In the recent results round, the need to raise more capital in response to regulatory change was used as one of the pretexts for the need to lift mortgage rates. Given we, on an international comparison basis, still have more ground to make up to reach “unquestionably strong” we can expect this to continue, and APRA says it will be further lifting capital requirements soon. Wayne Byers said recently:
We have been doing quite a bit of thinking on this issue, but had held off taking action until the international work in Basel on the bank capital regime had been completed. Unfortunately, the timetable for that Basel work now seems less certain, so it would be remiss of us to wait any longer.
We estimate the banks will need to raise another $20-25bn to cover likely rises in the next year or two. Whilst this is manageable, lending costs will rise further. Internationally, Basel III finalisation is in question.
Shareholder returns are under pressure in the current environment, with some able to maintain payouts whilst others are trimming. CBA’s return on equity was 16% as last reported down from 19.5% in 2011. The weighted cost of capital is lower than this but the higher capital demands is still taking its toll.
The drive to hold more capital is primarily to ensure financial stability in a time of crisis, and to protect tax payers from a direct bail-out during a crisis as happened for example in the UK in 2007. However, recent research has shown that higher capital requirements may encourage some banks to take MORE risk.
But, lifting capital does nothing to fix the root cause issues which lurk in the shadows, and which costs Australia Inc. dear. Some of the banks appear to be mounting a charm offensive where they demonstrate their contribution to society via the salaries they pay staff, the tax they pay, and returms which flow to shareholders (many of whom are institutional investors, and some offshore). But this effort sounds false to many.
The profitability of our banks sits at the top end of international lists, not because our management are especially talented, but because of the level of competition in the industry which allows higher margins to mask relative inefficiencies. ANZ’s recent trading update showed that when a bank tries hard, they can drive costs down and efficiency up, but not all players have this same focus. And this is hard to do.
The cultural norms where for all the lip service towards serving customers better, many customers do not feel the love; where capital costs are passed on to consumers and small business and where the litany of scandals and poor customer experiences continue to surface; are the real issues that need to be addressed.
But let us be clear, there is no necessary trade-off between good customer outcomes and profitability. Indeed, I would argue that superior long term returns will be achieved by those players who are really driving their business from a point of customer centricity. But this is hard, and requires a different set of cultural norms to those displayed in many financial services companies today. If they were to ban sales incentives, price products fairly, and put processes to train their staff to deal with errors effectively, this would lead to better outcomes all round. Such cultural changes cannot be legislated or regulated though, it requires management leadership to make this happen.
At the moment, there is a gap between (to use an old cheque processing phrase) “words and figures differ”. This is the gap between all the talk and real action. And more capital is not a replacement for the cultural change which is required.
