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The top four ASX-listed bank stocks

Banking stocks are one of few sectors of the Australian economy that stand to gain from the ongoing spate of interest rate hikes implemented by the RBA to suppress inflation.

Source: Bloomberg

The Reserve Bank of Australia (RBA) caused much shock and consternation at the start of May 2023, when it resumed rate hikes by increasing the cash rate target by 25 basis points to 3.85%.

The move marks the 11th rate hike by the RBA in a year-long period and brings the cash rate to its highest level since April 2012. The RBA is raising interest rates to contain the breakneck inflation that has engulfed major economies including Australia since the first half of 2022.

Rising interest rates tend to have a negative impact on the economy, by increasing the cost of funds and stepping up pressure on demand. When interest rates are high it becomes more expensive for businesses and households to borrow, whether for investment or consumption purposes, which can in turn lead to a contraction in demand.

This is the reason that the target interest rates set by monetary authorities and central banks have such a pivotal impact on the behaviour of the economy and are the object of intense scrutiny by the financial press and investment analysts.

The one sector of the economy that is likely to remain exempt from the negative impact of rising interest rates is the banking sector. This is because banks derive their revenues from the interest paid on loans, which means rising interest rates can have a positive impact on their earnings.

This is especially the case if banks are well-positioned to maintain wide net interest margins, which are the difference between their lending and borrowing rates and a key measure of their earning capacity.

In the US, however, the recent spate of hawkish monetary policy has had a tumultuous impact on the banking sector, causing the failure of major regional lenders including Silicon Valley Bank (SVB), Signature Bank and First Republic.

Rising interest rates undermined the asset side of the balance sheets of these lenders, because the value of their bond holdings fell in response to hikes by the Fed (the value of fixed-income securities has an inverse relationship with interest rate levels).

Rising interest rates also made it possible for depositors to obtain higher returns via convenient alternatives such as money market funds.

These two factors created the conditions for catastrophic bank runs at regional lenders, with a sudden exodus of deposits causing banks to default.

In Australia, strong regulation has for the most part helped to shore up the resilience of the banking sector, enabling it to weather the adverse impacts of hawkish monetary policy.

The Australian Prudential Regulation Authority (APRA) applies the strictest requirements to banks to ensure the stability of the financial system. Chief amongst them is the maintenance of ample capital adequacy levels, providing a buffer of billion of dollars against potential losses.

APRA – the one financial regulator of whom banks are leery, regularly tests capital adequacy levels and retains the power to require that financial institutions set more capital aside if it believes they are engaging in riskylending practices.

At various times in its history APRA has required major Australian banks put more capital aside, most recently in 2019 when Westpac stood accused by transaction regulator Austrac of breaching anti-money laundering laws.

As with other advanced economies, Australia's banking sector is also covered by deposit insurance courtesy of the government – a measure that was further beefed up during the Global Financial Crisis. In Australia, this insurance covers up to $250,000 of the funds in every deposit account maintained by all of the country's banking institutions.

In addition to forcefulregulation, Australian banks are better able to adjust to interest rate rises by passing rate hikes on to mortgage holders, because the vast majority of home loans in Australia are made on a variable-rate basis. This distinguishes Australia from the US, where most mortgages are fixed and long-term in nature.

For these reasons, Australian banks could be well-positioned to avoid the perils and pitfalls created by the RBA's current round of rate hikes, and potentially reap the benefits of increased earnings from thicker net interest margins.

Here is a list of four of the top ASX-listed stocks in the banking sector for investors to consider if they're optimistic about the impact of rising interst rates on the bottom line of lenders:

1. Westpac Banking Group (ASX: WBC)

2. National Australia Bank (ASX: NAB)

3. ANZ Group Holdings (ASX: ANZ)

4. Commonweatlh Bank of Australia (ASX: CBA)

1. Westpac Banking Group (ASX: WBC)

Sydney-based Westpac has its origins in the first bank founded in Australia - the Bank of New South Wales (BNSW) that was established in 1817. BNSW expanded into the rest of Australia as well as Fiji and Papua New Guinea during the century after its founding. Since its transformation into Westpac, the bank has amassed over 14 million customers globally and a staff team of more than 40,000 people.

Westpac is the only one of Australia's big four banks to currently enjoy a buy rating from Morgans due to its 'greatest potential improvement in ROE (vs relatively low-risk profile) via cost-out targets, business exits, rates leverage, efficiency lift and lifting loan growth.'

Morgans has given Westpac a price target of $25.98 - still well above its share price of just above $21.00 at the time of writing.

2. National Australia Bank (ASX: NAB)

Melbourne-headquartered NAB has one of the most extensive overseas networks out of the big four Australian banks, with offices in China, North America and Europe.

NAB has also recently made bold forays into the fintech sector, announcing at the start of 2021 that it would acquire neobank 86 400, as well as unveiling cryptocurrency ambitions in January 2023 with plans to create the AUDN stablecoin on the Ethereum network.

Morgans considers NAB to be the 'leading SME relationship banking franchise,' while also highlighting 'meaningful improvement in ROE that is in excess of cost of equity' alongside 'attractive yield and buyback.'

3. ANZ Group Holdings (ASX: ANZ)

Melbourne-headquartered ANZ has its origins in two of Australia's most venerable financial institutions - the Bank of Australasia and Union Bank of Australia, established in 1835 and 1837 respectively, well over a century prior to their merger into ANZ in 1951. As of 2023, ANZ is Australia's second-largest bank in terms of total assets.

Analysts from Morgans have retained a hold rating for ANZ with a price target of $26.24. The bank's share price currently stands at just north of $23.50.

According to Morgans analysts, ANZ has recently seen growth in its market share for loans and deposits and has the lowest level of exposure to low-return fixed-rate loans amongst Australia's big four banks. Morgans also looks favourably upon ANZ's diversification into both US dollar assets and the New Zealand economy.

4. Commonwealth Bank of Australia (ASX: CBA)

CBA is Australia's largest bank in terms of both market capitalisation and assets. In addition to Australia, CBA also has operations in New Zealand, Asia, the United States and the UK, with its other brands including Bankwest, ASB Bank, Colonial First State Investments and CommSec.

According to Morgans, CBA remains Australia's 'largest and highest quality bank, with a loyal retail investor and customer base,' as well as the highest return on equity out of the big four Australian banks.'

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