Banks are speaking out against Standard & Poor’s decision to downgrade the credit ratings of 23 small Australian lenders.

S&P’s knocked the smaller players down a notch, while retaining its ratings on the big four banks.

Their decision was influenced by the expectation that the federal government would protect the big four if there was a housing crash.

“Competition in banking took a backward step,” ME Bank boss Jamie McPhee said of the decision this week.

He said that S&P's had effectively increased the advantage the major banks enjoy from being ‘too big to fail’.

The Federal Government says its six basis point levy on the big banks would support competition in the banking industry.

Bank analyst Brett le Mesurier says the effects will be felt immediately.

“The cost of wholesale funding is going to rise and their wholesale funding costs were already very high, so they don't need another disadvantage being added to the pile of disadvantages they have,” he told the ABC.

“We saw yesterday there was a deal in the market launched before the downgrade, and that deal was repriced 50 basis points, or 0.5 per cent, higher after the downgrade,” said Charlie Jamieson, executive director of Jamieson Coote Bonds.

“So it's not a good sign for future borrowers. They're probably going to face increasing costs of mortgage funding.”