The relationship between exchange rates, interest rates and Australian bank returns

Abstract

Although there has been significant research on US financial intermediaries' stock returns and sensitivity to interest yields, there has only been limited research on Australian bank stock returns and key macro variables, such as interest rates and exchange rates. The aim of this article is to examine this relationship for four major Australian banks, namely the Australia New Zealand bank (ANZ), the Commonwealth Bank of Australia (CBA), the National Australia Bank (NAB) and the Westpac Banking Corporation (WBC). We use the EGARCH model and examine the relationship using monthly data covering the period 1992 to 2007. The results suggest that for all four banks: (1) there is a similar and statistically significant negative relationship between interest rates and stock returns; and (2) there is evidence of an increase in returns during the period of appreciation of the Australian dollar.

Notes

¹The BBSW is the average midpoint of banks' bid and offer rates in the bank bill secondary market, calculated and published daily, and is the predominant reference rate in Australia.

²The 2001 HomeSide losses of $4.1 billion and the 2004 $360 million foreign currency losses reduced NAB's share price by 33% and 19% for the respective periods. NAB's cost-to-income ratio rose to 57.7% in 2005 when the average cost-to-income ratio for the major banks was 49.1%. See Thomson and Jain (2006) for further details and comparison of the four major banks' profitability and cost ratios.