Australia's major banks could receive an even bigger advantage in competing with smaller rivals, after Standard & Poor's' cut to credit ratings of second-tier banks that excluded the dominant lenders.
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Nick Xenophon backs bank tax
Key crossbench senator Nick Xenophon has made his support for the government's new bank levy conditional on the tax applying to foreign banks.
S&P; on Monday pointed to the risk of a "sharp correction" in house prices as it cut the credit ratings of 23 financial institutions including Bendigo Bank, Bank of Queensland, AMP and a host of member-owned institutions.
The agency warned of growing "imbalances" caused by a surge in house prices and growing household indebtedness, despite signs of a property slowdown in recent weeks.
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"We believe financial institutions operating in Australia now face an increased risk of a sharp correction in property prices and, if that were to occur, a significant rise in credit losses," S&P; said.
However, there was no ratings change for the country's four largest banks that control 80 per cent of the home loan market between them: Commonwealth Bank, Westpac, National Australia Bank, and ANZ Bank.
That is because even though the major banks are just as exposed to the housing market, S&P; believes they would receive "timely financial support from the Australian government" if it was needed to protect them in a crisis.
While technical, the issue is significant for competition because by receiving a higher credit rating than otherwise, the major banks are able to raise money more cheaply when tapping bond investors.
The smaller banks claim this cheaper funding is a key advantage because it allows the big banks to more easily undercut smaller banks on the interest rates they charge for loans.
Prior to Monday's move the larger banks' credit ratings already received a two-notch upgrade because of the assumption they would receive a bailout. Smaller banks said S&P;'s Monday decision means the big four now receive a three-notch uplift.
Bank of Queensland highlighted the issue in a statement to investors, saying: "In effect, this means that the two notches of government support for these institutions has increased to three notches of benefit."
Bendigo Bank also told investors the major banks' issuer rating – the most meaningful credit rating for banks when tapping bond markets – would remain unchanged because of an "implicit guarantee from the Australian government".
This means that the two notches of government support for these institutions has increased to three notches
Bank of Queensland statement
If the big banks continue to receive a three-notch upgrade, it could undermine any benefits for banking competition caused by the federal government's bank tax, a cost that only applies to the big four.
However, the major banks' credit ratings would almost certainly be downgraded if the federal government's rating was cut – something analysts say is a real possibility after repeated warnings from S&P; over a stubborn budget deficit.
Monday's credit rating downgrade, which affected 23 financial institutions in Australia, painted a property "sharp correction" in house prices as a serious risk for banks, albeit one that is not S&P;'s main forecast.
While warning of increased "downside risks", S&P;'s "base case" was that the regulator's crackdown on property prices would dampen prices. It also said the outlook for Australian banks was "relatively benign" compared with overseas.
The downgrade comes after private debt has jumped from 117 per cent of gross domestic product to an estimated 136 per cent by this June, according to S&P.;