Will The Royal Commission Put Bank Profits Under Pressure? – Digital Finance Analytics (DFA) Blog

Given the range of issues already exposed by the Royal Commission into Financial Services Misconduct, including selling loans outside suitable criteria, fees from advice not given and other factors; we need to ask about the impact on the profitability of the banks and so share prices.

And all this is in the context of higher funding costs already hitting.

A number of international investors and hedge funds have placed shorts on the major banks, signalling an expectation of further falls in share price ahead, but the majors have already dropped by around 15% in the past year.

The recent RBA chart pack contained this picture on profitability. Bad and doubtful debts are very low, thanks to low interest rates. But that may change if rates were to rise, and “liar loans” are wide spread. There is no good data on the potential impact so far.

It is important to remember the Productive Commission recently called out that :

Australia’s major banks have delivered substantial profits to their shareholders — over and above many other sectors in the economy and in excess of banks in most other developed countries post GFC

A quick survey of the banks from last year show that the return on equity – a measure of absolute profitability – or ROE range from 14.5% for CBA, 10.3% from NAB, 10.9% for ANZ and Westpac was 13.3% while AMP was 11.5%.

Looking overseas, US based Wells Fargo, which happens to be a key Warren Buffett holding, was 11.5% , the Bank of America earned less than 6.8% and Lloyds earns 4%. Barclays was -2.7%. In fact among western markets, only Canadian banks come close to our ROE’s – for example of Bank of Montreal was 11.3% but then they have the same structural issues that we do.

Data from news.com.au from 2016 shows the relative profit to GDP across several countries. Australia Wins.

That means 2.9 per cent of every $100 earned in Australia ends up as bank pre-tax profit, compared to the US and UK at $1.2 and 90 cents per cent respectively.

China is the highest after Australia at $2.80, Sweden $2.60 and Canada $2.30.

The Australia Institute also pointed to public money being used to secure the banking sector.

“Excessive profits provide a drag on the economy and hurt consumers who pay higher margins on bank products. The Reserve Bank found the big four banks enjoy an implicit government subsidy worth up to $4 billion dollars a year,”

The Royal Commission revelations have the potential to impact the market value of the banks as reflected in their share prices, and also raises questions about the financial stability of the entire system in Australia. APRA, in particular and the RBA have been (over?) focussed on financial stability, as the recent Productive Commission draft report highlighted.

Regulators have focused on a quest for financial stability prudential stability since the Global Financial Crisis, promoting the concept of an unquestionably strong financial system.

The institutional responsibility in the financial system for supporting competition is loosely shared across APRA, the RBA, ASIC and the ACCC. In a system where all are somewhat responsible, it is inevitable that (at important times) none are. Someone should.

The Council of Financial Regulators should be more transparent and publish minutes of their deliberations. Under the current regulatory architecture, promoting competition requires a serious rethink about how the RBA, APRA and ASIC consider competition and whether the Australian Competition and Consumer Commission (ACCC) is well-placed to do more than it currently can for competition in the financial system.

Over the next few days we will try to assess the potential impact ahead, from higher loss rates, lower fee income and potential fines and penalties. Then of course, there is the question, will these additional costs be passed on to investors and shareholders, or simply recovered from the current customer based by higher fees.

We expect banks to start making provisions for the revenue hits ahead. ANZ, for example, said their RC legal bill will be around $15 million. CBA made a $200 million expense provision for expected costs relating to currently known regulatory, compliance and remediation program costs, including the Financial Services Royal Commission.

To start the journey lets look at the relative performance of the banks’ share prices over the past year. Westpac share price is 16.8% lower compared with a year ago.

ANZ is down 16% over the same period