Interest rates will remain a key driver of earnings for Australia’s major banks in 2026. The Reserve Bank of Australia (RBA) lifted the cash rate target to 3.85% in February 2026 after inflation rose sharply in the second half of 2025. That move reversed part of the 2025 easing cycle and shifted attention back to margin sensitivity, funding costs, and credit performance.
Major ASX banks face margin pressure as the RBA lifts the cash rate to 3.85% in 2026. [International Banker]
The RBA had reduced the cash rate from 4.35% in December 2024 to 3.60% by August 2025. It then held the rate steady until early February 2026. The Board said inflation had “picked up materially” and remained above target. Minutes from the 3 February meeting noted that trimmed mean inflation could peak near 3.7% in mid-2026, while headline inflation could reach 4.2% before easing toward 3% by mid-2027.
RBA Policy Path and Market Expectations for 2026
The RBA minutes state that inflation outcomes in late 2025 exceeded forecasts and sat clearly outside the 2–3% band. Staff forecasts assumed the cash rate would follow the market path, which implied two increases in 2026 and possibly more thereafter. However, the Board emphasised uncertainty around the outlook.
Reserve Bank of Australia cash rate trend [Commbank]
Market pricing at the time suggested a 70% probability of the February hike and another increase fully priced by year-end 2026. The RBA also noted that money market rates and government bond yields had risen as expectations adjusted. That shift matters for ASX banks because wholesale funding costs track bond yields and short-term rates.
Net Interest Margin Trends Across Major ASX Banks
Recent disclosures from the four major banks show margin outcomes moving in different directions. For the half year ended 31 December 2025, Commonwealth Bank of Australia reported a group net interest margin (NIM) of 2.04%, down 4 basis points from the prior corresponding period. The bank cited home loan pricing pressure and deposit margin effects.
National Australia Bank Limited reported a December 2025 quarter NIM of 1.80%, up 2 basis points. It attributed the improvement to deposit outcomes and replicating portfolio earnings. Westpac Banking Corporation reported NIM of 1.94%, down 1 basis point, while ANZ Group Holdings Limited reported 1.56%, up 2 basis points, supported by a favourable deposit mix shift.
These variations show that rate changes do not flow evenly across the sector. Deposit mix, competitive pricing, and hedging strategies shape outcomes more than policy moves alone.
How Interest Rates Flow Through Bank Balance Sheets
Interest rate changes affect both asset yields and funding costs. Variable-rate mortgages and business loans usually reprice more quickly than fixed-rate loans. However, banks also compete aggressively on mortgage pricing, which can offset rate increases.
On the funding side, deposit costs respond at different speeds. Transaction deposits typically reprice more slowly than term deposits. Competition can accelerate repricing when banks seek to defend market share. NAB and ANZ both highlighted deposit mix improvements as important margin drivers.
Banks also use hedging and replicating portfolios to smooth earnings. Westpac increased its domestic deposit hedge to $92 billion. CBA referred to the benefits from its equity hedge and replicating portfolio. These tools reduce volatility across rate cycles.
Earnings Sensitivity to Rate Shocks
CBA’s Pillar 3 disclosure provides insight into interest rate risk in the banking book (IRRBB). For the Australian dollar portfolio at 31 December 2025, the bank reported net interest income sensitivity of +$1.665 billion under a parallel upward shock and −$2.557 billion under a parallel downward shock. Group-wide sensitivity stood at +$1.945 billion under a parallel up scenario and −$3.322 billion under a parallel down scenario.
These figures indicate asymmetric exposure. Lower rates would reduce earnings more than higher rates would increase them under prescribed shocks. While these are not forecasts, they show how rate direction can influence income.
Other banks have not disclosed identical shock tables in the cited updates. However, management commentary across the sector confirms that hedging structures and deposit pricing behaviour strongly affect margin sensitivity.
Credit Quality and Capital Buffers in Focus
Credit performance remains central to the interest rate debate. The RBA minutes state that aggregate demand exceeded supply and that the labour market remained tight. That resilience may support loan performance, but higher borrowing costs can increase stress in rate-sensitive segments.
System-level data from the Australian Prudential Regulation Authority (APRA) show non-performing loans at 1.04% of total loans in September 2025, up 10 basis points from June. Bank-specific disclosures suggest stable or improving stress indicators. Westpac reported stressed exposures of 1.17% of total committed exposures, down 11 basis points. NAB reported gross loans and acceptances at 1.47%, down 8 basis points.
