system, increase the financial system's ability to absorb, rather than amplify, the effects of the pandemic.

Payment culture and rule of law:  In our view, the payment culture and rule of law in Australia are strong. We regard the legal framework as predictable and supportive of creditor rights, in that creditors generally can recover collateral without inordinate delays in the event of foreclosures. A customer failure to repay a lender is a personal or corporate bankruptcy where the lender has recovery rights over all the borrower's assets, not just over the collateral supporting the loan. We believe that with the amendment to the privacy Act 1988 and the introduction of the consumer credit framework in 2014 has further enhanced the support to creditors by sharing a broader array of borrower information with the credit scoring agencies. Implementation of open banking by all banks should further strengthen the rule of law and payment culture by reducing information asymmetries allowing lenders to be more risk sensitive.

Australia fares strongly on the World Bank's Worldwide Governance Indicators for 2019, scoring 1.73--ranges from approximately -2.5 (weak) to 2.5 (strong)--on Rule of Law and 1.81 on Control of Corruption. In addition, Australia also ranks well at 12 in Transparency International's corruption perception index. According to the World Bank's "2020 Doing Business Report," Australia is now ranked 14th in the world for "ease of doing business."

Table 3

Australia -- Credit Risk In The Economy
2017 2018 2019 2020 2021f 2022f
Claims of resident depository institutions in the resident nongovernment sector as a % of GDP 142 140 137 140 140 137
Household debt as % of GDP 104 104 102 101 104 102
Household net debt as % of GDP (173) (178) (188) (189) (201) (197)
Corporate debt as % of GDP 54 53 52 54 52 50
Domestic nonperforming assets as a % of systemwide domestic loans 0.9 0.9 0.9 1.0 2.4 1.4
f-- Forecast. Year ending June 30. Source: Australian Bureau of Statistics, Australian Prudential Regulation Authority, Reserve Bank of Australia, S&P Global Ratings. Corporate debt includes borrowings through capital markets.
Base-Case Credit Losses: Sound underwriting standards, government support, and loan repayment moratoriums should limit the rise in credit losses

In our base case, we estimate that COVID-19 will contribute to Australian banks' credit losses in fiscal 2021 increasing to about five times the historical low in 2019. We consider that a fall in GDP, elevated unemployment, and weak consumer and business sentiment will weaken the banks' asset-quality metrics. The credit losses should ease to levels close to our expected long-term average by 2023.

We believe that the full extent of losses will take some time to materialize. We expect that many businesses and households are likely to struggle to meet their financial obligations once the restrictions to contain coronavirus outbreak are lifted, when the moratorium on debt servicing ends, and the fiscal support from the government is reduced.

Table 4

Australia--Projected Credit Loss Rates* (As % of Lending)
(%) 2017 2018 2019 2020 2021f 2022f
Total 0.16 0.13 0.13 0.40 0.65 0.60
*Actual and projected credit loss rates as % of lending. f--Forecast. Year ending June 30. Source: Bank Financial Statements, S&P Global Ratings.

Industry Risk  |  3

We consider Australia's banking industry risk to be low by international comparison. We believe that Australian banks benefit from conservative regulation and supervision as well as proactive risk mitigation. Further, the implementation of recommendations by the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (Royal Commission) should bolster the resilience of the financial sector, in our view. We consider that the risk appetite settings of banks are conservative and that the industry structure is stable--an oligopoly dominated by four large banks. We note that the Australian banks have strengthened their funding and liquidity profile over recent years by increasing retail deposits, reducing dependence on short-term wholesale borrowing, lengthening average maturities, and increasing diversification. Nevertheless, we consider that the structural challenges with funding of the Australian banking system are likely to persist and the system remains exposed to the risk of a disruption in access to external borrowings--whether triggered by domestic or international stresses.

Institutional framework: Strong regulations and supervision remain a key strength of the system

Banking regulation and supervision:  We believe that banking regulation and supervision in Australia are strong. In our opinion, regulations are conservative by international standards, with good supervision and extensive regulatory coverage. There is one prudential regulator, APRA, which supervises all deposit-taking institutions, insurance companies, and superannuation funds in Australia. We believe that APRA monitors the banks closely and frequently. APRA works in close cooperation with the RBA, the corporate regulator--the Australian Securities and Investments Commission (ASIC)--and other government bodies or departments, when needed.

