Mr Medcraft said that the risks to the economy of high levels of indebtedness had been apparent for some time. He did, however, concur with Moody's analysis that higher levels of underemployment may constitute the swing factor.

"In my experience around the world in residential markets, the big driver in price declines is really unemployment. Yes, they [the banks] are more vulnerable, but the issue of what triggers the vulnerability is unemployment," Mr Medcraft said.

Pressure from regulators

One of the big four banks targeted in the downgrade – Westpac – lifted rates for variable interest-only loans for both owner occupiers and investors by 34 basis points on Thursday, citing pressure from the banking regulator to limit loan growth.

"APRA's limit on new interest-only lending is 30 per cent of new residential mortgage lending, so we have to continue to make changes to our interest-only rates and lending policies to meet this benchmark," Westpac's George Frazis said.

Speaking before Westpac's move, Mr Medcraft said that "wages growth has been very muted, Sydney property prices are eight times income: people need to really think about that. That is why interest-only is relevant – if you can't afford to pay off your principal, then maybe you should rent."

ASX-listed banks caught up in the surprise credit rating announcement acknowledged the downgrade in statements to the ASX late on Monday or early on Tuesday morning.

All five banks ended the day lower despite a solid lead from Wall Street with Westpac leading the falls down 1.8 per cent, ANZ down 1.4 per cent, NAB down 1.1 per cent, Commonwealth Bank down 0.7 per cent and Bendigo Bank down 0.1 per cent.

Many bank analysts said they did not feel compelled to comment on the downgrades. Credit Suisse equity strategist Hasan Tevfik said that the downgrades were unlikely to have an immediate or lasting impact on bank funding costs.

"Our analysts are a bit ho hum about it. They think the market is much more efficient at pricing funding, the market doesn't wait around for a rating agency downgrade to reprice risk," he said.

"Moody's have dropped the bank's credit ratings to a level that is in line with the downgrade from last month. They are playing catch up with the market and catch up with the other ratings agencies."

Largest transaction

Deutsche Bank analyst Andrew Triggs told clients "we expect no impact on funding costs" as a result of the Moody's downgrade of the major banks' long-term rating to Aa3 from Aa2.

CUA was another Australian lender caught up in the downgrade. CUA is Australia's largest credit union.

CUA chief financial officer Steve Chugg said he did not expect to see any significant market reaction to the Moody's downgrade. Tomorrow CUA will settle a $900 million residential backed mortgage securities (RMBS) issue, its largest transaction of this type.

"It's important to note we are one of just 12 financial institutions to have had our rating downgraded based on external factors, particularly high levels of household debt and credit growth" Mr Chugg said.

Among the smaller lenders that were also targeted in the downgrade were Newcastle Permanent, QT Mutual Bank, Teachers Mutual Bank, Heritage Bank and ME.

A spokesperson for ME also drew attention to the role macro outlook played in the downgrade and said the announcement would have minimal if any impact on the bank's capital requirements or funding costs.