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Australian Banks Brace for Financial Hit as Downgrade Risk Looms

Moody’s cut the credit ratings of Australia’s big four banks last month, but the news caused barely a ripple in the markets. But now worries are growing that Australia’s banking sector could face further ratings downgrades, which would have a significant impact on profit margins.

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Torsten Blackwood | AFP | Getty Images

The latest warning comes from Credit Suisse, which said on Tuesday that top lenders such as ANZ, NAB, Commonwealth Bank and Westpac are at risk of a 2-notch downgrade from AA to A-plus by Standard and Poor’s.

“A poorly received two notch downgrade could potentially lead to a 9% earnings impact, spread over 3-5 years,” Jarrod Martin, joint lead analyst at Credit Suisse told CNBC.

In its report the brokerage cited the fact that S&P was planning to increase the importance it gave to the funding profile of a national banking industry as part of a review of the way it rates banks.

Australia is particularly vulnerable because the country’s banking system doesn’t have enough deposits to cover its loans. According to Credit Suisse, the banking system has only $33 in deposits for every $100 it has lent out. That means the banks borrow heavily both from domestic and foreign debt markets.

The brokerage says an S&P downgrade would increase the banks’ long-term wholesale funding costs by up to 50 basis points. That would not only hurt their profitability but also impact their ability to borrow cheaply in the global debt markets.

“S&P said that they would look to finalize their framework by [the fourth quarter of 2011] with any ratings action occurring soon after,” Martin said.

The revised methodology would also place emphasis on “economic imbalances”. Here again, Australia is at risk because the country has experienced a 28-year housing boom, which some critics say is unsustainable.

When asked about the possibility of a two notch downgrade, Standard & Poor’s lead analytical manager of financial services ratings, Ritesh Maheshwari said, “It’s unfair for me to make a comment, so far the existing ratings criteria applies and there is no change based on that.”