In comparison with international peers, APRA applies stringent deductions when computing qualifying regulatory Tier-1 capital, higher loss-given-default floors on residential mortgages, and requires banks to hold capital for interest rate risk in the banking book. We also believe that APRA's capabilities are backed by adequately resourced staffing. Furthermore, we believe that APRA has a strong institutional culture of adhering to one of its key objectives of ensuring financial system stability, and it is willing to exercise its authority when needed.

We consider that APRA is typically an early adopter of international best practices. For example, the Basel III Net Stable Funding Ratio came into effect on Jan. 1, 2018, while the liquidity coverage ratio (LCR) was implemented on Jan. 1, 2015, with the minimum ratio requirement set to reach 100% on Jan. 1, 2019, with phase-in arrangements. Banks must also adhere to the Basel Leverage Ratio requirement of 3%. Further to ensure sector stability, in 2008 APRA introduced the Financial Claims Scheme (FCS), which is an Australian Government scheme that provides protection to deposits in banks, building societies, and credit unions, and to policies with general insurers in the unlikely event that one of these financial institutions fails.

In our opinion, Australian regulators have proactively adapted international standards and practices, as needed to adjust for Australia-specific system characteristics or objectives, to support financial system stability. For example, APRA--together with the RBA--resolved challenges posed by the limited availability of government securities for maintaining liquidity ratios. This was achieved by offering the banks an innovative solution in the form of a committed liquidity facility from the RBA, which is considered equivalent to high quality liquid assets for the purpose of calculating regulatory liquidity ratios. In addition, the Australian authorities have adapted a relatively unique plan to strengthen the total loss absorbing capacity of the systemically important banks via increasing their tier-2 capital by about 3% points of risk weighted assets.

We believe Australia's regulatory environment is supportive of fintech development and competition in the financial services sector. APRA and ASIC have adopted licensing programs for fintech, which act as a regulatory sandbox. However, Australia remains in the early stages of implementing key regulatory measures relative to international peers. For example, the implementation of European open banking regulations commenced in early 2018, while Australia's implementation began in July 2020.

Regulatory track record:  In our opinion, APRA has a good record of regulation and supervision of the banking sector. Regulatory management of crises and stressful market periods has been decisive and sound--even if Australia was not as negatively affected as some countries were by the global financial crisis. We consider that APRA's proactive banking regulation and supervision supported financial stability prior to and through the financial crisis in 2009-2010. At the same time, we consider that governance and risk management lapses that have emerged in the past two to three years, including those at the Royal Commission hearings, highlight some weaknesses in effectiveness of regulation.

Supervisory processes appear reasonably intrusive. APRA continues to make changes to its prudential standards to achieve a stable and competitive financial system. To offset risks faced by the financial system against rising imbalances, in the past four years APRA has progressively strengthened supervisory actions such as speed limits on riskier mortgage lending and appropriate pricing for risk. In March 2017, APRA announced a number of macro prudential actions that in our view have supported financial system stability because these measures have helped in abating the buildup of credit risk and imbalances in the economy, including the ongoing orderly unwinding of house prices. In response to the outbreak of COVID-19, APRA announced that banks may defer meeting the "unquestionably strong" capital benchmarks. That said, we expect these measures will not lead to any relaxation in the banking sector's capital levels.

Governance and transparency:  Notwithstanding lapses in governance highlighted in the past two to three years, we regard governance and transparency in the Australian banking industry as good by global standards. Furthermore, we expect that the implementation of the Royal Commission's recommendations should boost the Australian financial sector's regulation and governance. The Australian Corporate Governance Code sets out standards of good practice concerning board leadership and effectiveness, remuneration, accountability, and relations with shareholders. All of the largest banks are listed on the local stock exchange and are subject to strict continuous and timely disclosure requirements. Banks provide timely release of full-year accounts prepared and audited under IFRS standards. In addition, they release detailed six-monthly accounts, and quarterly trading updates and pillar-3 disclosures. Material accounting restatements are rare.

Competitive dynamics: A mature, stable, orderly industry dominated by four strong retail-commercial banks

Risk appetite:  Despite lapses in risk management and governance highlighted in the past three years, including at the Royal Commission, we view the Australian banking industry as benefiting from an overall low-risk appetite, reflected in a prolonged trend of strong earnings metrics by international comparison (see table 5). Banks generally have a track record of prudent risk pricing and management rather than chasing aggressive growth or returns. We believe that good regulatory and governance frameworks allow limited latitude toward risk-taking that could pose serious financial stability challenges. The banks operate in an oligopolistic industry structure, which enables good economies of scale and cost efficiencies.

