In a special report, the rating agency said that an emerging economic slowdown is likely to result in higher arrears in non-mining businesses. However, the agency added that its base case is for only a modest, manageable deterioration in asset quality, with a corresponding uptick in impairment charges.

"Revenue growth will probably be held back by subdued credit growth and net interest margins are under pressure from strong competition for loans and deposits. This, combined with the likely increase in impairment charges, will place pressure on profit growth, although the agency expects profitability to remain solid for the sector. Cost control is likely to remain a key focus for the industry," the report said.

The agency expects the funding and capital metrics to improve further in 2013. Subdued credit growth will assist in the continued rebalancing of funding toward deposits, while the duration of wholesale funding is likely to be lengthened further, the agency said.

Fitch expects capital accumulation to continue, albeit at a slower pace as banks approach targets under the new Basel III rules.

Commenting on China, the report said a Chinese ‘hard landing’ remains the most likely factor to drive a change in the outlook for the sector.

Chinese hard landing could lead to a sharp correction in commodity prices and a substantial slowdown in Australia, impacting bank asset quality, profitability and capital ratios. However, the rating agency added that this is not its base case.

"The system also remains susceptible to prolonged funding market dislocation given its reliance on offshore wholesale funding, although buffers in the form of liquid assets have increased substantially since 2008. In addition, banks may seek imprudent asset growth while credit growth is subdued," the report said.

Tim Roche, director in Fitch’s Financial Institutions group said: "Subdued credit growth and a moderate economic slowdown are likely to present some challenges for Australian banks in 2013. However, improvements to funding, liquidity and capital, and continued solid profitability should help them to navigate through these headwinds."