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Tougher conditions mean tougher measures for major banks

Tougher conditions mean tougher measures for major banks article image

Australian major banks continue to adapt to tougher market conditions, reporting a modest increase in aggregate profits for the 2017 full year.

The “majors” reported a cash profit after tax of $31.5 billion for the 2017 full year, up 6.4 percent (compared to 2016), according to KPMG’s Major Australian Banks Full Year Analysis Report 2016-17. 

The result was achieved in spite of the challenging margin environment, rising capital levels, and ongoing regulatory, legal and compliance costs.

“Against a backdrop of subdued economic growth, slowing demand for credit, continued margin pressure and high regulatory and capital costs, the majors have been adept at managing a number of headwinds to deliver a solid result for the full year,” said Ian Pollari, KPMG Australia’s Head of Banking.

“Stagnant wage growth and high levels of underemployment are keeping a lid on economic growth and in turn, demand for credit, with growth moderating to mid-single digits.

“Consequently, the majors will focus their efforts on cost management, simplification and investing in digital capabilities, whilst ensuring debt serviceability and disciplined pricing is maintained, to preserve future earnings.” 

Heightened competition

The majors have continued to face margin pressure, with heightened competition, higher wholesale funding costs, holdings of liquid assets and the prevailing low interest rate environment, not sufficiently offsetting mortgage re-pricing efforts. The major banks recorded an average net interest margin of 201 basis points (cash basis), down 5 basis point compared to 2016. This is expected to continue with the introduction of the Major Bank Levy to fully flow through in subsequent reporting periods.

The majors recorded net interest income growth, increasing by 1.7 percent to $61.3 billion in the year, while non-interest income also increased, by 3.8 percent to $24.6 billion, mainly due to improved market conditions and one-off asset disposals. Housing credit recorded credit growth in the full year of 5.3 percent, compared to non-housing credit which only grew by 0.1 percent.

The major banks’ aggregate charge for bad and doubtful debts decreased $1.2 billion to $4.0 billion (statutory basis) for the full year (down 22.5 percent on 2016). 

Challenging growth environment

Andrew Yates, National Managing Partner - Audit, Assurance & Risk Consulting said: “The majors have demonstrated an ability to preserve credit quality in a challenging growth environment. As interest rates inevitably rise, they will need to balance their pursuit of future volume growth, with profitability and a strong focus on pricing discipline.”

The majors’ capital position continued to strengthen, with their average Common Equity Tier 1 (CET1) capital ratio rising by 46 basis points over the full year to an average of 10.3 percent of risk-weighted assets (RWAs), reflecting the impact of increased regulatory capital requirements.

In response to regulatory requirements, the increase in banks’ capital levels has continued to compress industry returns. The majors’ returns on equity (ROE) were flat on 2016, increasing 15 basis points to an average ROE of 13.9 percent for the full year. 

Greater financial and operational leverage

“Given a number of structural factors are impacting the banking industry simultaneously, the majors will need to adapt their business mix and product portfolios to give them greater financial and operational leverage to invest in future areas of growth and facilitate a transition to lower cost operating models,” Mr Yates added.

The average cost-to-income ratio decreased by 103 basis points across the majors to 43.4 percent, with revenue growth moderating compared to the increase recorded in underlying operating expenses. The rise can be directly attributed to meeting high and rising regulatory compliance, legal and remediation requirements, as well as restructuring costs and investment in technology.

Mr Pollari concluded: "The Australian major banks will need to be targeted with their investment in new technologies and balance short-term cost pressures to enable them to transition to lower cost operating models where the benefits are expected to be secured over the medium to longer term.

“Ultimately, this focus on cost management will provide greater capacity for the majors to invest in enhancing the customer experience, which will form a critical part of their response to growing competition from fintech firms, as well as the looming threat posed by the technology giants.”

Mr Pollari said in the medium to long term, there are substantial opportunities for the banking industry to make its customer engagement and operating models more efficient through the application of enhanced process automation, machine learning and cognitive computing.

“The key will be augmenting this capability with a human element,” he said.

The full report will be available on the KPMG website: http://www.kpmg.com/au/majorbanks later today.

KPMG is a professional services firm with global reach, and deep expertise in audit and assurance, tax and advisory.

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