Balancing act for the major banks with regulatory and economic headwinds

Wherever you look, it seems there’s a headline about challenge or change in our financial services sector and particularly in November each year when the Australian banks release their full year results.

KPMG’s detailed report on those results captures a decline in aggregate cash profits for FY 2019 for Australia’s ‘big four’ banks.

Our key takeout from the analysis of the results is that the Australian major banks (“the Majors”), like many other businesses, are dealing with substantial economic and regulatory headwinds.

The impact is highlighted in the KPMG Major Australian Banks Year End Analysis Report 2018-19, with the Majors reporting a combined cash profit after tax from continuing operations of $26.9 billion, down 7.8 percent on FY2018.

A key turning point for the Majors in FY19 was the overall decrease in total operating income, driven by strong competition, particularly in mortgages, as well as a rebasing of fees following the Hayne Royal Commission.

Indeed, the fallout from the Royal Commission and the high volume of ongoing prudential, regulatory and parliamentary inquiries, together with litigation proceedings have generally impacted the Majors’ operating costs.

There is a continued trend of re-allocating investment spend towards compliance, regulatory and customer remediation costs. This is forcing investment and resources away from enhancing technology and digitalisation priorities.

We believe there will need to be a careful balancing act: on the one hand, the Majors must work on fixing problems and re-building trust with customers; on the other they must create capacity to invest in digital and technology capabilities in a lower growth cycle.

That’s not going to be easy particularly given the ongoing effects of their customer remediation programs negatively impacting financial results – routinely called out as ‘notable items’ within their cash profits.

Yet as much as the Majors’ profits are down significantly (as a result of shrinking margins in a low interest rate environment and higher costs, including refunds to customers, in the aftermath of the Royal Commission), we also see underlying resilience in the Australian banking sector.

On a more positive note, we see that credit quality has remained sound across the Majors, with a marginal increase of 1 basis point in impairment charges as a percentage of average gross loans and advances, to 14 basis points.

In addition, the Majors have announced that they are well positioned to meet APRA’s “unquestionably strong” benchmark of Common Equity Tier 1 (CET1) ratio of 10.5 percent by the implementation date of 1 January 2020.

Looking more broadly at the sector, the introduction of an Open Banking regime, scaled fintech companies entering from international markets and the launch of a number of new challenger banks, as well as the continued growth of international banks and non-bank players, will mean the competitive landscape is set to benefit Australian consumers.

For 2020 and beyond, our view is that the Australian banks will maintain and enhance their strong structural foundations and meet the multi-faceted challenges thrown up by complex regulation and economic change. We will see the Majors actively seek opportunities to invest in targeted areas of growth, enhance their customer-facing digital services and capabilities, as well as take greater action on reducing the cost of their operating models in order to position for the future.

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