Low interest rates, weak credit growth, and a drop in fee income will curtail bank earnings. However, the earnings should remain sufficient to absorb the higher credit losses, in our view. In addition, we expect the banks to maintain their capital strength by cutting dividend payments and issuing new capital, if needed. The recovery of earnings and credit losses to pre-COVID levels will be drawn out. Banks will struggle to regain earning metrics, reflecting the longer-term trend of gradual erosion in earnings, and low interest rates that are likely to prevail for some time.

In our view, the Australian banks will continue to price rationally for risks, affording them a buffer for unexpected situations such as the current pandemic. In the longer term, however, continued weak bank earnings could engender greater risk taking.

Table 5

Australia -- Competitive Dynamics
(%) 2017 2018 2019 2020 2021f 2022f
Return on equity (ROE) of domestic banks 12.9 11.9 11.6 8.2 5.5 6.2
Systemwide return on average assets 0.8 0.8 0.7 0.5 0.4 0.4
Market share of largest three banks 62.3 62.3 61.7 60.1 60.4 60.4
Market share of government-owned and not-for-profit banks 1.1 1.0 1.1 0.9 0.9 0.9
Annual growth rate of domestic assets of resident financial institutions 3.4 1.8 10.1 13.1 (0.0) 5.0
f-- Forecast. Year ending June 30. Source: Australian Prudential Regulation Authority, Bank Financial Statements, Reserve Bank of Australia, S&P Global Ratings.

Governance issues have emerged in the Australian banking sector in the past three years, including overcharging customers, nonadherence to responsible lending standards, or failure to timely report suspicious transactions to the financial crimes regulator. The need for monitoring and management of nonfinancial risks has also been highlighted. We consider some of these lapses to be indicative of potentially latent aggressiveness in governance and risk appetite.

Our assessment of competitive dynamics considers low use of innovative, complex, and risky products, and limited high-risk lending. Australia's major and regional banks are retail commercial banks. Australian banks practice prudential capital management by maintaining a good capital buffer over the regulatory minimum and adopting prudent dividend payout policies, and where necessary, supplement it with dividend reinvestment schemes. We note that the banks are not engaged in broad-based investment-banking activities such as equity underwriting--except some financial market activities that are adjunct to core banking activities. The banks' exposure to interest rate risk is lower than in many other systems--and interest rate repricing flexibility is commensurately higher--because of the preponderance of assets and liabilities written at floating rather than fixed rates. Banks are partnering with fintech companies to maintain competitiveness in the core domestic and regional markets, particularly in trade finance and payments--to improve customer experience and efficiency.

We note that while residential mortgages form a significant portion of lending by the banking sector, use of subprime mortgages has been minimal. We believe that use of securitization and covered bonds is limited to vanilla products and is aimed mainly at diversifying funding risks rather than shifting them. We believe that banks do not engage in significant proprietary financial market trading, and that offshore activities are generally not in significantly riskier geographies. Furthermore, foreign currency lending forms only a small percentage of total lending, with currency risks typically hedged.

Industry stability:  In our opinion, Australia's banking industry is stable. We believe that the probability of material new entrants upsetting the current stable industry dynamics is low. We do not see overcapacity in the banking system, noting that the banks have historically been able to generate satisfactory risk-adjusted returns without engaging in irrational price competition or taking undue risks. At the same time, we believe technology has the potential to disrupt the competitive landscape in Australia, similar to most other banking markets globally. APRA has awarded a number of online banking licenses in addition to use of online banking platforms and brands by some existing banks. We also do not expect the recent advent of virtual banks to significantly change the banking landscape, given that the top banks are likely to maintain their market leadership due to their well-established franchise. Virtual banks are more likely to be niche players than direct challengers to the existing big four banks and these banks would mainly be active in the retail and small and midsize enterprise (SME) segments. The introduction of an open banking regime, scaled fintech companies entering from international markets, and the launch of a number of new challenger banks, as well as the continued growth of international banks and nonbank players, are compelling the major banks to invest in digital and technology capabilities and in new customer propositions.

