S&P/ASX 200 Index (ASX: XJO) bank shares have seen a rapid change in the economy over the past year or so. In that time, economic conditions have been shaped by inflation and climbing interest rates.
The ASX 200 has a large weighting to banks. It includes the Commonwealth Bank of Australia (ASX: CBA), Westpac Banking Corp (ASX: WBC), ANZ Group Holdings Ltd (ASX: ANZ), National Australia Bank Ltd (ASX: NAB), Macquarie Group Ltd (ASX: MQG), Bank of Queensland Ltd (ASX: BOQ), and Bendigo and Adelaide Bank Ltd (ASX: BEN).
Indeed, how the banks perform could have a significant influence on how the overall ASX 200 performs in the 2024 financial year.
I'm going to look at one area that's affecting banks now and another factor that could define FY24.
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Competition and margins under pressure
Many banks have spoken about the downward pressure on their net interest margins (NIMs) and uncertainty for the wider economy.
When BOQ released its FY23 first-half update, the regional bank said:
Economic growth is moderating due to elevated inflation and higher interest rates. Further slowing is expected in the second half of the financial year. Australia is well positioned through the economic cycle with a strong banking system.
We can expect to see heightened mortgage competition continuing as well as increasing competition for deposits. This will, in part, be spurred by the refinancing of expiring fixed-term loans, with interim margin compression anticipated.
The ANZ CEO Shayne Elliot said in the bank's recent outlook statement for the current period:
The next six months will be more difficult than the last. Competition in retail banking is as intense as it has ever been, both in Australia and New Zealand. We understand that sustained higher inflation and interest rates create further challenges for some households and businesses across the economy. While the number of ANZ customers in difficulty remains low, we stand ready to help in these potentially challenging times.
Interest rates have gone from almost nothing to 4.1% as the RBA tries to bring down inflation. While this may mean that banks can earn more money on transaction accounts that don't pay interest, it could also mean that loan arrears may rise.
Are lenders going to see rising arrears?
When banks lend money, they do so with a buffer to ensure that borrowers will still be able to afford the loan if interest rates rose. The 4% rise in the RBA interest rate has gone further than what lenders would have calculated two years ago for borrowers to be able to handle.
At this stage, ASX banks have not yet seen a significant rise in arrears, despite that large increase in interest rates. However, fund manager Christopher Joye has pointed out that:
…we are already seeing the biggest global default cycle since 2010 and delinquencies on riskier Aussie home loans originated by unregulated non-bank lenders have begun to soar. The commercial real estate market globally is also toast. But make no mistake, there is much more pain to come.
While ASX banks haven't reported an increase in arrears yet, it seems logical that arrears will rise – it's just a question of by how much.
In the CBA quarterly update for the three months to 31 March 2023, it reported a loan impairment expense of $223 million. The ASX 200 bank said that it was strengthening its loan provisions and its balance sheet position as "financial conditions continue to tighten".
Foolish takeaway
ASX 200 bank share valuations have suffered over the last five months as competition and NIM pain became apparent. It seems that competition is going to remain, and arrears could worsen, so FY24 could show weaker profit numbers than FY23 if the current conditions continue for the next 12 months.
