Australian Banks: Watching the Housing Market

The outlook for the Australian housing market has softened. Three quick rate hikes and tax changes announced in the Federal budget have started to weigh on activity. This has seen some easing in loan applications and auction clearance rates, alongside signs prices may be close to a peak. For investors the big question is what this means for bank share prices.

The most immediate impact for banks will be on earnings. History shows that there is a strong link between bank earnings and housing credit. Housing credit has been very strong over the past two years but this has been mostly driven by investors and they are the most affected by the changes in negative gearing and capital gains tax announced in the budget. A slump in credit growth could lead to an outright decline in bank earnings over the next couple of years. The effect could be large because when credit growth slows, bank competition tends to pick up so there can be pressure on both volumes and margins.

Credit growth could slow from around 7% to near 3% as investor demand fades. History is unforgiving: three prior credit slowdowns since 2012 each triggered bank earnings downgrades, and share prices fell every time. The 2023 episode cut earnings by around 10%. Competition is already intensifying, with CBA cutting margins to defend volumes.

The added complication is that the Australian banks are not priced for a more-challenging environment. Valuations are elevated and this could become more of a problem as earnings are downgraded. Forward price-to-earnings multiples are back near 20-year highs, while the dividend yield premium over investment grade credit has turned negative for the first time in years.

The better news is that balance sheets of the banks are in good shape. The major banks are carrying more capital, and more conservative provisions, than at any point in their modern history. At their March 2026 half-year results, CET1 (Common Equity Tier 1) ratios ranged from 11.6% at CBA to 12.4% at Westpac, comfortably above APRA’s 10.5% “unquestionably strong” benchmark.

The banks are also considered to have “excess provisions” after adding to buffers during COVID in anticipation of an asset quality deterioration that did not ultimately occur. While some deterioration in asset quality should be expected from here as higher interest rates bite, this is very unlikely to lead to balance sheet problems at the banks.

The major banks remain among the best-capitalised and best-provisioned in their history, and there is only a limited case for an asset quality scare. But the combination of a turning housing market, a modest yet persistent earnings-downgrade cycle, and valuations above both their own history and the market leaves limited upside. Given the banks’ heavy weight in the ASX 200, this is a headwind for index returns and a source of potential re-rating elsewhere, particularly materials and mid-caps. We reiterate our recommendation to reduce bank holdings in favour of these areas.