Measures that cut bank profits may push up interest rates for borrowers, a banking analyst has told the Senate Economics Committee inquiry into banking competition.
UBS analyst Jonathan Mott told the inquiry on Tuesday that reforms which reduced banks' profits may threaten their prized double-A long-term credit rating and make borrowing more expensive.
Australia's major banks fund the country's current account deficit by borrowing offshore, Mr Mott said at the public hearing in Sydney.
"When they borrow offshore they do that cheaply due to their double-A rating," he said.
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But if the banks' become less profitable they will be perceived as less likely to repay their debts by offshore investors who will, in turn, demand a higher premium to lend to them and possibly force a credit rating downgrade, he said.
Higher premiums would push banks' funding costs higher and be passed on by the banks to their customers in the form of higher
interest rates, he said.
"If the credit ratings of the banks come under pressure because the fixed income investors are worried that they're less likely to be paid, they will demand a higher rate of return as every investor would.
"That means that the average funding cost to the Australian banks will rise and that will lead to the Australian banks needing to pass that through.
"It's a vicious circle."
The Senate inquiry comes after a public uproar over the big banks' profits amid their moves to push up interest rates beyond the Reserve Bank's increase in the cash rate.
The big four banks made a combined $21 billion in profits in 2009/10, largely thanks to a drop in bad debts, with Westpac's reported $6.3 billion profit a record for Australian banks.
The big four now have a combined $150 billion of capital and $2.5 trillion of assets between them, and their return on equity and return on assets are still below pre-financial crisis levels.
Mr Mott said the debate about bank competition should not focus on banks' profitability or the price of mortgages, but instead focus on housing unaffordability and household debt levels.
He said the proposed reforms were attempting to "treat the symptoms, not the disease".
Growth in housing credit over the past 30 years had not been matched by growth in household incomes, so Australian households are among the world's most indebted, making them sensitive to interest rate rises.
Mr Mott said it was "inevitable" that an authorised deposit-taking institution would fail in Australia and place others under stress given the interconnections among the banking system.
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