Are Australian Banks Better Off Than Those in the U.S. and EU?

On the whole, Australian banks seem in better shape than those in the EU27 and U.S. Though Australian banks will not be immune to asset quality deterioration and funding difficulties during the global credit crisis and recession, Australia’s recession will likely be milder than in its North Atlantic counterparts. With less exposure to on- and off-balance derivatives, Australian bank health is tied primarily to the strength of loans – 55% of which are housing-related, the highest share among the 3 regions. Fortunately, Australia’s housing market has swung around an inflection point into an uptrend driven by lower interest rates and the government’s First Home Owner Grant. As of end-2008, Australia scored best on most of the alphabet soup of bank performance indicators (see table below):

Profitability: ROE, ROA, NIM

Australian banks are more profitable than those in the U.S. and EU27. Return on Equity (ROE) is 10 times that of the U.S. and EU27. Return on Assets (ROA) in Australia is only half that of the EU27 but is 5 times that of the U.S. Australian banks’ net interest margin (NIM) – the difference between lending rates and deposit rates – has remained wide at 6.47%, slightly higher than the 6.1% at end-2007. Banks have sought to widen spreads between borrowing and lending rates to help recuperate bank profitability. NIM in the U.S. and EU27 is only half that of Australia’s, which implies a lower net interest income. Operating expense as a share of assets in Australian banks is 5 times higher than in the U.S. though.

Balance Sheet Risks: NPLs

The 2008 share of non-performing loans (NPLs) – or, loans in arrears for 90 or more days – in the total loan portfolio is lower in Australia (0.74%) than in the U.S. (1.03%) and is down from 1.61% in 2007. No data was found for the EU27. The ratio of impaired assets to total assets in Australian banks fell from 0.19% in 2007 to 0.04% in 2008. The Reserve Bank of Australia’s Financial Stability Review as of March 2009 highlighted 4 factors supporting asset quality in Australia: 1) Lending standards were not eased to the same extent as in the U.S. and EU; 2) The level of interest rates in Australia did not reach the very low levels experienced in the U.S. and elsewhere; 3) All Australian mortgages are ‘full recourse’; 4) The legal environment in Australia places a stronger obligation on lenders to make responsible lending decisions than is the case in the U.S.

Balance Sheet Risks: LDR, LLR

Though asset quality has not deteriorated as much as in the U.S., the size of Australia’s loan book poses a risk if asset quality does take a sharp downturn: Australia’s loan-to-deposit ratio (LDR) of 115% is nearly as high as the EU27’s 118% and higher than the U.S.’s 83%. Moreover, Australia’s loan loss reserves (LLR) cover only 80% of non-current loans (loans on which payments are past due) – not much better than the 79% coverage ratio in the U.S.. As assets exceed liabilities, Citigroup believes Australia’s high LDR will constrain asset growth in the long-term.

Balance Sheet Risks: CAR

Thankfully, Australian banks are better capitalized than those in the U.S. and have been more aggressive with write-downs than the EU27. The ratio of Tier 1 (core) capital ratios to risk-weighted assets is higher in Australia than in the U.S.. The core capital adequacy ratio (CAR) in Australia and EU27 is 8.3% – above the Basel II required 8% – while it sits lower at 7% in the U.S. The write-down rate has been lower in Australia than in the U.S. but noncurrent loans are also a smaller share of all bank loans in Australia compared to the U.S.

Off-Balance Sheet Risks and Other Weak Spots

Derivatives are a bigger threat to the U.S. than Australia. Derivatives are 16 times bank assets and 14 times 2008 GDP in the U.S., whereas in Australia derivatives are only 3.95% of bank assets and 33% of GDP. However, off-balance sheet derivatives are 5 times bank assets and 12 times 2008 GDP in Australia.

Aside from off-balance sheet risk, Australian banks are also relatively more vulnerable than the U.S. and EU27 in terms of liquidity and external liabilities. Cash and liquid assets are only about 4% of total assets in Australia, compared with 8% in the U.S. Banks’ external liabilities as a share of GDP in Australia are double that of the U.S..

