Where Are We Now: The Current Banking Landscape
Amidst escalating allegations and revelations of financial misconduct, the Australian banking sector has faced intense scrutiny by both the ACCC and the Royal Commission. This, compounded by the threat of class-action lawsuits, led to severe economic penalties enforced upon leading banks. These corporate punishments, headlined by CBA’s $700 million penalty following the AUSTRAC scandal, were immediately followed by a plummet in the financial markets. Although the cases reviewed were predominantly ones of signature forgery, over-billings and creation of unauthorised accounts for customers by the Big Four banks, repercussions were widespread within the banking industry, rattling shareholder confidence as a result.
Cases of unethical behaviour unearthed by the Royal Commission indicated that uncompromising, self-interested attitudes were endemic in the industry. Such judgements upon the banks have led to stringent regulations to neutralise the current breeding ground for deceptive and insidious practices which financial advisors engaged in. Of particular note, APRA has imposed new loan standards requiring greater capital to mortgage loan ratios to curb irresponsible lending whilst ASIC has been granted powers to embed its staff to enforce best practice compliance and governance.
Figure 1. Despite the Royal Commission Admissions, the Big Four Banks Remain Integral to the Australian Economy
While this may seem to have a greater impact on investors rather than the banks, they too have to suffer the consequences. Investors have sought to attain loans from smaller financial lenders who are under less rigid regulation than the Big Four banks, although we note the out-of-cycle rate rises by the non-majors has nullified any material shift in market share. Faced with rising funding costs and an opportunity to capitalise on the bad press from the Royal Commission, the non-major banks (bar AMP) Bank have sought to benefit by promoting themselves as a “community bank” and distancing themselves from the notion of “bad bankers”. Bendigo and Adelaide Bank Managing Director Marnie Baker recently claimed that smaller banks are just as capable as the Big Four in meeting the banking needs of customers. So, what, if any, are the significant points of difference between the banks in Australia?
The Clear Divide: Where the Big Four Sit in the System
Historically, investors have desired the stability and security offered to them by the major banks in a banking system that was set up to favour these institutions. With lending books not to be sneezed at even on a global scale, these banks have significantly lower risks of default and can leverage their size to offer attractive offers across home loans, credit cards and term deposits. Although the years of consecutive record profits during early to mid-2010s have largely subsided, the gradual rollout of fintech across these businesses in lieu of previous manual procedures have allowed the Big Four to continue posting multi-billion-dollar profits in recent times.
Smaller banks, on the other hand, are able to offer targeted services towards a niche community, creating a more personal relationship, a stark dichotomy to the stereotypical corporate facades of larger enterprises. Whilst we note that this dynamic is changing in the face of significant divestments and acquisitions, such as Westpac owning Bank of Melbourne and St. George, rather than exacerbating the divide between small and large banks, it has allowed smaller banks to encroach upon the Big Four banks’ traditional client base. We have seen examples of this recently with non-majors targeting the owner-occupier mortgage and insurance customers in a bid to capitalise on the Big Four’s time in the Royal Commission headlights.
A Global Perspective: How Does Australia Compare?
Government regulation of banks has been a stalwart of modern society. The notion that the banking sector as a whole, if compromised, may culminate in crippling economic repercussions, is shared by legislative councils worldwide. Preventative measures, as implemented by the Big Four Banks in line with Basel III requirements overseen by APRA, are designed to to minimise the possibility of a catastrophic recession as devastating to the global financial markets as the Great Depression in 1929 and the 2008 Global Financial Crisis.
Reminiscent of the subprime mortgage crisis which contributed to the United States’ recession, the housing bubble has displayed years of rapid expansion, drawing in significant investment at the expense of ballooning household debt. Whilst noting that the credit world has changed dramatically since the GFC, and the incomparable regulatory environment within the Australian banking system, there are signs of concerns that Australia’s record high levels of household debt could spell trouble for the banks. With lax policies regarding subprime lending, mass scale loans by the banks throughout the United States culminated in the inability for financial institutions to swiftly liquidate their holdings, thus triggering a correlated default across the credit sector. While JPMorgan Chase, Bank of America, Goldman Sachs, Citigroup and Morgan Stanley were afforded government bailouts totalling near half a trillion dollars, Lehman Brothers, in conjunction with 77 other banks became insolvent as a direct result of “unsound risk management practices”. Closer to home, Macquarie bank was given an eleventh hour bail out deal by our own government at the time as it edged towards the brink of collapse.
Figure 2. The Big Four’s Strong Funding and Liquidity Positions Leave Them Well-Placed in the Current Economic Conditions
Adopting these new standards may somewhat mitigate the possibility of a future travesty occurring in Australia, but there are also negative implications upon our markets. Dangers of overregulation of the banking sector include stymieing innovation, departure of institutions to less tightly regulated jurisdictions, higher consumer costs and a burgeoning household debt bubble. Should further, more draconian measures be implemented, the room for deviation by managers, executives and banker will be significantly cramped, boding negatively for additional advancement of the sector.
Undercutting the Competition: ANZ and CBA Make Their Moves
Contrary to expectation, ANZ and CBA have recently cut home loan rates, a move diverging from smaller lenders, seeking to increase their already sizeable market share (noting that CBA is already the largest lender in the sector). Utilising margin loans, CBA and ANZ seek to capitalise upon the increase in costs associated with wholesale funding, specifically the continual surge in the interbank swap rate (BBSW), which has caused smaller banks to initiate out-of-cycle rate rises. While it may seem to be counter-intuitive to reduce rates, compressing profit margins for shareholders, the cuts are offered to new customers only, with variable rates the target of ANZ’s 34 bps cut and fixed rate benefiting from CBA’s 10 bps cut. In doing so, ANZ and CBA, and other large banks if they follow suit, may enlarge the existing chasm between them and their smaller counterparts.
Further reflecting this attempt to strengthen their worth, large banks have gradually divested from the wealth management and life insurance sector. CBA CEO Matt Comyn highlights that these actions seek to consolidate their “core banking franchise”, following their divestment of CommInsure and Sovereign. Later coupling this move with its sale of BoComm Life to Mitsui Sumitomo Insurance, CBA’s actions are echoed by NAB’s divestiture of MLC and ANZ’s sale of OnePath Pensions.
Figure 3. The Bank Divestment Trail Has Gathered Steam Throughout 2018
With the Royal Commission now shifting its attention to superannuation funds and insurers, the reputation damage, along with significant capital requirements and high compliance costs are all causes for these banks to sever their wealth management arms. Viewing these investments as being potential breeding grounds for cowboy advisers and poor governance, as well as dwindling profit centres. The Royal Commission will likely impose further rigid frameworks upon banks offering holistic financial services, such as the proposed changes to ADI capital requirements by APRA earlier this week, thus reducing the attractiveness of wealth management and life insurance from a profitability perspective for the banks.
The current banking landscape is facing a tense and uncertain period characterised by innovation in technology, while the economy awaits with the findings from the Royal Commission, due in February 2019. Whilst Commissioner Kenneth Hayne and his team sift through thousands of financial misconduct allegations, looking further ahead, regulators will have the unenviable job of seeking the fine line between the dangers of letting the banking sector off the leash and the dangers of being too restrictive. On the one hand, being lenient comes at a social cost that may not be tolerated in the current political landscape, whilst the prospect of a housing market toppling due to tighter lending and restricted credit growth is arguably even more catastrophic.
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