Aussie banks at risk if house prices slump

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A real estate agent's sign outside a house shows that it has recently been sold, in Sydney September 30, 2014. REUTERS/David Gray

SYDNEY (Reuters) – Australia’s four major banks could suffer a ratings downgrade in the event of a severe housing market downturn with second-order economic effects, a stress test published by Fitch Ratings showed yesterday.

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The test was undertaken as risks within the household sector continue to grow, the ratings agency said, adding Australian banks were vulnerable due to their large mortgage books.

House price growth across Australia’s major cities have already tempered since late last year, and the run of losses is generally expected to continue as banks clamp down on so called “liar loans” amid an exhaustive year-long public inquiry.

Just a few weeks after it commenced, a comprehensive, year-long Royal Commission has already uncovered a series of poor lending practices and wrongdoings among banks as they compete to expand their loan books.

Fitch’s stress test showed Commonwealth Bank of Australia and Westpac Banking Corp – the country’s top two mortgage lenders – experiencing the largest losses.

But the proportionally larger commercial exposures of Australia and New Zealand Banking Group and National Australia Bank would render them vulnerable in a broader stress event, Fitch added.

Australia’s four biggest banks derive 40-60 percent of their earnings from home loans, the most lucrative part of their business.

“The severe scenarios would involve a negative shift in Fitch’s view of the operating environment for Australian banks, as well as our assessment of asset quality, capitalisation, profitability and, potentially, funding,” Fitch said.

“These factors combined would be more likely to lead to downgrades.”

To be sure, Fitch’s central scenario is not a sharp or substantial correction in Australia’s housing market. The test, in fact, showed the banks could still withstand “a significant housing market downturn” without experiencing losses that threaten their viability.

It expects house price growth to moderate further in 2018 although a rapid rise in Australia’s unemployment rate could drive a sharper correction, while steep interest rates could pressure some borrowers given record high household debt.

The household debt to income ratio in the country is at an all-time high of 190 percent as Australians took advantage of record low interest rates to invest in the housing market, worrying policymakers.

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