Sept. 24 (Bloomberg) -- Australian banks continue to weather the global recession as a surge in earnings from lending to home buyers offsets rising bad debts, the central bank said.

“The Australian financial system has remained resilient,” the Reserve Bank of Australia said in its half-yearly financial stability review published today in Sydney. “Banks have experienced only a modest decline in profitability” and are better placed than those in other economies to weather any further global turmoil, it added.

The nation’s four largest banks, including Westpac Banking Corp. and Commonwealth Bank of Australia, posted combined after- tax profits of A$8.6 billion ($7.5 billion) in the latest half year as their net interest income jumped 22 percent, today’s report said. Earnings were also boosted by increased demand for loans from home buyers after the central bank slashed the benchmark lending rate to a 49-year low.

“The last six months have definitely improved much more strongly than policy makers thought they would, and that applies to the situation in banks as well as broader financial markets,” said Brian Redican, a senior economist at Macquarie Group Ltd. in Sydney.

The Australian dollar traded at 87.05 U.S. cents at 12:15 p.m. in Sydney from 87.10 cents before the central bank’s report was released. The two-year government bond yield fell 2 basis points to 4.22 percent. A basis point is 0.01 percentage point.

‘Solid Profits’

“In contrast to those in many other countries, the Australian banking system has reported solid profits throughout the financial turmoil,” the central bank said.

The resilience of Australia’s four biggest banks, which are among only nine of the world’s 100 largest lenders to hold a Standard & Poor’s credit rating of AA or higher, was helped by an economy that expanded 1 percent in the first half of the year as the U.S., the U.K. and Japan fell into recessions.

To spur economic growth, Reserve Bank Governor Glenn Stevens slashed the overnight cash rate target by a record 4.25 percentage points to 3 percent between September and April, and the government distributed more than A$20 billion in cash to households.

The cuts in borrowing costs reduced the ratio of household interest payments to disposable income from above 15 percent in June 2008 to around 10 percent at present, the bank said.

“While the household sector’s interest-payment burden remains fairly high by historical standards, this reduction has been more rapid than in the early 1990s,” when the economy was last in a recession, the report said.

Home Sales

A report published earlier today by the Housing Industry Association showed sales of newly built dwellings rose 11.4 percent last month from July, the biggest increase in almost four years.

Still, while the outlook for the banking system has improved from six months ago, it faces “some important challenges,” including the prospect of higher loan defaults, the bank said.

Australia’s largest banks reported charges for bad and doubtful debts of A$6.2 billion in the latest half year, compared with A$2.8 billion in the same period a year earlier, today’s report said.

“The major banks’ trading updates and analysts’ expectations suggest that provisioning charges are likely to rise further in the near term,” the bank said.

The ratio of banks’ non-performing mortgage loans, which account for over half of lenders’ on-balance sheet loans, has climbed to 0.62 percent in June from 0.49 percent a year earlier.

Funding Costs

By contrast, comparable ratios in the U.S. and the U.K. are around 5.7 percent and 2.4 percent respectively, the report said.

While wholesale funding costs for banks rose “significantly” during the global financial crisis that followed the collapse of Lehman Brothers Holdings Inc. a year ago, “more recently, conditions in funding markets” have been improving, today’s report said.

“With investor risk appetite returning, the higher-rated banks have been increasingly willing to tap wholesale markets on their own credit standing, without the support of the government guarantee,” introduced last year.

To contact the reporter for this story: Jacob Greber in Sydney at jgreber@bloomberg.net

Last Updated: September 23, 2009 22:24 EDT