Capital levels provide another buffer. CBA reported a CET1 ratio of 12.3% at 31 December 2025. NAB reported 11.48%, Westpac 12.31%, and ANZ 12.15%. APRA requires a minimum CET1 of 10.25% for internal ratings-based banks, including buffers. From 1 January 2026, the total capital requirement for domestic systemically important banks increased to 18.25%.
Funding Stability and Liquidity Indicators
Liquidity ratios remain above regulatory minimums. CBA and NAB both reported Net Stable Funding Ratios (NSFR) of 117%. Westpac reported 112%. These figures suggest stable funding profiles as banks navigate potential wholesale refinancing at higher yields.
Customer deposit growth helps offset rising wholesale funding costs for ASX banks
Wholesale funding costs tend to rise when bond yields increase. The RBA acknowledged that yields moved higher alongside expectations for further rate increases. That environment may lift marginal funding costs even if deposit growth remains solid.
Deposit trends also matter. ANZ reported customer deposits of $39 billion, or 5%, compared with September 2025. NAB reported 6% growth in transaction accounts excluding offsets. Strong deposit growth can offset some wholesale funding pressure.
Rate Scenarios and 2026 Outlook for ASX Banks
Under a base case where the RBA delivers one additional hike after February, asset yields may improve modestly. However, deposit competition could narrow margin gains. Banks with strong operational deposit bases may perform better in that setting.
In a more hawkish scenario with multiple increases, earnings could benefit if asset repricing outpaces funding costs. Yet borrower stress risk would rise. Credit metrics and impairment charges would become key indicators.
In a dovish scenario where rates stabilise or decline late in 2026, asset yields may compress. Banks’ previous commentary shows that lower-rate environments can weigh on core margins. Deposit repricing speed would determine how much pressure emerges.
Interest rates will shape ASX bank performance in 2026 through margins, funding costs, and credit outcomes. Current disclosures show solid capital buffers and stable liquidity. However, margin dispersion across the sector highlights that strategy and balance-sheet mix matter as much as the policy rate itself.
FAQs
- How will interest rates affect ASX bank earnings in 2026?
Interest rates influence net interest margins, funding costs, and credit quality. Higher rates can improve asset yields but may increase funding costs and borrower stress. Lower rates can compress margins if deposit pricing slows repricing.
- Why did the RBA raise the cash rate to 3.85% in February 2026?
The Reserve Bank of Australia raised the cash rate after inflation rose sharply in late 2025, exceeding the target band and prompting policymakers to tighten monetary conditions.
- What is net interest margin (NIM) and why does it matter for ASX banks?
IM measures the difference between what banks earn on loans and what they pay on deposits. It’s a key profitability metric that shifts with interest rate changes and competitive pricing.
- Are all major ASX banks experiencing similar margin trends?
No. The four major banks reported varied trends: some saw slight NIM increases while others saw NIM compression due to pricing and deposit mix differences.
- How do deposit costs impact bank margins?
Deposit repricing influences funding costs. Transaction deposits often reprice slowly, while term deposits adjust faster. A favourable mix of low‑cost deposits can support margins.
- What are IRRBB sensitivity measures, and what do they show?
Interest Rate Risk in the Banking Book (IRRBB) sensitivity shows how net interest income could change under rate shocks. Banks have shown asymmetric sensitivity, gaining less from rate rises than they might lose from rate falls.
- What role does credit quality play in earnings outlooks?
Credit performance affects provisions and impairments. Rising costs or borrower stress from higher rates can weaken loan performance, while stable conditions support earnings.
- Do ASX banks have strong capital and liquidity positions?
Yes, the major banks report capital ratios above regulatory minimums and liquidity measures like NSFR above required levels, providing buffers against stress.
- How could different rate scenarios impact bank profits?
- Hawkish scenario: More rate rises could lift asset yields if funding costs are controlled.
- Base case: Modest yield improvement but deposit competition could constrain margins.
- Dovish scenario: Lower or stable rates risk margin compression.
- What factors beyond policy rates matter for bank performance?
Balance‑sheet composition, deposit mix, hedging strategies, competitive pricing, and credit quality all shape earnings outcomes alongside the official cash rate.
