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Is the party over for Australia’s big four banks?

Australia’s big four banks have delivered record profits in recent years but rising bad debt charges and high unemployment could hinder their rate of growth in 2015.

While low bad debt charges have helped propel profits higher in recent years, a new report by Fitch Ratings shows the bad debt levels could change direction this year as borrowers come under increased pressure to make repayments on their loans. This is partially due to the high unemployment rate (which is currently sitting at a seasonally adjusted 6.1%, according to the Australian Bureau of Statistics) as well as subdued economic growth, as reported by The Australian.

Last year, Commonwealth Bank of Australia (ASX: CBA), Australia and New Zealand Banking Group (ASX: ANZ), National Australia Bank Ltd. (ASX: NAB) and Westpac Banking Corp (ASX: WBC) combined to post a record profit of $28.6 billion. While they are still expected to post an enormous combined profit, the percentage at which their individual earnings increase could become more limited as competition in the sector heats up.

According to official figures, Australia experienced a surprise decline in new home lending in November. This would suggest that each of the banks could become more competitive in their approach to attracting new customers, which will likely impact their net interest margins (the profits recognised on their loans).

The fact is, these are just a few of the headwinds facing the banking sector right now. While a further reduction in interest rates could provide another boost to the banks’ returns in the short-run, they could also be hit by regulatory challenges and a slowing economy. As it stands, each of the big four banks are trading at outlandish prices which suggest that investors expect the good times to continue forever.

Despite their offering of solid, fully franked dividend yields, investors need to be aware that this is precisely the wrong stage of the economic cycle to buy bank stocks. While their earnings growth could come under pressure, so too could their dividend growth, meaning investors should look towards some of the market’s other high-yield alternatives.

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Motley Fool contributor Ryan Newman does not own shares in any of the companies mentioned. You can follow Ryan on Twitter @ASXvalueinvest.

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