Bank stocks are soaring today as investors brush aside concerns about Greece. In Asia the Chinese government has also intervened to prop up its sharemarket.
The Reserve Bank of Australia's (RBA) decision to keep interest rate on hold at a record low of 2% isn't hurting sentiment either.
Shares in Westpac Banking Corp (ASX: WBC) are leading the charge with a 3% surge to $33.45, while National Australia Bank Ltd. (ASX: NAB) has gained 1.9% to $34.11 after announcing more details of its UK divestment.
But it's not China or Greece that bank investors need to fear. The enemy is within.
That's the assessment of Goldman Sachs which is warning that bank profits are set to deteriorate due to the demographic shift from aging baby-boomers.
Baby-boomers, those born between 1946 and 1964, are paying down debt and saving more and that's not good news for banks as household lending contributed to 40% of sector profits in 2013-14 and 35% of the big bank's return on tangible equity (RoTE).
But that's not the only headwind that will crimp on bank profits. The demographic problem is compounded by the fact that Australian households are already among the most leveraged in the developed world, which makes our economy particularly sensitive to any increase in the cost of debt.
That's bad news because debt is likely to become more expensive from here given our record low interest rates.
What's more, banks may push up interest rates on loans independent of what the RBA does, as financial institutions will be made to hold more capital as a buffer against macro-economic shocks.
Goldman Sachs for one believes the sector will need another $27 billion in new capital if the tier-1 common capital ratio for banks is lifted to 10% from 9%. Banks will have to charge more for loans or suffer a 2%-3% drop in RoTE.
Interest charges account for around 8% of household income, which is close to the average since 1990, but it will escalate to nearly 15% of household income if the cash rate rises to "normal" levels of about 5%.
Commonwealth Bank of Australia (ASX: CBA) appears to have the most to lose from this potential outcome as it is the nation's biggest mortgage lender and is trading at a premium to its three peers.
The only bank Goldman thinks is worth buying is Australia and New Zealand Banking Group (ASX: ANZ) due to its Asian exposure.
However, I don't think things might be quite as dire for the sector for a few reasons. Firstly, bank stocks have undergone a de-rating and their valuations are not as onerous as they once were.
Also, investors are not drawn to the banks for earnings growth but for dividends. If banks can grow earnings along with inflation or keep them flat, that may be enough to keep most investors onside.
Further, strong migration growth can quite easily turn the demographic headwind into a tailwind. The danger here is politics getting in the way of economics.
I won't be overweight on the banks but I think being severely underweight in the sector during this part of the cycle will cost you in terms of performance.
