By Sid Ruttala

For most Australian investors, owning the big four banks has barely felt like a decision. Australian bank shares sit in almost every super fund, every income portfolio and every index product, and for good reason. For the best part of two decades, rising house prices meant growing mortgage books, growing mortgage books meant rising profits, and rising profits funded some of the most generous fully franked dividends in the developed world.

That arrangement is now being tested more seriously than at any point since the 2022 and 2023 rate cycle.

House prices are falling across almost every capital city. Mortgage applications have slumped. The Reserve Bank of Australia has already lifted rates three times this year and meets again on 29 September, with markets leaning towards a fourth increase. And the S&P/ASX 200 Financials index has fallen more than 10% from its August peak.

The question for long term investors is not whether the backdrop has become harder. It clearly has. The more useful question is how much of that is already reflected in bank share prices, and how much may not be.

The setting for 29 September

The RBA held the cash rate at 4.35% in August. Since then, the data has pushed in one direction. Headline inflation eased to 3.5% in the year to July, but trimmed mean inflation, the measure the RBA watches most closely, stayed at 3.6%. The economy also grew faster than expected, expanding 0.4% in the June quarter and 2.1% over the year.

Market pricing for a September hike has been volatile, swinging between roughly 55% and 80% over the past fortnight. Economists are more divided. Among the major banks, NAB is forecasting a September move to 4.60%, while ANZ, CBA and Westpac expect the increase to come in November.

Two timing details matter. The next monthly inflation figures are released on 30 September, the day after the meeting, which gives the Board a reasonable argument for waiting. And the global backdrop has shifted. The US Federal Reserve raised rates on 16 September for the first time since 2023 and signalled more to come.

For the banks, though, the exact date is less important than the direction. A November hike appears to be broadly priced in either way. The real issue is what a higher cash rate does to a housing market that is already turning down.

The Australian bank shares story now runs through housing

The housing numbers have deteriorated quickly.

Cotality’s national home value index fell 0.9% in August, the fifth consecutive monthly decline, leaving values 3.6% below their March peak. July’s decline was revised to 1.2%, the largest monthly fall of this cycle. Through winter, 93% of capital city suburbs recorded a fall in values, and every capital except Darwin fell over the three months to August.

Activity has slowed too. Sales volumes are running around 15.5% below a year ago, and advertised listings in the capitals are 24% higher, not because more homes are being listed but because they are taking longer to sell. The ABS has since confirmed that the total value of Australia’s housing stock fell by A$34.1 billion in the June quarter to A$12.7 trillion, the first decline since September 2022.

Forecasts are now being revised lower. Macquarie recently doubled its expected peak to trough fall in national home prices, from around 5% to around 10%.

For the banks, the more immediate issue is volume. Every major bank reported a sharp drop in mortgage applications after the May Budget changed the tax treatment of investment property. Westpac’s post Budget run rate was down around 20% on the prior quarter, with investor applications down 26%. CBA and NAB both reported falls of around 15%.

Why higher rates do not simply mean higher bank profits

A common assumption is that rising interest rates are good for banks. There is some truth in that. Banks earn more on the deposits and capital that sit on their balance sheets when rates rise, and the early stages of a tightening cycle often help margins.

But that is only one part of the equation. The other parts are volume, competition and credit quality, and at present all three are moving the wrong way.

Start with volume. The banks’ own economists expect housing credit growth to slow materially. Westpac sees it easing from 6.8% this financial year to 4.7% in FY27. CBA is guiding to between 5% and 7%. NAB is the most cautious of the majors at just 2.5%. Macquarie and Morgan Stanley sit near the bottom of that range, at around 3.5% and 3% respectively.

Then consider competition. When fewer new loans are being written, banks compete harder for existing borrowers who are refinancing. That usually means sharper pricing and thinner margins. Deposit competition is intensifying as well, with CBA advertising a 12 month term deposit special of 5.15%.

This is where the brokers’ concerns are concentrated. Macquarie has FY27 net interest margins for the majors one to four basis points below consensus, with earnings one to four per cent lower. Morgan Stanley expects margins to fall by around six basis points between the second half of FY26 and the second half of FY27, and has cut its FY27 earnings forecasts for the majors by roughly 7% since May.

Finally, there is credit quality. Both brokers expect bad debts to rise from here. That is not a prediction of crisis, but it is a reminder that loan losses are currently running from very low levels and have more room to rise than to fall.

What the latest results tell us

CBA’s FY26 result, released on 12 August, is a useful reference point because it shows both the strength and the strain.

The headline numbers were solid. Cash net profit rose 7% to A$11.0 billion, pre provision profit rose 6% to A$16.5 billion, and return on equity improved to 14.0%. The bank grew at or above system across all five of its core domestic product categories, which it described as a first for any major Australian bank in 15 years. The full year dividend was A$5.05 per share, fully franked.

But the tone was more cautious beneath the surface. Management noted that growth is slowing and that higher rates and inflation are putting pressure on households. Loan impairment expense rose from low levels, arrears increased in some consumer portfolios, and the bank chose not to extend its on market buy back, which expired with only A$300 million of the A$1 billion program completed.

None of that suggests a bank in difficulty. It suggests a well run institution preparing for a tougher period.

