The Effect of Macroeconomic Conditions on Banks’ Risk and Profitability

Abstract

This paper examines the overall variability of Australian banks’ credit risk during the 1990s. It assesses the extent to which this overall variability can be explained by variability in the level of banks’ aggregate credit risk over time, or alternatively, by variation in the average credit risk of different banks. The ability of macroeconomic variables to explain movements in bank risk is also considered. Discussion of banks’ credit risk is supplemented with analysis of the rate of return on assets earned by banks since the 1960s. While most of the variability in banks’ credit risk and profitability is due to differences between banks, macroeconomic variables are found to exert a strong influence on banks’ risk and profitability. The share of interest payments in the corporate and household sectors’ income, real credit growth and property prices are most strongly correlated with banks’ risk and profitability.

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