How would a credit rating downgrade for Australia affect the country, banks, and home loan borrowers? 

While Australia currently holds a AAA rating from the major credit rating agencies, the prospect of a downgrade wouldn’t make much of a difference from an economic point of view, said Narayanan Somasundaram, an economics and financial reporter.

A downgrade would simply place Australia on the same level as the United States, the world’s largest economy, and effectively, the global reserve currency. We’d also lose our position among the elite economies that are part of the exclusive AAA club.

As for individual companies and banks, a downgrade would lead to repercussions because the three major credit rating agencies (Standard & Poor’s, Moody’s Investors Service, and Fitch Ratings Agency) typically rank such entities as being subordinate to the sovereign. Hence, a sovereign downgrade could provoke a raft of corporate downgrades.

“That, in theory, should lead to higher funding costs. Still in a world flooded with central bank liquidity and ultra-low interest rates, it would be at best a small increase,” said Somasundaram.

He further argued that since Aussie banks are well-regulated and well-capitalised, even at the A+ category, the country would remain competitively positioned relative to its global peers.

“Globally, there are only a handful of banks rated AA- or better with a stable outlook like the major Australian banks. Moreover, it is important to recognise bank funding is a dynamic portfolio.”

Of the three major credit rating agencies, only Standard & Poor’s has flagged Australia for a potential credit rating downgrade. S&P lowered Australia’s AAA credit rating outlook to negative on 7 July after the current conservative government was re-elected with a slight majority.

Ratings cuts are consequential for banks because ratings agencies and most investors layer sovereign ratings over the credit ratings of individual firms.

S&P has already reduced the ratings outlook for the Big Four as their credit scores are perceived to benefit from government support.

“Banks already struggling with net interest margins, a measure of lending profitability, at an eight-year low have passed on some higher funding costs to customers,” said Somasundaram. “For instance, all of them have raised mortgage rates to landlords this year.”

Macquarie Group and JPMorgan are among the entities forecasting a 1% cash rate this year, from the current 1.5%. Deutsche Bank and Morgan Stanley are among those predicting the cash rate will slip to 1.25% this year.

Would higher interest rates deter borrowers? Current data seems to suggest otherwise. Investor housing credit rose 0.8% in December, according to the Reserve Bank—the largest monthly increase since June 2015.

A 25 basis point increase on a 30-year $300,000 home loan would only add $62 to the monthly interest payment, according to a loan repayment calculator on a leading bank’s website.

This is an increase many but the most financially stressed borrowers would be able to accommodate.