Fitch: Australian Bank Outlook Remains Stable in 2016

Fitch Ratings maintains a Stable sector outlook on Australia's banking sector in 2016. We expect strengthened capitalisation and recently tightened underwriting standards to offset slower profit growth and modest asset-quality pressure.

Profit growth in the banking sector is likely to slow due to ongoing asset competition, higher funding costs, and a modest increase in loan-impairment charges. Improvements in cost-management are likely to be offset by increased investment in technology.

Australia's household debt is likely to remain high in 2016, making borrowers sensitive to increased unemployment and higher interest rates. House prices will remain high relative to peer countries, but we expect house-price growth to moderate after 18 months of unsustainable growth in some Australian cities. Economic growth is likely to benefit from stronger household spending, which could either reduce Australia's savings rate or increase household debt. The unemployment rate is expected to remain relatively stable in 2016 before modestly improving in 2017.

Fitch expects Australia's credit cycle to turn in 2016, although any weakening in asset quality should remain manageable. Credit standards are likely to have improved following the Australian Prudential Regulatory Authority (APRA) review in early 2015. Banks have already made significant changes in borrower-serviceability assessment, and limited annual growth in investor mortgages. The inability to maintain the recently improved underwriting standards could lead to negative rating action as it could result in weaker asset-quality, possibly impacting banks' profitability and capitalisation.

We believe capitalisation will remain solid, especially in light of APRA's requirement to ensure that banks are unquestionably strong. We expect the banks to continue to strengthen their capital positions especially in preparation of the implementation of higher risk-weightings on residential mortgages on 1 July 2016. The new capital regulation is likely to result in a decline of regulatory capital ratios of the four major banks but we expect the ratios to recover, benefiting from high levels of retained earnings. Capitalisation could also benefit from slowing risk-weighted asset growth and the sale of non-core assets in 2016.

Australian banks are likely to remain reliant on wholesale funding markets due to a general lack of deposits in the system. However, the banks are likely to focus on lengthening the maturity of their wholesale funding instruments and attracting high-quality deposits.