RC changes S&P’s view of Australian banking system

The ratings agency said that developments in the lending space over the last two years, including information coming out of the Hayne royal commission, show weaknesses in the conduct, governance and risk appetite shown by Australian banks.

“Consequently, we no longer assess the Australian banking system’s institutional framework and competitive dynamics to be very low risk, the lowest risk level on our six-point scale within our Banking Industry Country Risk Assessment (BICRA),” S&P noted in an update published on Tuesday.

“We have revised our assessment of the Australian banking system’s institutional framework and competitive dynamics to low risk from very low risk.”

Out of about 90 countries in which it rates banks globally, S&P now assesses institutional framework as being very low risk for only three banking systems: Canada, Hong Kong and Singapore. S&P no longer assesses competitive dynamics as being very low risk in any banking system globally.

“Reflecting the revisions in our assessment of institutional framework and competitive dynamics, we consider that the industry risks faced by the Australian banks are marginally greater than those reflected in our previous assessments,” the ratings agency said.

“Although the revisions have not resulted in us lowering bank ratings, they have eroded the cushion for further adverse developments within the current rating tolerances. Furthermore, this has also limited the upside to the ratings due to any system-wide improvements.”

According to S&P, the revision in industry risk scores for the Australian banking system reflects a recalibration of its assessments against its criteria for assessing banking system risks, in light of new information that has emerged in the past two years.

“We do not consider that industry risks have heightened in recent times. Indeed, we consider that the response to recent developments, including the hearings at the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, is likely to contribute to making regulation, governance and risk appetites within the banking sector more conservative in the next two years.

“We now assess the economic risk trend for Australia, as it affects the banking sector, as positive. We expect that the trend of an orderly unwinding of imbalances should continue for at least the next year. This trend, in our view, would alleviate economic risks faced by the banking system, if the four-year average growth of private sector debt to GDP slows to about 2 percentage points.”

S&P believes the banks are likely to further strengthen their underwriting and documentation standards, which should contribute to lower lending growth than that seen in recent years.

“Continuation of prudential limits on growth in investor mortgages and a likely increase in the risk weights applicable to interest-only, investment and high loan-to-value mortgages written by the larger banks should also dampen lending growth.”

The ratings agency is confident that these developments should partly offset the impetus on house prices from low interest rates, a relatively benign economic outlook, and an imbalance between housing demand and supply.

“We currently expect that any alleviation of economic risks, by itself, would not result in any changes to our issuer credit ratings on the Australian banks or finance companies.”

[Related: S&P flags risk of reduced access to refinancing]