Headwinds blowing fiercely for the banking industry

Australia’s four major banks have released results showing returns remain under pressure for the foreseeable future as a result of remediation-related cost increases and slower income growth, with headline cash earnings dropping 5.5 per cent year-on-year to $29.5 billion after the record $31.2 billion delivered in 2017.

PwC’s 2018 Major Banks Analysis found return on equity has fallen to 12.5 percent, the lowest since the GFC, as significant customer remediation and regulatory, compliance and restructuring costs materialised. This is despite bad debt expenses hitting record lows, some momentum in business credit growth, and efforts to improve productivity.

PwC Australia’s Banking and Capital Markets Leader, Colin Heath says the full year results show the impact of ongoing economic, competitive and conduct challenges, especially the impact of ongoing regulatory reform.

“Over the course of the year, the major banks have collectively expended and provisioned $3.5 billion for remediation, compliance, restructuring, and related costs,” Mr Heath says.

“The expense-to-income ratio for the last six months was up 355 basis points year-on-year, and 222 basis points against the first half of 2018, to 46.36 per cent, predominantly driven by remediation and restructuring costs.

“Cash earnings will continue to be impacted as the banks address both previous compliance and conduct issues and new operating challenges thrown up by today’s environment.

“With ongoing matters flowing from the Royal Commission, as well as related reviews by different regulators, we would expect the costs of legacy matters to remain notable in bank financials for some time.

“One critical question for the major banks now is how much higher should their cost bases be to meet the new customer conduct expectations and requirements? And can those higher costs be offset by the productivity benefits of simpler, more streamlined business models?,” he says.

“When you exclude the cost of items specifically called out by the banks on these legacy matters, the cost to income ratio has actually improved by more than 1 percent. The balance between these two factors will be closely monitored.”

Margin pressures starting to show

Another highlight for these results is that the aggregate bank interest margin fell below 2.0 percent for the first time ever to 1.97 percent in the second half.

“A broad range of factors, rather than any one thing in particular, drove this decline, including higher wholesale funding costs, a fading tailwind of earlier mortgage and other repricing, the impact of the bank levy, and a higher cost of holding liquid assets. Notwithstanding recent mortgage repricing that has yet to flow through to bank revenues, managing margins remains one of the critical levers at the banks’ disposal to support returns going forward,” Mr Heath says. “It will be interesting to see how the new regulatory environment impacts banks’ ability to re-price their products independently of movements in official rates.”

Bad debt expense hits a record low

Credit losses, at 12 basis points of loans and advances, are now lower than at any time in the last 25 years. Specific provisions and charges have materially reduced while collective provisions have only marginally increased in line with a slight tick-up in mortgage arrears.

“If credit losses had hit their average for the last 25 years, cash profits would have been $3.5 billion lower, which is more than 10 percent. Obviously many eyes are on the property market, while the outlook for interest rates in particular will continue to receive plenty of attention,” Mr Heath says.

Slowing growth and market share a challenge

Business lending growth surpassed residential mortgage lending for the first time since 2015, with hopes that this is a sign of a turn in business confidence and bank focus.

However, overall lending growth for the majors has been subdued, in part because of a deliberate system-wide slowdown in housing credit, and in part because the majors have lost share to smaller banks and non-banks.

“The major banks share of credit is starting to decline, with non-banks in particular seeing a notable lift in lending, reaching 27 percent on an annualised basis for the third quarter of this calendar year. While this data is too early to call a trend, if non-banks continue to grow at this rate, regulators will need to keep a close eye on the implications for the system,” Mr Heath says.


“The headwinds of growth, competition and conduct are blowing fiercely for the majors. In the short term the main opportunity for mitigating this is the cost base,” Mr Heath says.

“Despite ongoing challenges, the major banks have been working on this for some time and it does appear to be starting to deliver cost efficiencies, notwithstanding increased investment in change management and new technology.

“In the long run though, especially with the introduction of open banking, we will continue to see choice being more clearly put into the hands of the customer. Banks that focus on becoming simpler, smaller and more deeply connected to customers should also be able to price more effectively, expand relevant services and maintain market share – as well as being more efficient and less error-prone by design.”