Moody's signalled late on Thursday that a ratings downgrade is more likely, a move that would raise funding costs, citing sluggish profit growth, housing market risks, declining loan quality and low wages outcomes after the end of a mining boom.
The move followed an outlook cut by Standard & Poor's (S&P) in July, and came on the same day Australia's four dominant banks revealed they were among 17 global lenders being sued by U.S. funds for alleged interest rate fraud.
The writ, filed on Aug. 16 by two U.S.-based investment funds and a derivatives trader, fuelled demands for a Royal Commission inquiry into financial sector malpractice ahead of the first sitting of a new Australian parliament next week.
"A Royal Commission would get to the nub of the problem, the core of the problem, a proper examination of the culture and practices of Australia's banking industry," opposition Labor Party treasury spokesman Chris Bowen told reporters in Sydney.
Labor says a series of scandals has exposed deep flaws with Australia's banking culture that went unnoticed as the industry survived the global financial crisis relatively unscathed and posted successive record profits in recent years.
A commission would have far-reaching powers to order disclosure of internal communications and question top executives in public and under oath. It would not hand out punishments but it could lead to prosecutions and its recommendations would be highly influential.
Prime Minister Malcolm Turnbull has stood by the banks in rejecting the need for such an inquiry, despite strong pressure from Labor and from minor parties which will hold the balance of power in parliament following the July election.
Turnbull said the government was instead considering setting up a tribunal to deal with consumer complaints against banks.
"We want to ensure that where there are failings, where there are problems, that we deal with them," he said.
The "Big Four" banks - National Australia Bank Ltd, ANZ Banking Group Ltd, Westpac Banking Corp and Commonwealth Bank of Australia - have denied any wrongdoing in relation to the U.S. writ and pledged to fight the allegations.
Seven of the world's biggest banks in May agreed to pay $324 million to settle a private U.S. lawsuit accusing them of manipulating interest rates. Banks around the world have been fined billions of dollars over the manipulation of global benchmark interest rates like Libor.
On top the of U.S. suit, the Australian Securities and Investments Commission (ASIC) has laid charges against three of the "Big Four" for allegedly rigging bank bill swap rates used to price financial products.
While the banks, which control more than three quarters of the market, are fighting the allegations, they have been damaged by emails, phone calls and electronic chats tendered in court revealing brokers joked and boasted about rate manipulation.
When one ANZ trader sarcastically commented "lucky the rate sets are all legit and there is no manipulation within the Australian financial system", his colleague replied "ahahah", according to the U.S. filing.
Moody's cut its outlook on the banks to negative from stable, even though Australian banks' 'Aa2' credit ratings are among the highest in the world.
"They've got a fair few more headwinds now than they've got in a while," said Andrew Martin, portfolio manager at Alphinity Investment Management, which owns stakes in the banks.
"One of the many is rising funding costs in a slowing economy and political risks. These are things that are causing very low growth in the industry."
The Big Four acknowledged Moody's action but noted in separate statements that the rating agency had reaffirmed their ratings.
Bank profits are under pressure from new onerous capital rules, higher loan defaults led by a mining downturn and a squeeze on margins due to rising funding costs and stiffer lending competition.
Earnings growth at the four has already slowed after six straight years of record profit.
(Additional reporting by Sonali Paul in Melbourne; Editing by Stephen Coates and Lincoln Feast)
By Swati Pandey