What are ASX bank shares?
An ASX bank stock is a share in a financial institution listed on the Australian Securities Exchange that takes deposits and makes loans to individuals and businesses.
In addition to deposit-taking and lending activities, Australian banks are involved in many other aspects of the financial system, such as stockbroking, wealth management, and insurance.
Banks serve a critical social need but have business models that are relatively simple to understand. In essence, banks make money by taking deposits and lending out the money, profiting from the difference in interest rates.
Why invest in ASX bank stocks?
Bank shares can be rewarding long-term investments, especially for investors seeking passive income. Australian bank shares have a long history of paying attractive dividends, especially when the economy is firing.
Bank shares can, however, be sensitive to economic cycles and fluctuations in interest rates. Banks rely on people being willing to spend and borrow money. And people are more inclined to take on loans and splash their cash when the economy is flourishing.
When a recession arises, consumers and businesses tend to rein in spending, and some may encounter problems paying existing debts. This can result in losses for banks. Banks are, therefore, cyclical businesses.
Interest rates can also impact banks’ profitability — falling interest rates can negatively impact profit margins, while rising interest rates are generally seen as a positive. However, the correlation is not exact.
Top bank stocks on the ASX
Of the 22 banks listed on the ASX, here are the top three performers based on market capitalisation from higher to lower.
| Top ASX bank stocks | Company description |
| Commonwealth Bank of Australia (ASX: CBA) | Provides integrated financial services, including retail, business, and institutional banking, superannuation, insurance, and share broking services |
| National Australia Bank Ltd (ASX: NAB) | Banking services include business, personal and home lending, wealth management, investment banking, and stock market investment platforms |
| Westpac Banking Corp (ASX: WBC) | Provides consumer, business, and institutional banking and wealth management services through a portfolio of brands and businesses |
Commonwealth Bank of Australia
Australia’s largest bank by market capitalisation, CBA provides banking services to retail, SME, and institutional clients, as well as providing superannuation, insurance, and share trading products and services. In its March update, CBA noted continued growth in household deposits, home loans, business lending, and business deposits.
Commonwealth Bank (CBA) reported net profit after tax (NPAT) of $2.5 billion for the quarter ending 30 September 2022, underpinned by strong operating performance and sound portfolio credit quality. The bank reported a 12% rise in operating performance, driven by higher operating income, including stronger deposit earnings and volume growth across core products.
NAB
Founded in 1858 as the National Bank of Australasia, NAB’s modern incarnation can be traced to the merger with the Commercial Banking Company of Sydney in 1982. Since then, NAB has grown to become Australia’s largest business bank. It provides business lending services, personal and home lending, wealth management, investment banking, and stock market investment platforms.
The bank’s FY22 results included cash earnings growth of 8.3% and underlying profit growth of 11.5%. The outcome reflects targeted volume growth and a disciplined approach to managing costs whilst investing for growth. After 11 years of interest rate reductions, earnings have also benefited from the rising interest rate environment.
Westpac
Australia’s oldest bank, Westpac started life in 1817 as the Bank of New South Wales. It became Westpac in 1982 following a series of mergers. These days, the bank provides a broad range of banking and wealth management services through a portfolio of brands and businesses.
Westpac announced its full-year 2022 results in November, revealing a 4% increase in profit. The bank reported higher growth in mortgages and business lending and improved credit quality. Costs were down 19%, and most key credit metrics improved over the half.
What to look for when buying ASX bank shares
As bank stocks account for a significant proportion of the S&P/ASX 50 Index (ASX: XFL), one might argue that a well-diversified portfolio should include some allocation to the banking sector.
When investing in the banking sector, Australian investors can buy shares in individual banks directly or utilise an exchange-traded fund (ETF) with broad exposure to the sector. Investors should note that any ASX index ETF will include an allocation to financial shares, including ASX bank shares.
Australian banks are particularly attractive to dividend investors due to their history of paying dividends to shareholders. The dividend yield is one criterion investors look at when choosing which bank shares to invest in. The dividend yield is the percentage of that share’s current market price paid out in yearly dividends. All things being equal, a higher dividend yield will be preferable to a lower yield.
Other key profitability metrics applicable to banks include return on equity (ROE), return on assets, and net interest margin (NIM). Return on assets is the percentage of net income a company makes relative to its total assets. NIM measures the difference between the interest income generated by banks and the value of interest they pay to their lenders (for example, interest on deposits) relative to the value of their (interest-earning) assets.
These metrics can indicate how profitable a bank is, and can be used to compare different banks against each other.
Pros of investing in ASX bank shares
Stability and substantial volumes: After the economic disruption of the COVID-19 pandemic, bank profits are returning to pre-COVID levels thanks to continued strong volumes in mortgage and business lending. A level of stability has returned to the sector.
Rate rises support margins: The increase in the cash rate that has taken place in FY22 should support a recovery in net interest margins.
Size: The big four banks – Commonwealth Bank, NAB, Westpac, and Australia and New Zealand Banking Group (ASX: ANZ) – dominate the Australian banking industry. Between them, they hold a whopping $1.87 trillion in home loans.1
Cons of investing in bank shares
Uncertain economy: The economic outlook is uncertain, given increasing inflationary pressures and geopolitical tensions. As the Reserve Bank of Australia lifts the cash rate in response to rising inflation, the banks pass these rises to borrowers.
Benefits of rate rises dampened: A higher mix of fixed-rate loans in back books and steepening yield curves may dampen the benefits of rising rates for banks. This correlates to increased mortgage distress and softening house prices.
Slowed lending: Having divested non-core businesses, the major Australian banks are now more dependent on mortgage and business lending, which may slow down due to higher interest rates.
Are ASX bank stocks a good investment?
Whether bank shares are a good investment for you will depend on your financial situation and investment strategy. Bank stocks are some of the largest companies on the ASX by market capitalisation and are known for paying consistent dividends.
The most recent round of financial results from ASX banks have been positive, but investors should be aware that an investment in banking shares is not without risks. If in doubt, seek financial advice that takes into account your personal circumstances.
Increasing inflation may put pressure on profit margins. Central bank rate hike decisions should lead to increased profitability over the medium term but may be a double-edged sword – while they allow banks to charge more for loans, they may also slow growth in lending and could impact asset quality.