As Australia’s central bank continues to jack up interest rates in a bid to tackle rising inflation, bank margins are benefiting– passing the rate increases in full to borrowers while what is pays on customer deposits has risen less.

A glance at the fiscal 2022 results for Australia and New Zealand Banking Group (ASX:ANZ), Westpac (ASX:WBC) and National Australia Bank (ASX:NAB) revealed a boost in net interest margin – the spread between what banks pay on funding (customer deposits and other debt) to what it charges borrowers.

ANZ was first to report with its NIM ending the year down 1 basis point to 1.63% - in line with Morningstar’s expectations. However, Morningstar bank analyst Nathan Zaia believes that momentum on cash rate increases will set the bank up for a strong result next year. Next was Westpac. Its NIM was 1.87% while NAB reported a 1.65% increase in its NIM also in line with Morningstar’s forecast.

In his analysis of all three banks, Zaia noted that NIM for these banks had further widened in the second half of the year – and fourth quarter in particular - driven by rate hikes from the RBA.

Echoing his previous view on the impact of rate hikes on the big 4, Zaia noted that the banks are already beginning to see the benefits to NIM from cash rate increases.

“Despite competition being intense, the positive earnings momentum will continue given the benefit of rate increases (and more to come) will be in the numbers for a full 12 months.”

“Interest income makes up around 80% of bank major bank revenue, with higher NIM and low-single-digit loan growth, we forecast net interest income to grow 6% per year to fiscal 2026.”

While Zaia remains confident that banks are well positioned in a rising rate environment, they now confront a challenged economic outlook.

In fact, he noted that the recent fiscal results revealed the big banks swapping COVID-related provisions with provisions for economic uncertainty with expected loan defaults.  

Growth outlook

In his fiscal 2023 outlook statements, banks chief Ross McEwan seemed tempered in his views about the likelihood of loan defaults, at least for now.

“Strong employment conditions, along with substantial household and business savings gives us confidence in the resilience of our customers and the broader economy,” NAB boss Ross McEwan said when announcing the results.

Similarly, Westpac CEO Peter King noted that many of the bank’s customers had built up savings over the past two years – 68% remained ahead on their mortgage repayments – adding that “it is inevitable that the impact of higher rates will be felt, including when borrowers’ low fixed-rate loans are rolled over”.

For Zaia, the percentage of borrowers of the big banks who are ahead on their mortgage payments by six months or greater will help cushion the impact of a recession if people lose their jobs. Zaia also notes that people would either cut their discretionary spending or take on additional jobs before defaulting on their loans.

Westpac’s King acknowledges that credit growth will be expected to ease as GDP growth stalls and unemployment rises. Here he sees these as “necessary outcomes” (nice if you have a job) “if we are to lower inflation”.

Despite the outlook for lacklustre credit growth, Zaia forecasts the major banks toachieve average revenue growth of 3% per year over the next five years.

The big four of course also have access to cheaper wholesale funding than the smaller banks and non-bank lenders. This will better position them to compete on interest rates.

On the dividend front, there are also positives.

“The banks have all reset the dividend payout ratios to levels we see as maintainable – so we think earnings growth will support growth in dividends from current levels.”