Funding Outlook

Looking ahead, the scourge of external liabilities may subside in the medium-term. Many forecasters believe the Australian Dollar will not go much lower than its nadir of 61.9 cents per U.S. Dollar in October 2008. Since the Federal Reserve announced quantitative easing, the Australian Dollar has enjoyed a run on inflation concerns – against which Australia is better protected with its higher interest rates. An upturn in commodity prices has also pumped up Australian Dollar demand. And, of course, the milder recession in Australia in contrast to the rest of the developed world makes the Australian Dollar seem a safer bet than the traditional safe havens, such as the Japanese Yen and the U.S. Dollar.

Exchange rate concerns aside, wholesale funding costs may remain elevated compared with pre-crisis levels as banks around the world tighten credit and seek liquidity. Moreover, bank debt costs may rise in Australia as banks face an increased risk of rating downgrades. In March 2009, Moody’s warned that Australia’s bank ratings could survive a severe economic downturn but the damage to lending books could last for years. Bank shares meanwhile are stuck in a bear market but, unlike the U.S., have not come under government ownership.

Asset Quality Outlook

Key to the asset quality outlook for Australia is the housing market. Housing loans are 55% of Australia’s bank loan portfolio – higher than in the U.S. (26%) and EU27 (30%). An increasing majority of housing loans are owner-occupier loans and the rest is a stagnating share of investor loans. As 90% of home loans are variable-rate loans, the number and value of loans for housing investments contracted in 2007-2008 as rates shot up.

Fortunately, the Australian housing market downturn is likely to be milder than in the U.S. and EU27 in 2009. Australia’s house price correction had a head start going back to 2003. Furthermore, housing demand from migrants to the commodities-rich West and the chronic housing shortage in eastern Australia will keep prices from stabilizing back at pre-boom levels unless Australia fails to avoid a deep recession. Indeed, housing loans to owner-occupiers began to recover since October 2008 after the government provided grants for first-time purchases of homes. The 2009/10 Budget extended the grant program to December 2009, which should boost the affordability of houses. A Pauletich survey determined Australia had the 2nd least affordable housing in the world, behind New Zealand.

The New Zealand Zinger

Though the local housing market looks unlikely to pose an existential threat to Australian banks, New Zealand’s housing market may give some banks a run for their money. Australian banks own most of the banks in New Zealand, where the housing market is undergoing a deeper correction as immigration to New Zealand slumps. With housing assets 5.7x household disposable income, New Zealand property markets are even more leveraged than their U.S. counterparts. As the Australian Financial Stability Review states: “As at December 2008, the Australian banks’ overseas exposures accounted for around 30 per
cent of their total assets, with New Zealand and the United Kingdom together accounting for about two thirds of these foreign exposures.” Considering the relative outlooks for housing markets in Australia and New Zealand, external assets are a more significant danger to Australian banks than domestic assets. This could be the hidden dragon that swallows up Australian banks in the years ahead despite its ostensibly more comfortable position versus European and American banks.


Data Sources: APRA, RBA, ECB, Committee of European Banking Supervisors, FDIC, U.S. Federal Reserve


1 – weighted average for EU27 countries

2 – weighted average for EU27 countries

3 – median EU27 CAR for risk-weighted assets

4 – as of September 30 for Australia

5 – as of H1 2008 for EU27

6 – as of H1 2008 for EU27

7 – as of September 30 for Australia

Related Spotlight Issues:

Australian Dollar: Poised to Win the G-10 Beauty Contest?

Australian Economy: One Step Away from a Technical Recession

Australian Bank Sector: Credit Ratings Under Fire?

13 Responses to "Are Australian Banks Better Off Than Those in the U.S. and EU?"

  1. apj   May 14, 2009 at 10:18 pm

    Where on earth did that NIM come from? Looks way out. Best check some of the other data too….

    • Mikka   May 15, 2009 at 12:53 pm

      I used the average lending rate and average deposit rate across all maturities to derive the NIM for australian banks. The data was from RBA – I used Tables F04 and F05.

    • apj   May 15, 2009 at 11:45 pm

      hmm…well…recent half year results show ANZ’s net interest margin increased…but to 2.22%NAB’s is at 2.53%.And Westpac’s is 2.24%.Can’t remember CBA, but it’s close to these. They’re all up, but their not 6.47%.Maybe you didn’t take into acct the manner in which they’re funded, or that deposits are just over half of the banking system’s liabilites, or it’s a faulty weighting, but the numbers above are the NIMs for majors, and therefore, pretty much the whole system.

