While the fires would not have a material earnings impact for the major banks, Morgan Stanley said late last week they would create another headwind for the sector by reducing earnings by between 1 per cent and 2 per cent – or about $270 million to $540 million. Major bank earnings fell to their lowest level in seven years in 2019.

Fires could result in higher provisions as banks give more time for affected customers to repay loans and account for higher losses on loans to small businesses whose cash flow will be crunched, Morgan Stanley said.

Small businesses will also be hit by higher paid leave for bushfire volunteers. Other direct financial costs will come from insurance claims and banks' pledged contributions to bushfire recovery.

But the investment bank also called out various "second order effects", including disruption to retail sales and the potential for further interest rate cuts by the Reserve Bank of Australia.

This would accelerate the contraction in bank net interest margins, given around $400 billion of major bank deposits are already close to zero, meaning additional official rate cuts won't be able to be passed through on many deposits to offset lower rates charged to borrowers.

"We believe that the downside risks from the bushfires' second order effects add to existing operating headwinds," Morgan Stanley analyst Richard Wiles said on Friday.

S &P said it did not expect the fires to impact on the credit ratings on banks' residential mortgage backed securities (RMBS) given the geographic diversity in RMBS portfolios and banks' higher exposures to more densely populated capital cities. It estimated areas where bushfires had been most severe accounted for less than 6 per cent of the RMBS sector.

Yet S &P Global Ratings credit analyst Erin Kitson said mortgage arrears "are likely to remain elevated for some time in areas already affected by drought conditions, particularly where agriculture forms a large share of local employment".


Longer cycles

S &P also warned bank investors might have to readjust modelling for bad debt cycles in response to climate change.

While mortgage arrears typically increase during the summer period, reflecting the pre- and post-Christmas spending and extended holiday season, before declining during the second quarter, the agency said, "if the longevity and intensity of bushfire seasons become a more regular occurrence, arrears could remain elevated for longer periods in drought-prone areas due to the flow-on effect of bushfire devastation on local employment conditions".

The corporate regulator could also also face a higher workload in the wake of the devastating fires as more borrowers experiencing financial difficulty apply for financial hardship provisions under the National Consumer Credit Regime. This is administered by the Australian Securities and Investments Commission.

Hardship concessions can include a reduction in the interest rate or payment, lengthening of loan maturity, or full or partial deferral of interest for a temporary period.

In a separate report published at the weekend, S &P said the fires presented "no immediate risk" to its ratings on the Australian sovereign or states.

But it said they reinforced the importance of "strong fiscal outcomes ... because they allow governments to respond to unforeseen events, such as the ongoing bushfires, without weakening their credit profiles".

The direct costs to banks of up to 2 per cent of earnings would be lower than other natural disasters that occurred in areas with larger populations, Morgan Stanley said, including the Brisbane floods, Cyclone Yasi and the Christchurch earthquake, which all struck in 2011.

Commonwealth Bank is the first bank to report its interim earnings on February 12, Bendigo and Adelaide Bank will follow on February 17. National Australia Bank is scheduled to give a first-quarter trading update on February 13.