Moody's Investors Service says its outlook for Australia's banking system is stable despite, against an increasingly challenging operating environment.



"Our expectation is that economic growth will slow on subsiding investment in the resources sector. Rising imbalances in the housing market are another notable downside risk over the next 12-18 months," says Ilya Serov, a Moody's Vice President and Senior Credit Officer.



"However, Australian banks should retain their strong credit profiles against these potential challenges, as they continue to benefit from their entrenched market power and healthy balance sheets," notes Serov.



Moody's analysis is contained in its report "Banking System Outlook: Australia," which is an overview of credit trends affecting the banking system in the next 12-18 months.



The report says that Australian economic growth will remain under pressure from falls in resources investment and the terms of trade as well as a subdued outlook for broader business capital expenditure.



These headwinds underpin Moody's central scenario assumption of below-historical-trend GDP growth of around 2% for 2015 and 2.5% in 2016.



In response, monetary policy has been accommodative, with interest rates likely to remain at record lows for the foreseeable future, supporting the non-mining sectors of the economy.



"With respect to the housing sector, we see the strong appreciation in housing prices, particularly in Sydney and Melbourne, as a key and rising tail risk for the Australian banking system," says Serov, adding, "While house price appreciation has not been accompanied by a broad-based relaxation in lending standards, the sharply increased proportion of residential investment lending over the past 18 months represents a material downside risk."



"In this context, measures taken by the Australian Prudential Regulation Authority (APRA) aimed at slowing the growth in investment lending and at ensuring underwriting standards remain prudent, and the recent steps taken by a number of banks in this respect, are an important credit support for the system, although they may take some time to bear fruit," says Serov.



Notwithstanding this deteriorating operating environment, Moody's expects the banks' financial metrics to remain broadly healthy, thereby supporting the stable outlook.



The challenges of Australia's economic transition will exert incremental pressure on asset quality metrics, and push loan impairment charges moderately above the current low levels.



But, any increase in net credit costs will be contained at a level that is well below the long-run average, tempered by the country's record low interest rates and the healthy state of Australian corporate balance sheets.



Australian banks' capital levels will strengthen and remain strong relative to their global peers, as their capital management will increasingly take into account current regulatory reforms under the aegis of the Basel Committee on Bank Supervision and Australia's Financial System Inquiry.



In addition, the banks' liquidity and funding profiles will remain stable. Since the 2008-09 global financial crisis, Australian banks have materially improved their funding profiles with a sharp reduction in their reliance on short-term wholesale funding.



Moody's continues to incorporate a very high level of government support in the senior debt and deposit ratings of Australia's major banks, and a moderate level of support in the ratings of the three regional banks, primarily in recognition of the authorities' historical supportive stance and the incentives for support created by the system's dependence on foreign funding. In the rating agency's view, implementation of a statutory creditor bail-in regime is unlikely over the next 12-18 months.