Market distortions:  In our view, the Australian banking industry is characterized by an absence of market distortions. The government does not influence the competitive dynamics by measures such as directed lending or ownership of banks. Also, the government does not impose administrative controls over deposit and lending rates on authorized deposit-taking institutions. We believe there are no material competitive distortions from nonbank competitors, which are mostly finance companies with their own niche focus. In our view, these institutions show generally conservative growth and earning appetites, and stick to their niches. There is no meaningful so-called shadow banking industry, with APRA supervising most of the financial system assets. Despite some traction, the Australian peer-to-peer lending market remains a structurally challenged niche market.

Systemwide funding: Relatively High Reliance On Non-Deposit And Offshore Funding

The Australian banking system's relatively low levels of customer deposits and its sizeable dependence on net external borrowings--despite some improvements in banks' funding profile in recent years--remain key weaknesses compared with other banking systems (see table 6). Nevertheless, early, decisive action by the RBA has alleviated funding concerns--traditionally considered among the biggest risks facing Australian banks, particularly during periods of economic or financial market dislocation. In addition, strong deposit growth and weak credit growth have boosted banks' funding positions in recent years.

Table 6

Australia -- Systemwide Funding
(%) 2017 2018 2019 2020 2021f 2022f
Systemwide domestic core customer deposits by formula as a % of systemwide domestic loans 46.6 47.0 48.1 51.3 55.7 56.2
Net banking sector external debt as a % of systemwide domestic loans 18.2 19.2 20.4 16.5 18.0 20.2
Systemwide domestic loans as a % of systemwide domestic assets 69.2 70.7 66.1 60.6 60.6 60.6
Outstanding of bonds and CP issued domestically by the resident private sector as a % of GDP 46.0 43.7 43.2 40.8 37.9 36.6
Total consolidated assets of FIs as a % of GDP 237.4 230.7 230.1 273.1 273.8 268.0
Total domestic assets of FIs as a % of GDP 204.5 198.5 207.5 230.8 231.4 226.5
f-- Forecast. Year ending June 30. Source: Australian Prudential Regulation Authority, Reserve Bank of Australia, S&P Global Ratings.

Core customer deposits:  Australian banking system assets are funded by lower levels of customer deposits compared to a number of developed countries as well as almost all other countries in Asia-Pacific. Nevertheless, we believe that confidence in bank deposits is high, reflected in the absence of a major run on bank deposits for more than two decades, noting that prompt action by the government in guaranteeing bank deposits following the onset of the global financial crisis minimized the possibility of this occurring at that time. Deposits are also supported by a healthy domestic savings rate, although a large part of household savings are channeled as contributions to superannuation funds. The superannuation system in Australia is large by international standards and has grown rapidly in recent years, primarily as a result of government policy settings to support an ageing population. As of Sept. 30, 2020, superannuation assets totaled A$2.9 trillion, about 150% of GDP.

We note that compared with the four major Australian banks, a large number of the smaller deposit taking Australian banking institutions show a stronger proportion of customer deposits to their total funding. Nevertheless, we consider that the funding profile of a number of these smaller Australian banking institutions to be weaker and less stable relative to the major Australian banks. We believe that in a systemic banking crisis that leads to a run on deposits, the major banks are likely to benefit from a flight to quality due to potentially perceived greater financial strength. Furthermore, we expect that the major banks' larger balance sheets and more profitable operations would enable them to more aggressively compete for domestic deposits if they decide to or were forced to do so, for example if there were a dislocation in overseas wholesale funding markets. And the smaller institutions would find it difficult to match the pricing power of the major banks in such a scenario.

External funding:  In our opinion, the systemwide funding of Australia's banking industry is weakened by a sizeable dependence on net external borrowings. Although there has been a trend of reducing dependence in recent years, net offshore borrowings are likely to remain material in our view. We consider cross-border funding to be a more vulnerable source of funding for a banking system during periods of economic, financial, or liquidity distress. In particular, we believe that the Australian banking system's potential sensitivity to a disruption in external funding could be more pronounced during a period of falling property prices, increased credit losses, or any other significant banking or economic crisis. Nevertheless, we believe that the major Australian banks have developed good franchises in the global wholesale funding markets across a number of geographies and types of investors--which we regard as being able to assist them in managing these risks. Since the introduction of covered bonds in 2011, banks' funding capabilities have improved. The Australian banks have managed to find offshore investors for these bonds.

