Outlook for banks still weak despite new capital requirements

Strengthening of the major banks’ balance sheets thanks to higher capital requirements should not be viewed by investors as a signal to increase their exposure to the sector, say commentators.

Tony Davison, general manager of financial advice boutique Henderson Maxwell, said the rally in bank shares was understandable, given a major cause of uncertainty had been removed and the banks would be able to meet the new rules with little difficulty.

“The relief rally is totally warranted. The banks are already quite close to the 10.5 per cent target level. It is readily achievable and they have a long time to come up to the standard,” Mr Davison said.

The prudential regulator has lifted the target for major Australian banks’ equity capital ratio to “at least 10.5 per cent”, up from the level of common equity tier 1 capital of about 9.5 per cent as of December.

APRA says it wants the big four banks to meet the new requirements ahead of the 2020 deadline.

Andrew Tiggs of Deutsche Bank noted that forthcoming changes to the risk weightings, due to be unveiled later in the year, were included in the capital rules announced on Wednesday, removing the risk the banks would have to raise capital.

Outlook lacklustre

But Mr Davison said he was using the share price strength to reduce clients’ exposure to bank stocks because of the lacklustre outlook for the industry, which he blamed on low credit quality and pressure on margins. “It makes us think the earnings picture may weaken over time,” Mr Davison said.

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Mr Davison, like many other advice professionals, has long been concerned that Australian individual investors are too concentrated in local equities and in bank shares in particular, potentially dramatically increasing the risk in their portfolios.

Giselle Roux, chief investment officer of Melbourne-based advice boutique Escala Partners, said the Australian Prudential Regulation Authority’s move to make local banks “unquestionably strong” had “taken a little black cloud away”.

But, she said, it did not change the long-term outlook for the banks. “This should be no reason to increase exposure to the banks. The outlook for the banks remains weak,” Ms Roux said.

Ms Roux said she was concerned by the major lenders’ overexposure to the local housing market, the softness in the local economy and consumer spending, high levels of household debt. Increasingly banks are also pulling out of business lines such as wealth management and Asian financial services, she said.

“They are becoming straightforward lenders which won’t grow much more than GDP,” Ms Roux said.

Meanwhile, banks are highly leveraged. 

“The banks are not low risk. They are 10 times leveraged. Australians are of the view that they are low risk, but they are not low risk at all. They will always be highly leveraged and highly sensitive to interest rates and the economy,” Ms Roux said.

Shares of the big four banks and Macquarie rallied hard on Wednesday following the release of the banking regulator’s new capital requirements.

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