      • Mikka   May 26, 2009 at 10:29 pm

        If I strip out the lending rates for revolving credit, the NIM as of December 2008 falls to 5.46%. I only looked at lending and deposit rate data recorded by the RBA. I didn’t look at non-deposit liability rates and there was no weighting involved. I intend to do a more refined NIM calculation in the next update. FYI, the NIM for SME and corporate credit versus bank deposit rates is 3.56%

  2. devils advocate   May 15, 2009 at 5:03 pm

    very good overview- but leaves me asking…the Kiwi/UK exposure to Aussie banks is importantif 66% of the 33% overseas exposure is to NZ and to UK,that comes out to about 22% of Aussie bank assetswill NZ and UK try to mitigate the foreclosures a la USA? -quickly?that would decrease the Aussie bank losses from piling upand what about the commercial losses? -how much of the exposure is residential housing vs commercial?the 5.7x NZ home price to income will mean a large deleverage of home price for some homes,but NZ unemployment is relatively low and the home owners mostly put in down payments -unlike USA -so how to estimate the coming loss? in combination with a mortgage mitigation?furthermore…NZ migration has recently been reduced but still the in-coming migrants will tend to buttress up the housing market

  3. Guest   May 16, 2009 at 3:11 am

    As a shareholder in all 4 of the major Australia banks and Macquarie I hope they are better but let’s face it a housing price fall and defaults like in the US / UK and it’s all over. The one saving in Australia is that people are actually made responsible for their debts and can’t walk away from a property under water.

    • devils advocate   May 16, 2009 at 8:50 am

      hold onto your shares…although some (mostly younger) Aussies and Kiwis may “throw the keys in the kitchen sink” and walk out of the house, most will struggle to pay their mortgagethe Australian 3% interest rate is also helping to cut costs, and homeowners can quickly learn to spend less and credit card more to continue to pay their mortgagesquestion: are your banks seeking to modify the loans to help?

      • devils advocate   May 16, 2009 at 8:52 am

        p.s. the reduced # of migrants is still large enough to support the housing market (at least the renting)

  4. Anonymous   May 16, 2009 at 9:10 am

    Hope hope….we need it…house prices have to (will) go down in Australia to meet fundamentals…market is totally overpriced (around 30-40%) and recursive nature of loans in Australia + government grants is only thing which kept it from sharp fall…still inevitable will come as unemployment will rise (9%+) and slowly but surely people will not have other options even if interest rates are 1%. Let’s face the reality and admit that all that negative gearing and other tax incentives in Australia have backfired and the longer they are put off the bigger the price to pay. We need reform and I meant it..not just a fix, stimulus or bailout….. true reform and new base to grow our economy. Current Game is over!!

  5. devils advocate   May 16, 2009 at 10:29 am

    Australia Govt is talking with Telstra about the $43 Billion (US) expansion of broadband infrastructure and additional stimulus-infrastructure building-this will help with unemploymentplus, if it focuses on migrant-investors … business folk who can buy or start business instead of the mechanic/technician … this will help with unemploymentplus, if it focuses on Asian tourists … who love to travel … and you’re a CONTINENT close to Asia… this will help with the loss of tourist business and jobsand most of all, if it fosters competition and capitalism instead of socialism

  6. Anonymous   May 23, 2009 at 11:21 pm

    a lot of migrants from uk, ireland, cannot sell their homes + increased value of aud v pound/ euro will keep some migrants out of the market

  7. Anonymous   May 29, 2009 at 7:55 pm

    The real estate section in this post is a disappointing re-hash of housing industry spin, not up to rge does this “the Australian housing market downturn is likely to be milder than in the U.S. and EU27 in 2009” square with this “A Pauletich survey determined Australia had the 2nd least affordable housing in the world, behind New Zealand.”and this “The 2009/10 Budget extended the grant program to December 2009, which should boost the affordability of houses” makes no sense. The grant just created a bubble in prices in the first home buyer price range that will crash shortly after the grant expires.

    • micmac   June 2, 2009 at 4:07 pm

      There are pressures for Australian house prices to continue correcting but the grant will keep the correction mild at least in 2009. 2010 and beyond may be a different story though.