Big banks bolster bottom lines but pressures persist

Australia’s big four banks — ANZ, Commonwealth Bank, NAB, and Westpac — posted $16.7 billion in statutory earnings over the first half of the 2023 calendar year (1H23), up 10 per cent on 1H22.

Return on equity (ROE) rose 190 basis points (bps) to 12.6 per cent, while the net interest margin (NIM) increased by 17 bps to 1.88 per cent.

“In this reporting period, we see the majors have grown both the volume and profitability of their loan books,” Steve Jackson, KPMG Australia’s head of banking and capital markets, said.

But the 1H23 boost was expected to be short-lived, with headwinds threatening to curb growth over the coming six months.  

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Doug Nixon, EY Oceania’s banking and capital markets leader, said Australia’s major banks were “walking a tightrope”.

“The resilience of the Australian economy continued to support credit growth and quality throughout the first half of the year,” he said.

“However, intense competition in response to retail credit growth compression, coupled with rising funding costs, amplified by the recent dislocation in financial markets, will likely erode the benefits the banks have gained from the higher interest rate environment.”

Nixon also flagged risks associated with a deterioration in credit quality off the back of 11 hikes to the cash rate in 12 months, with the major banks increasing their credit impairment expenses to $1.4 billion.

This would be compounded by increased operating expenses, particularly labour, technology, cyber security, and remediation costs.

“So, while Australia’s major banks remain strong and resilient, pressure on net interest margins, combined with the increasingly uncertain operating environment, means they face a complex high-wire balancing act when it comes to managing profitable growth, customer expectations, investment priorities and shareholder returns,” Nixon added.

Heightened banking sector competition for new borrowers is also expected to weigh on future earnings.

Following the release of ANZ’s 1H23 results, CEO Shayne Eliott said competition in retail banking was “as intense as it has ever been”.

Nixon said these pressures would only persist over the medium term.

“Retail credit growth compression has created highly competitive pricing practices for mortgage business, with some lenders appearing to price loans at or below the cost of capital,” he said.

“Banks have been offering significant cash back incentives and discounted rates in the battle to attract new and retain existing borrowers.

“However, competitive pressures are showing early signs of easing as the banks respond to rising funding costs and expectations that the current monetary tightening cycle may soon end.”

To offset threats to earnings growth, KPMG’s Jackson said banks needed to “decouple” headcount and cost growth from revenue growth.

Nixon said banks should consider a “new and more holistic approach” to their expense management.

“Simply focusing on cost reduction misses a unique opportunity to drive greater operational effectiveness and move towards the type of transparent cost base investors are increasingly looking for,” he continued.

“Banks need to engage in structural cost transformation, targeting client segments, products, geographies and distribution channels to add flexibility and scalability to their operating models.”

This would help offset an expected increase in wholesale funding costs amid volatility in the global banking system and deposit costs as savers look for higher yields.

“Given the first real opportunity for yield in several years, customers are looking for higher-yielding deposits, and banks are seeing plenty of movement in term deposits offering higher returns,” he said.

“This switch from low to higher cost deposits will likely undo some of the funding cost gains the banks have enjoyed in recent years.

“In this environment, Australian banks are taking a more granular look at their deposit mix, including the proportion of insured to uninsured deposits.”

To hedge against banking volatility, Australia’s banks should “closely monitor and stay ahead of key risk indicators”.

“Looking ahead, we expect the banks to refine a range of their balance sheet and liquidity risk management capabilities,” Nixon added.

“Banks will also need to prepare for APRA’s upcoming resolution planning requirements by assessing potential critical functions and interconnectedness.”

The major banks’ capital positions remain strong, with an average common equity tier 1 (CET1) of 12.3 per cent, and a liquidity coverage ratio (LCR) of 131 per cent.