Domestic debt-capital markets:  We consider that the Australian banking system benefits from access to a generally broad and deep debt capital market. We believe that funding sourced from domestic-debt capital markets is more stable than that sourced externally, although it is potentially less stable than core customer deposits. In our view, the outstanding short- and medium-term debt issued by the Australian private sector within the domestic capital markets is sizeable. Australia also has an active hybrid market that is mainly geared toward the retail sector. Although the domestic market is more limited for speculative-grade debt, we note that all the Australian banks are rated in the investment-grade range.

Government role:  In our opinion, the Australian government plays a strong role in supporting the funding needs of Australia's banks, and has been responsive and flexible during times of stress. This year, the RBA swiftly responded to the pandemic by making a substantial amount of funding available to the Australian banks, thus alleviating any funding or liquidity concerns. The government also has an effective track record of providing guarantees for wholesale and retail funding throughout the global financial crisis. Further, given the limited supply of high quality liquid assets (mainly Australian Government and semigovernment securities) in Australia, the RBA set up a committed liquidity facility for the Australian banks that also supports the implementation of the Basel III liquidity reforms in Australia, including the LCR framework.

Peer BICRA Scores

We see the banking system in Canada as a close peer for Australia. The Australian and Canadian banking industry structures are broadly similar, being stable and orderly, dominated by a small number of strong banks. Similar to Australia, banks operating in Canada are also exposed to elevated home prices and credit growth in recent years. Nevertheless, we see economic imbalances in Canada as less intense than those in Australia partly because we consider that the Australian economy is exposed to significantly greater external risks.

Similar to Australia, we consider the Singapore, Hong Kong, and Canadian banking systems as having low risk institutional and competitive frameworks (see table 7). A relative weakness for the Australian banking industry, in our view, is that systemwide funding risks are higher compared with those in the other three countries, reflecting Australian banks' greater dependence on offshore borrowings in conjunction with limited support from customer deposits.

While the Australian economy lacks size, depth, and diversity compared with some other countries, such as the U.S., the U.K., and Germany, we consider that on an overall basis Australia's economy is equally resilient and has good forward prospects.

Table 7

Australia -- Peer BICRA Scores
Australia Canada Hong Kong Norway Singapore Sweden
BICRA group 3 2 2 2 2 2
Economic risk score 3 3 3 2 3 2
Industry risk score 3 2 1 3 2 3
Government propensity to support Highly supportive Supportive Supportive Uncertain Highly supportive Uncertain
Source: S&P Global Ratings.

Government Support: Highly supportive

We classify the Australian government as being highly supportive of the country's private sector systemically important banks (see table 8). We expect the government will provide timely financial support to ensure the stability of the financial system, if needed. This assessment factors in a well-developed institutional framework that should facilitate a timely and coordinated response. The government has a track record of proactive and prompt support for the banking system through measures such as guarantees for funding during the global financial crisis. In addition, the authorities provided various funding and liquidity support mechanisms during the current pandemic. We believe that the government's existing legislation, policy, and relationships with supranational agencies do not hinder it from assisting the banking system.

Table 8

Australia -- Five Largest Financial Institutions By Assets
Assets (bil. AUD) Likelihood of government support
Australia and New Zealand Banking Group Ltd.@ 1,042 High
Commonwealth Bank of Australia$ 1,014 High
Westpac Banking Corp. @ 912 High
National Australia Bank Ltd.@ 867 High
Macquarie Group Ltd.@ 231 Moderately high*
*Moderate likelihood of support applies only to Macquarie Bank Ltd. within Macquarie Group Ltd. $ At June 30, 2020. @ At Sep 30, 2020. Source: Bank Financial Statements, S&P Global Ratings.

This report does not constitute a rating action.

S&P Global Ratings Australia Pty Ltd holds Australian financial services license number 337565 under the Corporations Act 2001. S&P Global Ratings' credit ratings and related research are not intended for and must not be distributed to any person in Australia other than a wholesale client (as defined in Chapter 7 of the Corporations Act).

Primary Credit Analyst:Sharad Jain, Melbourne + 61 3 9631 2077;
Secondary Contacts:Nico N DeLange, Sydney + 61 2 9255 9887;
Lisa Barrett, Melbourne + 61 3 9631 2081;
Sovereign Analyst:Anthony Walker, Melbourne + 61 3 9631 2019;

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