What are ASX bank shares?
A bank stock is a share in a financial institution that takes deposits and makes loans to individuals and businesses. In addition to those main activities, Australian banks are involved in many other aspects of the financial system, such as stockbroking, wealth management, and insurance.
Banks serve a critical social need but have business models that are relatively simple to understand. In essence, banks make money by taking deposits and lending money, profiting from the difference in interest rates.
Why invest in them?
Bank shares can be rewarding long-term investments, especially for investors seeking passive income. Australian bank shares have a long history of paying attractive dividends, especially when the economy is firing.
However, bank shares can be sensitive to economic cycles and fluctuations in interest rates. Banks rely on people being willing to spend and borrow money. And people are more inclined to take on loans and splash their cash when the economy is flourishing.
When a recession arises, consumers and businesses tend to rein in spending, and some may encounter problems paying existing debts. This can result in losses for banks. Banks are, therefore, cyclical businesses.
Interest rates can also impact a bank's profitability — falling interest rates can negatively impact profit margins, while we generally see rising interest rates as a positive. However, the correlation is not exact.
Top bank stocks on the ASX
Of the 17 banks listed on the ASX, here are the top three ranked by market capitalisation from higher to lower.
| Company | Description |
| Commonwealth Bank of Australia (ASX: CBA) | Provides integrated financial services, including retail, business, and institutional banking, superannuation, insurance, and share broking services |
| National Australia Bank Ltd (ASX: NAB) | Banking services include business lending, personal and home lending, wealth management, investment banking, and stock market investment platforms |
| ANZ Group Holdings Limited (ASX: ANZ) | Provides banking and financial products and services to more than 8.5 million customers |
Commonwealth Bank of Australia
Australia's largest bank by market capitalisation, CBA provides banking services to retail, SME, and institutional clients, as well as delivering superannuation, insurance, and share trading products and services.
Commonwealth Bank (CBA) reported net profit after tax (NPAT) of $10.188 billion for FY23, an increase of 5% on the previous financial year. Operating income was up 13% thanks to volume growth and higher net interest margins. Despite cost of living pressures and rising interest rates, arrears and impairments remained below long-term averages.
NAB
Founded in 1858 as the National Bank of Australasia, NAB's modern incarnation can be traced to the merger with the Commercial Banking Company of Sydney in 1982. Since then, NAB has become Australia's most prominent business bank. It provides business lending services, personal and home lending, wealth management, investment banking, and stock market investment platforms.
In its third-quarter trading update, NAB reported an unaudited statutory net profit of $1.75 billion, which followed a strong first-half performance. The net interest margin declined five basis points to 1.72% following a 14 basis point increase in the first half.
The decline reflected continued home lending competition combined with higher deposit costs. Despite the challenging economic environment, customers have proved resilient, with only a modest deterioration in asset quality during the quarter.
ANZ
One of the top 100 banks in the world by market capitalisation, ANZ can trace its history back 186 years. It opened as the Bank of Australasia in Sydney in 1835 and in Melbourne in 1838. Since then, it has merged with 15 other banks, bought and sold assets and built its business with its customers. Most recently, ANZ implemented a scheme of arrangement to separate its banking and non-banking businesses, following which it sold off its share investing and investment lending businesses.
ANZ reported a 12% increase in cash profits in 1HFY23, a record result. This was driven by solid revenue growth and the benefits of having a well-diversified business. The bank has followed a deliberate strategy to simplify and de-risk its business, allowing revenue replacement after the disposal of non-core assets.
What to look for when buying ASX bank shares
As bank stocks account for a significant proportion of the S&P/ASX 50 Index (ASX: XFL), one might argue that a well-diversified portfolio should include some allocation to the banking sector.
When investing in the banking sector, Australian investors can buy shares in individual banks directly or utilise an exchange-traded fund (ETF) with broad exposure to the sector. Investors should note that any ASX index ETF will include an allocation to financial shares, including ASX bank shares.
Dividend investors find Australian banks particularly attractive due to their history of paying dividends to shareholders. The dividend yield is one criterion investors consider when choosing which bank shares to invest in. The dividend yield is the percentage of that share's current market price paid out in yearly dividends. All things being equal, a higher dividend yield will be preferable to a lower yield.
Other key profitability metrics applicable to banks include return on equity (ROE), return on assets (ROA), and net interest margin (NIM). Return on assets is the percentage of net income a company makes relative to its total assets. NIM measures the difference between the interest income generated by banks and the value of interest they pay to their lenders (for example, interest on deposits) relative to the value of their (interest-earning) assets.
These metrics can indicate how profitable a bank is and can be used to compare different banks against each other.
Pros of investing in ASX bank shares
Stability and substantial volumes: After the economic disruption of the COVID-19 pandemic, bank profits are returning to pre-COVID levels thanks to continued substantial volumes in mortgage and business lending. A level of stability has returned to the sector.
Rate rises support margins: The increase in the cash rate that has taken place in FY22-23 should support a recovery in net interest margins.
Size: The big four banks – Commonwealth Bank, NAB, ANZ, and Westpac Banking Corp (ASX: WBC) – dominate the Australian banking industry. Between them, they held a whopping $1.87 trillion in home loans in 2022.1
And the cons
Uncertain economy: Given increasing inflationary pressures and geopolitical tensions, the economic outlook is uncertain. As the Reserve Bank of Australia lifts the cash rate in response to rising inflation, the banks pass these rises to borrowers.
Benefits of rate rises dampened: A higher mix of fixed-rate loans in back books and steepening yield curves may dampen the benefits of rising rates for banks. This correlates to increased mortgage distress and softening house prices.
Slowed lending: Having divested non-core businesses, the major Australian banks are now more dependent on mortgage and business lending, which may slow down due to higher interest rates.
Are ASX bank stocks a good investment?
Whether bank shares are a good investment for you will depend on your financial situation and investment strategy. Bank stocks are some of the largest companies on the ASX by market capitalisation and are known for paying consistent dividends.
The most recent financial results from ASX banks have been positive, but investors should understand that investing in banking shares is not without risks. If in doubt, seek financial advice that takes into account your personal circumstances.
Increasing inflation may put pressure on profit margins. Central bank rate hike decisions should lead to increased profitability over the medium term but may be a double-edged sword – while they allow banks to charge more for loans, they may also slow growth in lending and could impact asset quality.
