The current low interest rate environment could impact the ability of smaller banks to compete against the major institutions, APRA chair Wayne Byres has cautioned, via InvestorDaily.
In an address to the European Australian Business Council in Melbourne, Mr Byres spoke on financial stability and the challenges ahead for the banking system.
To briefly recap the different experience:
The return on equity (RoE) of the Australian major banks has certainly declined but has not fallen below 10 per cent, even during the GFC, and is now in the order of 12 per cent; for large global European banks, RoE was negative at the height of the crisis, and has struggled to get much above 5 per cent since then.
Reflecting this, the price-to-book (PTB) ratio of the Australian majors averages around 1.5x, and capital is readily available; for large European banks, PTB has typically been in the order of 0.5x and new capital is therefore expensive.
In 2018, a decade after the crisis, the four Australian majors were ranked in the top 35 banks in the world by market capitalisation. Europe, despite a much larger banking system and population, only had four banks in the top 35.
All four Australian major banks enjoy AA credit ratings, and ready access to funding; very few European banks (without explicit government support) enjoy similar ratings.
He compared the experience of the Australian market to Europe, noting local banks are having to get used to low interest rates, as opposed to their weathered overseas counterparts.
In Europe, where the continent’s GDP fell more than 5 per cent at the height of the global financial crisis and didn’t make it back to 2008 levels for another five years as well as unemployment rising to 11 per cent and only just recovering, he noted the environment has been tough.
“For European banks, of course, it is nothing new – Europe has operated with its interest rate on the ECB’s main refinancing operations at 1 per cent or below since late 2011, and zero since early 2016,” Mr Byres said.
“In that regard, the European experience illustrates some of the challenges potentially ahead for Australian banks. A very low interest rate environment will see margins squeezed, adding to the headwinds from slow lending growth.
“Profitability, and therefore capital generation, will come under more pressure. And given their different funding profiles, these trends may well impact smaller banks more forcefully than larger ones, reducing the ability of the former to apply competitive pressure to the latter. But to be clear, neither group will welcome further rate reductions.”
He reflected on the market around 2014-15, when APRA was concerned the banks were not responding prudently to the environment of high house prices, high household debt, low rates and subdued income growth.
“Speculative activity was increasingly prominent,” Mr Byres said.
“Such an environment would, one might think, see prudent bankers trimming their sails and battening down the hatches. Instead, intense competitive pressures across the industry saw a tendency for standards go by the wayside – for lenders, it was full steam ahead.”
APRA and ASIC worked to drive standards to more prudent levels, while ASIC focused on responsible lending.
“However, it is worth remembering that the original risks we were concerned about in 2014 – high prices, high debt, low interest rates and subdued income growth – have not gone away, and in some cases increased,” Mr Byres said.
“When it comes to the supply of credit, it would therefore be unwise for lending standards to be allowed to erode again as a means of generating lending growth. And on the demand side, it would be unhelpful if recent (and prospective) interest rate reductions led to a resurgence in speculative activity.”
