We will need our healthy banks if the $US700 billion should fail to pass the US Congress in the next few days and markets shudder. But is heading for approval, according to the latest reports.
There's a great deal of fear and loathing abroad, especially since the collapse of Lehman Brothers (which is looking more and more like a major catalyst).
The Reserve Bank has constantly pointed out that the Australian banking system is sound, with little if any of the impact here that we have been seeing in countries like the US or UK.
But as the bank said, we are not immune there has been more upward pressure on interest rates as cash has gotten tighter.
Our banks are well capitalised, have low levels of bad debts and impaired assets while individuals and businesses have voted with their wallets by dumping billions of dollars of cash into the banks in short and longer term deposits.
But investors have taken a more jaundiced view.
The RBA points out that the banking sector on the ASX has fallen to be around 32% below its peak in November last year (when the ASX peaked).
There has also been a very pronounced increase in the volatility of bank share prices since mid 2007 with the daily absolute movement in the banking index averaging 2.3% over this period, compared with an average of 1% over the previous 10 years.
The largest movements occurred in July (of this year) , when the banking index fell by around 15% over three days, after the market was surprised by a couple of banks announcing higher provisioning charges.
The RBA points out that the fall in the Australian banking index since its peak has, however, been slightly less than the falls in the European and US banking indexes since their respective peaks, with these markets having declined by about 40%.
"Over a longer horizon, Australian banks have significantly outperformed many of the international peers."
The bank pointed out that the share prices of the companies included in the ASX 'diversified financials' index have been more volatile than for Australian commercial banks, with the relevant index declining by around 60% since its peak mid last year.
"The movements in banks' share prices have resulted in significant changes in market-based valuation measures, with the banks' price/earnings ratio falling to its lowest level since the mid 1990s and dividend yields rising equivalently.
"Each of the four largest Australian banks is rated AA by Standard & Poor's, with these ratings having recently been affirmed. Of the world's largest 100 banks, only a handful have higher ratings.
"Moreover, unlike some of the large financial institutions abroad, no Australian-owned bank has had its rating downgraded since the onset of the credit turmoil.
"A couple of foreign-owned banks operating in Australia have had their ratings downgraded," the RBA pointed out.
"In this difficult environment, Australia has benefited from having strong and profitable financial institutions with few problem assets on their balance sheets, and a sound regulatory regime.
"While the Australian financial system has not been completely insulated from developments abroad, it is weathering the current difficulties much better than many other financial systems," The central bank said yesterday in its bi-annual Financial Stability review, released yesterday.
And, yet there's a cash drought as the banks are nervous, prefer to keep billions of dollars in accounts at the Reserve Bank and are reluctant to lend to anyone.
Short term money market rates are spiking and if the RBA doesn't cut rates next month, we could be facing rate increases from banks nervous about their funding levels.
Several banks have already revealed high bad debt provisions, such as the ANZ and the National, which has provided over a $1.1 billion for possible losses on CDOs.
The Reserve Bank said that these higher charges are likely to see the banking system's aggregate post-tax profits fall in the near term, "with analysts generally anticipating that the aggregate profits of the five largest banks will be around 10 per cent lower in the second half of 2008 than in the same period a year ago.
"If this were to occur, the annualised post-tax return on equity over this period would be around 16 per cent which, while lower than the average return over the past decade, would be much higher than that being earned in many other banking systems around the world and many other industries in Australia."
"While provisioning charges have increased, the Australian banking system continues to experience a low level of problem loans. As at June 2008, non-performing assets accounted for around 0.7 per cent of banks' on-balance sheets assets, which is below the average since the mid 1990s.
"Only around half of the non-performing assets are classified as 'impaired', in that payments are in arrears by more than 90 days (or are otherwise doubtful) and the outstanding amount is not well covered by the value of collateral. (See the two graphs at the start of this story).
"Although the non-performing assets ratio is low, it has nonetheless increased over the past six months, with the rise evident across all the main segments of the domestic loan portfolio.
"The most notable increase has been in the non-performing business loan ratio, with this increase largely accounted for by a small number of exposures to highly geared companies with complicated financial structures and/or exposures to the commercial property sector. In banks' commercial property loan portfolios, the impaired assets ratio stood at 0.9 per cent as at March 2008 (the latest available data), up from the unusually low levels of recent years.
(That's a reference to the likes of Centro Properties, MFS, Allco and a group of smaller property financing companies).
"Much of the recent rise has been accounted for by loans for residential development and, particularly, retail property, with no apparent rise in the arrears rate on loans for office property.
"In the mortgage and personal portfolios, non-performing loan ratios have also risen, but remain around, or only slightly above, their levels of a year ago.
"As at June 2008, non-performing housing loans accounted for 0.4 per cent of Australian banks' outstanding onbalance sheet housing loans.
"For credit unions and building societies, non-performing housing loan ratios are slightly above their levels in June 2007 but, in aggregate, are below the level in the banking sector.
"The modest increase in housing loan arrears rates over recent years was not unexpected given the increase in financing costs for borrowers, and the easing of credit standards that took place over the past decade.
"Importantly though, this easing of standards was not nearly as marked as that in some other countries, most notably the United States. Reflecting this, the non-conforming housing loan market in Australia (the closest equivalent to the sub-prime market in the United States) has remained very small, with ADIs having virtually no presence in this market.
"Non-conforming loans account for less than one per cent of outstanding mortgages in Australia – compared with about 12 per cent in the United States – with the vast majority of these loans having been provided by a small number of specialist, non-ADI, lenders.
"More broadly, even on prime housing loans, arrears rates have historically been considerably lower in Australia than in the United States and the United Kingdom.
"As in their Australian operations, there has recently been a modest increase in measures of problem loans in Australian banks' foreign operations, although again from a low base.
"Entities in New Zealand account for the largest share of Australian-owned banks' foreign exposures, at around 40 per cent, with these exposures largely arising through the four largest banks' New Zealand-based operations.
"These operations continued to account for around 10–20 per cent of the four largest banks' group-wide profits in the latest half year. US exposures account for less than 10 per cent of Australian-owned banks' total foreign claims, and typically do not arise through lending to the US household sector.
"While some banks have reported that they have exposures to the US sub-prime market through holdings of financial instruments, these remain small when compared to the size of these banks' balance sheets.
"Another factor that has stood the Australian banks in good stead throughout the recent turmoil is that they have traditionally not relied heavily on income from trading activities for profitability.
"For the five largest banks, trading income accounted for only around 6 per cent of their total income in the latest half year, which is well below the equivalent share for some of the large globally active banks.
"Consistent with this, Australian banks have traditionally had only small unhedged positions in financial markets, with the value-at-risk – which measures the potential loss, at a given confidence level, over a specified time horizon – for the five largest banks equivalent to 0.03 per cent of shareholders' funds in the latest financial year.
"Reflecting the strong profitability of recent years, the Australian banking system remains soundly capitalised, with the aggregate total capital ratio standing at 10.6 per cent as at June 2008, and the Tier 1 ratio at 7.3 per cent.
"Similarly, the credit union and building society sectors remain well capitalised, with aggregate capital ratios of 16½ and 14½ per cent, respectively.
"Strong profitability has meant that retained earnings remain an important source of banks' Tier 1 capital, with issues of preference shares and the dividend reinvestment plans of the five largest banks adding to Tier 1 capital over the past year."
That's a clean bill of health, but the pressures from the US are immense and this weekend looms as crucial.
