"The valuations of the Australian banks are stretched": the UBS report says our big four banks have lost some of their lustre.

The UBS report says "the valuations of the Australian banks are stretched". Photo: Louie Douvis

Australian bank stocks rank among the most expensive in the world but remain attractive because of high dividends, a new global report has concluded.

The report by UBS ranked Australia's banks below those in the United States and Britain in terms of their appeal to international investors over the coming year, but ahead of those in emerging countries such as Brazil and India.

International investors are important holders of Australian bank stocks, helping to propel the big four to record high share prices over recent months.

"Within a domestic context, we are 'market-weight' [on] the Australian banks," the UBS report said. "Although the earnings growth outlook is subdued, earnings risk is relatively low, provided there are no systemic shocks.

"In absolute terms, the valuations of the Australian banks are stretched."

While they have tailed off in recent weeks, shares in ANZ Banking Group, Commonwealth Bank of Australia and Westpac Banking Corp have hit record highs over recent months, while National Australia Bank has been at the highest in five years.

Record profit results and bumper dividend payments have helped drive bank share prices higher.

Investors have been the big winners as a result of the share price run, but it has also sparked concerns that Australia's banks are too expensive.

According to the UBS report, Australia's banks are trading on a forecast price to earnings ratio – a gauge of how expensive stocks are – of 14 times.

This compares to 10.6 times in Japan, 11.7 times in Britain, 13.1 in the US, 13.3 in Europe and an average of 11.1 across all global banks.

On the flip side, Australia's banks are offering a dividend yield of 5.6 per cent to investors, well ahead of the 3.4 per cent of British banks, 1.6 per cent in the US and the global average of 3.1 per cent.

UBS cautious on emerging-market banks

UBS said it had upgraded Australia's banks from an "underweight" rating to "neutral", saying they had strong balance sheets and that bad debts were declining amid low interest rates.

"Rate cuts, and booming housing and commercial real estate markets are enabling the banks to clear residual non-performing loans at good prices, while new non-performing loans remain subdued. This should enable the banks to deliver another year of super low bad debt charges," UBS said.

As the global economic backdrop improves, UBS said it was upbeat about the prospects for the world's banks in 2014, though it favoured banks in developed markets over those in emerging countries.

"Reflecting our preference for ­developed market banks over ­emerging-market banks, we are overweight on banks in the US, Britain, the Nordic [countries] and France, and upgrade Australia to neutral from underweight," UBS said.

"In contrast, we remain underweight in emerging [markets], being most cautious on banks in Brazil, India, Indonesia, South Africa and Turkey."

According to UBS, the major risk for bank stocks in 2014 was tougher regulation and the impact of a reduction in quantitative easing stimulus measures in the US. "Potential risks could arise from quantitative easing tapering, political posturing and more onerous bank regulation," UBS said.

The Australian Financial Review