Australian banks are facing the same type of regulatory onslaught their UK peers experienced in the wake of the 2008 financial crisis and an overcorrection is “seemingly inevitable”, said Brian Hartzer, chief executive of Westpac.
The warning from Australia’s second-biggest bank by assets comes during the sector’s worst results season in at least a decade with three of the four biggest banks — ANZ Bank, National Australia Bank and Westpac — reporting big falls in profit, reduced dividend payouts and a challenging outlook.
Mr Hartzer’s comments follow disappointing annual results from the fourth large institution, Commonwealth Bank of Australia, in February and reflect a sharp deterioration in the operating environment for the nation’s banks, which until recently were among the most profitable in the world.
“It is certainly a far more challenging time that we are staring into,” said Mr Hartzer, who led Royal Bank of Scotland’s retail division until joining Westpac — the world’s 20th largest bank by market capitalisation — in 2012.
He said low interest rates, tougher regulation and a weak domestic economy are creating the most difficult conditions for banks in years.
Combined assets of Australia’s four biggest banks
He warned further cuts to official interest rates would only undermine confidence in the economy and cautioned against creating an environment where banks find it difficult to attract and retain good people due to proposed changes to employee incentives.
“Some of what we are seeing here is very similar to what we saw in the UK coming out of the financial crisis,” Mr Hartzer told the Financial Times. “There has been a huge step up in regulatory intensity in other markets and we are seeing some of that. It is seemingly inevitable that there’s an overcorrection.”
The four big banks, which hold A$1.4tn (US$960bn) in assets, equivalent to 140 per cent of Australian gross domestic product, also face the continuing fall out from a public inquiry into misconduct across the finance sector.
A searing final report published in February exposed greed, dishonesty and misconduct at the heart of the banking system and prompted Canberra to tighten regulation and forced the Big Four lenders to repay customers.
NAB revealed on Thursday it paid out A$1.1bn in customer-related remediation in 2019 and has a team of 950 employees working through a litany of problems at its wealth and insurance divisions.
Philip Chronican, NAB chief executive, said management had spent a lot of the year dealing with regulatory and litigation issues, while admitting these were largely of the bank’s own making.
Shaw & Partners, a Sydney-based broker, estimates the final bill for compliance and remediation across the big four banks and AMP could top A$10bn.
Australia’s prudential regulator, Apra, has tightened lending standards, raised capital requirements, bolstered executive accountability and shone a spotlight on cultural problems in the banking sector after the inquiry. An ongoing capital review by the Reserve Bank of New Zealand is expected to result in further capital requirements on the four banks, which own operations in the nation.
Meanwhile, market watchdog Asic has adopted a “why not litigate” strategy, which is leading to rise in the number of court actions pursued against banks and other financial institutions.
Last month, Canberra directed the competition regulator to conduct an inquiry into home loan pricing following decisions by several banks not to pass on the full 0.75 per cent cuts in official interest rates to customers implemented by the Reserve Bank of Australia since June.
David Morgan, former chief executive of Westpac, describes this latest inquiry as a “jihad” on mortgage pricing and warns these cumulative regulatory interventions could have severe consequences for banks and the economy.
“There is only one thing worse than a profitable banking system — that’s an unprofitable one,” said Mr Morgan.
But consumer advocates and regulatory experts say such fears are overblown and the wrongdoing exposed in the inquiry, known as the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, justifies tighter rules.
Bank profitability, dividends and returns on equity may be falling but they remain healthy and none of the main banks has reported a loss.
An analysis by KPMG shows the four big banks made a combined A$26.9bn cash profit after tax in 2019, down 7.8 per cent on 2018. Return on equity fell by 131 basis points to 11 per cent, as banks focused on strengthening capital and their profits fell.
“Banks only have themselves to blame,” says Elizabeth Sheedy, a financial risk expert at Macquarie University. “As we saw from the royal commission, banks exploited their customers on an industrial scale, which helped them generate super profits.”
She says there are signs of tougher competition in the market but the four big banks’ 75-80 per cent market share positions them well in the medium term when the cost of remediation abates. Banks may now be on a path towards more sustainable profits over the long term, says Ms Sheedy.
However, the main lenders forecast that the challenging outlook will continue in 2020 and 2021 owing to the weak domestic economy and super-low interest rates, which reduce the amount of money they can generate off their loan and deposit books.
“The profitability of Australian banks is inherently tied to the domestic economy, much more so than major international banks with big investment arms,” says Elio D’Amato, analyst at Lincoln Indicators, a fund manager in Melbourne. “Home loans and deposits are the steak and potatoes of Aussie banking.”
Mr Hartzer warns that any further official interest rate cuts could be counterproductive, as they are likely to be interpreted by businesses and consumers as a sign of weakness.
“It is certainly a cyclically challenging time for banks,” says Mr Hartzer. “But Australia remains a good, open economy and notwithstanding its challenges we are still going 28 years without recession.”