The Royal Commission into alleged misconduct in Australia’s financial sector announced on 30 November 2017 adds to the challenges for the system, says Fitch Ratings. It could potentially weaken the reputation of the system or individual entities, and exert further pressure on profitability, even if it does not identify broad or significant failings.
We continue to believe the system is well regulated and that the major banks are among the strongest that we rate globally. However, momentum for an inquiry has increased following a number of conduct issues across wealth management, life insurance and banking that have been identified in recent years. These incidents appear to be isolated, and we have not changed our view that the risk-management frameworks and policies of Australian banks are fundamentally sound. Any commission findings to the contrary are likely to result in Fitch reviewing ratings of affected banks.
Public perception of Australian banking has been weakened by the debate leading up to this inquiry, and may be further undermined by the Royal Commission, regardless of whether it exposes significant shortcomings. The reputation of the system is particularly important as the Australian banking sector is heavily reliant on foreign investors for funding. Any loss of trust may lead to higher wholesale funding costs, which in turn could intensify competition for deposits and push up funding costs for the entire system.
Profitability would be pressured by a rise in funding costs, while interest rates and fees on banks’ products would also be most likely to come under additional scrutiny. We already expect profitability to be squeezed in 2018, with margins likely to narrow as a result of low local interest rates, competition for assets and deposits, and upward pressure on funding costs from rising global interest rates. Slower asset growth and a rise in loan-impairment charges could also drag on profits.
Banks may seek to offset any sustained impact on profit by taking on additional risk, although we would expect the regulator to ensure this is adequately managed, meaning any increase in risk appetite should be limited.
The major banks have a strong competitive advantage in the Australian market, and there is a danger that the commission ultimately leads to some erosion of this position at smaller Australian banks and other competitors, such that the banks’ ability to set prices is weakened. The commission may also move the focus of bank management away from the day-to-day running of the bank, which could give an advantage to competitors.
The inquiry is to submit its final report within 12 months of its establishment, with an interim report to be provided by September 2018.