"It is not a constant of the universe."
That's what Glenn Stevens, chairman of the Reserve Bank of Australia, had to say about the unrealistic expectations of investors that the Big Four banks' earnings are immune to tougher regulations, and that investors are not guaranteed a specific rate of return on their investments.
It might seem silly, but that appears to be the assumption of many bank shareholders who have enjoyed strong wealth generation in recent decades (especially when dividends are included).
That has particularly been the case in the years since the Global Financial Crisis, largely thanks to falling interest rates (resulting in an increase in demand for loans), diminishing bad debt charges, a booming property market and their solid, fully franked dividend yields.
Shares of all four banks hit fresh heights earlier this year but have retreated considerably in the time since.
So, does that mean it's now time to buy the shares?
Not necessarily…
Indeed, Australia's big four banks – comprised of Australia and New Zealand Banking Group (ASX: ANZ), Westpac Banking Corp (ASX: WBC), National Australia Bank Ltd. (ASX: NAB) and Commonwealth Bank of Australia (ASX: CBA) – enjoy higher returns on equity compared to most global counterparts, but whether that will last is up for debate.
The major banks are now facing tougher regulations, requiring them to hold more capital as a safeguard against any potential downfalls facing the local or global economies.
To quote the Australian Prudential Regulation Authority's chairman Wayne Byres, as cited by the Fairfax press, "it remains open to debate where the 'right' ROE for a more resilient banking system is likely to settle."
This is part of the reason why the banks' shares have all fallen so sharply since earlier this year. Another reason is that, while the banks have so far passed on higher costs to customers, there remains a very real possibility that shareholders could soon wear some of the responsibility in the form of lower dividends.
Another possibility is the banks will engage in new rounds of capital raisings, further diluting earnings and dividends per share. This is likely another factor weighing on the banks' share prices.
Should you buy?
ANZ, Westpac and NAB have all reported record results for the 2015 financial year (FY15) recently, while Commonwealth Bank reported its first-quarter results for FY16 yesterday. Although earnings continued to rise, net interest margins (NIMs) are contracting, reflecting the lower level of profitability on loans being written.
Despite their recent share price falls, I would suggest that the banks are still more than fairly priced today. Further weakness could create a buying opportunity but even then, investors would still need to assess the risks facing the sector before committing to a purchase.
