The results are now in for the last year from the major banks, and combined they delivered more than $28bn in cash profit, higher than the $27bn last year.
There are several key drivers of profitability, the first is housing lending. Rises in property prices inflates new loans, and the banks’ balance sheets. If the property market takes a turn down, this will have an impact. Net interest margin is down a little (thanks to discounting) but is now being offset by lower deposit rates.
The second is efficiency and some players are doing a lot better than others in excellence of execution, thanks to technology investments, and cultural transformation. This will continue as new technology and channels become ever more mainstream. This may open the door on new competitors, as discussed in our Quiet Revolution report.
The profit contribution from wealth management will continue to grow, as superannuation balances increase thanks to the enforced savings scheme. This may be offset by a reduction in fees. Is FOFA another sleeper? Well, unless the Senate does something surprising, the FOFA regulation will work in the banks favour, so no.
The enigma factor with regards to continuing performance is whether via the FSI or directly, the regulators lift the capital requirements for the majors. There is a strong argument to do this, because as the concentration risks in the mortgage book become an ever larger share of the total book, the Basel III rules mean the banks can get away with ever lower capital reserves. Those within the banks will claim they already have more than enough capital, and would be put at a disadvantage compared to other international players. However, on an international comparison basis, Australian banks are relatively less well capitalised. The current rules also make lending to business less attractive in comparison to home loans. Capital rules may be selectively targetted at property investors and especially those signing up to interest only loans.
If capital requirements are lifted, the banks will have to raise their pricing to match, but on the other hand they can also trim their deposit margins, and tweak their discounting strategies. So, we believe that even if capital requirements were adjusted up, there is really little likely impact on bank profit. Margins and fees in Australia are still relatively high and competition works for the majors.
So, overall, we think that profit landscape is going to remain relatively benign, external economic shocks excepting. Those with a strong local franchise will be best positioned.
