Australia’s major banks will continue to face heightened regulatory scrutiny following recent public inquiries, including the Royal Commission, that identified shortcomings in conduct, governance and compliance, and will all be engaged in remediation that could distract management from day-to-day business, says Fitch Ratings. These challenges come amid other near-term pressures on earnings from a generally tougher operating environment.
The four major banks – ANZ, CBA, NAB, Westpac – have large market shares across most products in Australia and New Zealand, which support strong earnings and balance sheets and help moderate risk appetite compared with many international peers. However, it may be difficult for the banks to exercise these advantages fully in an environment of increased public and regulatory scrutiny, and pressure to increase their focus on customers rather than shareholders.
In the longer term, there is a risk that the findings of the inquiries may erode the market position of the four major banks, either by reducing management focus on revenue growth or through reputational damage – of which there is so far little evidence.
CBA and NAB were found to have the most significant weaknesses in their operational and compliance risk frameworks, and therefore face larger risks from the remediation process. This is reflected in the Negative Outlooks Fitch has assigned to these banks’ Long-Term Issuer Default Ratings. Shortcomings that allowed misconduct issues to arise were particularly evident at CBA, which is the only bank that will go through to a formal remediation process and face increased capital requirements.
Addressing conduct, culture and governance problems should improve the soundness of the system in the longer term, but will exacerbate banks’ short-term challenges. Fitch maintains a negative outlook on the sector as earnings are likely to remain under pressure in 2019 due to slower loan growth, especially in the residential-mortgage segment, falling net interest margins, rising wholesale funding costs, and increasing impairment charges, albeit from a low level.
The main downside risks to bank performance continue to stem from the housing market, where prices continue to decline after large increases up to mid-2017. A sharp drop may result in negative wealth effects for consumers and could undermine banks’ asset quality. However, our central scenario is that house prices will fall by only around 5% in 2019, which would represent a gradual easing of housing market risks. Moreover, regulatory intervention in the mortgage sector, including more stringent underwriting measures, has helped to reduce risks in newer vintages of loans, and should make the major banks more resilient to any downturn.
