International investors are being urged to steer clear of banks in Australia, Canada and Sweden by a leading investment consultancy, which has sounded the warning about the risk they may pose to the entire financial system if interest rates rise and the Chinese economy slows.
"High house prices, a build-up of household debt post-GFC, and – for Canada, Sweden and Australia – banking sectors that are more than 20 per cent of local market cap and 13 per cent of 'global banks', make these markets likely sources of financial market instability in the year ahead," ASR said. "The banking sectors in three of these economies have increased in size relative to their own economies and, potentially, in importance in the global financial system." While the four economies it dubbed the "CANNS" (Canada, Australia, New Zealand, Norway and Sweden) represented a modest portion of the global economy, the size of their banking sectors, which have benefited from low rates and exposure to China, had grown dangerously out of proportion.
A banking sector, they said, that accounted for 20 per cent of total market capitalisation was a "danger signal" in developed markets as major economies have not been able to "sustain" such a large financial sector.
ASR cited Japan in the 1990s, the United Kingdom in 2003-04 and the eurozone in 2007 as instances when banks had reached one fifth of their respective equity markets only to fall sharply in value. Australia, it noted, has been "the only major counter-example".
"The problem is that to keep sustaining 20 per cent of total market cap, the banks need to keep generating increased income.
"In a world of low rates, this entails an expansion of their assets. However, there are only so many financial assets that the home economy can generate before saturation kicks in, or the asset quality deteriorates."
The big four Australian banks account for over 25 per cent of the S&P/ASX 200 Index" .
The potential for issues in the banking sector to spread to the broader economy should not be underestimated, ASR said.
"The key lesson for us from [the global financial crisis] was that systemic risk is multiplicative, rather than additive. It was the collapse of relatively small, but important, institutions that triggered the market meltdown".