Balance sheets are stronger than in past downturns

It is important to keep perspective. Australian banks enter this period with considerably more capital, tighter lending standards and larger borrower buffers than in previous cycles. CBA alone reported nearly A$95 billion in average mortgage offset balances during FY26, a sign that many households still have savings to draw on.

The key variable for bank losses is not house prices in isolation. It is unemployment. Falling prices become a genuine credit problem mainly when borrowers also lose income. The unemployment rate rose to 4.5% in July, which is higher than a year ago but still low by historical standards. That is the number to watch most closely over the coming months.

The more immediate risks may sit outside the major banks. Developer Bathla Group entered voluntary administration in late August with around A$3.2 billion of liabilities, largely funded by private credit. The majors have no direct exposure, and UBS has characterised it as a private credit event rather than a banking one. But the second order effects, including tighter non bank lending, weaker developer confidence and pressure on construction collateral, are worth monitoring.

Valuation: what is already priced in?

This is where the picture becomes more nuanced.

Based on CommSec forecasts, CBA trades on around 24 times FY27 earnings, while Westpac trades on around 16 times and NAB and ANZ on around 15 times. CBA’s premium reflects genuine quality, but it also leaves very little room for disappointment if margins or credit costs move against it.

Over the past 12 months, the banks have fallen around 4% while the materials sector rose more than 50%. The recent sell off has taken some of the heat out of valuations, but it is not yet clear that earnings expectations have fully adjusted to slower credit growth and thinner margins. That gap between what the brokers are forecasting and what consensus still assumes is the heart of the debate.

The income argument has also changed. For much of the past decade, bank dividends looked compelling next to cash. With term deposits offering more than 5%, the gross up from franking credits still matters, but the margin of advantage is much narrower than it was.

Broker positioning reflects this caution. Macquarie is underweight the sector, with ANZ and NAB its preferred exposures. Morgan Stanley is overweight ANZ, largely because its business mix is less tied to Australian conditions, and underweight CBA, NAB and Westpac. Wilson Asset Management has also said it remains underweight the major banks.

Risks and counterpoints

A balanced view needs to consider both sides.

The bear case is straightforward. If the RBA hikes and house prices fall by 10% or more, credit growth slows further, margins compress and bad debts rise at the same time. With banks making up roughly a fifth of the ASX 200, a sustained de rating would weigh heavily on the index and on the many portfolios that track it closely.

There are also risks specific to individual banks: CBA’s valuation premium, the pace of consumer arrears, execution on large technology programs, and competitive pressure in mortgages and deposits.

But there is a credible counterpoint. The banks are highly capitalised and profitable, and unemployment remains relatively low. Higher rates still provide some support to deposit margins. The current downturn has also been concentrated at the premium end of the market, with lower quartile values up 10.8% over the year to August, which may limit stress among more stretched borrowers. And the banks came through the 2022 and 2023 correction with earnings largely intact.

If the RBA holds in September and inflation continues to ease, the sector could find some breathing room sooner than the current mood suggests.

Investor implications

For long term investors, the practical question is not whether to own banks. It is how much, which ones, and at what price.

A few considerations seem sensible.

Be aware of concentration. Many Australians hold more bank exposure than they realise through super funds, index products and income portfolios. A period of slower earnings growth is a reasonable time to review whether that weighting still reflects an investor’s objectives.

Differentiate between the banks. The majors are not interchangeable. Business mix, offshore exposure, valuation and capital position all vary, and brokers are already expressing strong preferences within the sector.

Treat dividends as earnings dependent. Fully franked income remains valuable, but dividend growth ultimately depends on earnings growth. If credit growth slows and margins narrow, payout ratios and buy backs will come under closer scrutiny.

Watch the right indicators. Unemployment, arrears, net interest margin guidance and credit growth will matter more than the monthly swing in house prices. The November reporting and trading update period for the majors will be an important test.

Avoid overreacting to a single meeting. Whether the RBA moves in September or November, the direction of travel is broadly the same. Portfolio decisions are better anchored to earnings and valuation than to the timing of one decision.

TAMIM Takeaway

Australia’s major banks are entering a more demanding phase. House prices have fallen for five consecutive months, mortgage applications have slumped, and the RBA is likely to lift rates again, whether on 29 September or in November. Brokers increasingly believe that consensus earnings forecasts do not yet fully reflect slower credit growth, sharper competition and rising bad debts.

That does not make the banks poor businesses. They remain well capitalised, profitable and central to the economy. But the easy tailwind of rising house prices and strong lending growth has faded, and valuations, particularly at the premium end of the sector, still assume a smoother path than the data currently suggests.

For long term investors, the sensible approach is to own banks deliberately rather than by default: understand the exposure, differentiate between the majors, and let valuation rather than habit guide position sizes. The dividend cheques may keep arriving, but the growth that once came with them can no longer be taken for granted.

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Disclaimer: Commonwealth Bank of Australia (ASX: CBA), National Australia Bank (ASX: NAB), Westpac Banking Corporation (ASX: WBC), and Australia and New Zealand Banking Group Limited (ASX: ANZ) are held in TAMIM portfolios as at the date of article publication. Holdings can change substantially at any time.