THE BIG FOUR BANKS AFTER THE ROYAL COMMISSION
By Denise Slattery
Following the release of the findings from the recent Royal Commission on the Banking industry, there is no doubt that the perception of the big four banks has certainly changed. However, it is difficult to imagine the financial landscape without them – history has shown that they are too big and important to fail.
Investors in the banks have been long-term beneficiaries of the regular dividends they pay and yet some of the conduct uncovered through the Royal Commission has been shameful. So, how should investors be looking at banks moving forward?
There are three key areas which need to be considered:
1) The importance of managing risk
Since the Global Financial Crisis banks have done a great deal to strengthen what were already strong capital foundations. Capital ratios have risen almost 3-fold in ten years to ‘unquestionably strong’ levels and liquidity management has also strengthened with banks switching to more stable sources of funding and increasing their holdings of liquid assets. As a consequence, return on equity (ROE) has slightly decreased to around 12% but still remains strong by international standards (around 8% for large US banks).
Today the banks are largely at the tail-end of this strengthening process. However, as highlighted by the Royal Commission there is still some serious work to do to mitigate operational risk stemming from poor culture. To date, the financial implications for ‘banks behaving badly’ has been relatively minor, but the consequences of reputational damage could considerably impact profitability if this behaviour were to continue.
2) A slowing credit market
Over the last 12 months, credit markets have noticeably slowed as demonstrated in the chart below:
Source: APRA, RBA
This is likely to continue as a result of households being more cautious and banks having tightened their lending standards. With household debt at very high levels relative to global benchmarks, this is actually not a negative. In fact longer-term it will have a positive impact on the bank’s financial security as they will be more resilient to a downturn.
Shorter-term however it does have some implications for the banks:
- Fewer loans means less profit.
- Tighter lending practices have meant more stringent checks and balances are in place, which has, in turn, impacted the time and cost it takes to process a loan application.
Currently, tighter lending standards have meant more paperwork and because of this, the process is still quite manual. Over time, however, it will become increasingly automated making the process much faster and importantly cheaper. Going forward, it is to be expected that the number of IT projects to replace people will increase, as the need to reduce the cost of labour intensifies.
3) Disruption from an intruder
In the last ten years, we’ve witnessed some remarkable changes in market leadership in the financial industry. Established business in the markets have fallen, as disruptors have swept in and completely sidelined their business models. So, could something like this happen to the major banks?
There will continue to be smaller companies which pick off individual niches. For example OzForex in foreign exchange and AfterPay in payments. But when it comes to the core banking operations, Australian banks have invested heavily in technology, particularly around service and convenience and a disruptor would have to offer something quite unique to displace them. Especially given the time it takes to establish the ‘trust’ many of us seek from our financial institutions.
The Financial Crisis proved that the major banks were ‘too big to fail’ but that doesn’t necessarily make them a good investment. In the current landscape of the Royal Commission, the requirement for strong capital adequacy ratios and tightening credit conditions, short term the banks face profit headwinds and it is unlikely to see revenue growth that we have been previously accustomed to.
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