Banks’ profits under rising pressure

EY’s analysis of the 2016 half year results of Australia’s major banks
Thursday 5 May 2016

  • Share

Australia’s big four banks have posted slowing results in their 2016 half year announcements. EY’s analysis of the half year results of the major banks shows headline cash earnings after tax of $14.8 billion, a decrease of 2.5% from the prior comparative period.

Profits have been affected by higher capital requirements and rising bad debt charges.
Evolving regulation is likely to result in further increases to capital and funding costs. Return on equity is also lower across the banks.

After enduring periods of contraction, net interest margins have stabilised on an average basis, notwithstanding the variations between banks. This is a result of re-pricing loans in the back book and the ‘passing on’ of slightly higher funding costs. But the Reserve Bank’s reduction in the cash rate to an historic low of 1.75% means the banks may face further margin pressure. The banks have moved quickly to pass on the reduction to customers.

EY Oceania Banking and Capital Markets Leader, Tim Dring says: “External pressures are squeezing the Australian major banks’ performance.”

“The past six months have been characterised by stock market volatility, escalating concerns about the trajectory of global and economic growth, concerns over falling oil prices and indications of slowing growth in China,” Mr Dring said.

“In this environment, the banks’ share prices have continued to fall, in a market now highly sensitive to strategic announcements.”

“As they continue to rationalise portfolios, strengthen balance sheets and focus on building their core domestic business, the key question that remains is: what will drive future growth?”

Innovation and growth programs constrain cost improvements
Tight cost management remains key to maintaining returns, but increased regulatory and compliance costs, coupled with the need to invest in innovation and growth programs, are reducing the impact of the banks’ efficiency measures. As a result, the majors’ banking jaws for the half year have been negative and cost to income ratios have been close to flat or have risen.

In this increasingly challenging operating environment, cost discipline has become one the banks’ top strategic priorities.

“The banks have been pulling hard on a range of cost levers. One of the key areas they are focusing on is how to deliver sustainable cost efficiencies through better use of technology,” Mr Dring said.

“Ongoing advances in automation technologies, such as robotics, are challenging the traditional business case for digitising banking operations – disrupting offshoring and outsourcing models. A greater level of process automation has the potential to not only reduce costs, but to help increase control, meet regulatory requirements and deliver an enhanced customer experience.”

“However, in a lower growth environment, the banks will need to consider a more holistic approach to automation to maximise return on investment. A vital component of this will be engaging more fully with their workforce on what increasing levels of automation may mean, particularly for those undertaking manual processing roles.”

Credit cycle finally turns
An increase in non-performing loans in the first half of the year presents a clear signal that the credit cycle may have finally turned. This has been marked by home and personal loan losses in the resources states of Queensland and Western Australia, as well as in a number of individual corporate exposures. Softening demand for apartments and flat rents for commercial property in select markets and exposure to the dairy industry in New Zealand are also adding to the pressure.

“I think it’s now clear we are coming off the bottom of the credit cycle. The end of the mining boom, a downturn in commodity prices and the generally softer economic environment are challenging asset quality,” Mr Dring said.

“However, the increase in non-performing loans is off a very low base and is occurring in pockets, rather than across the board. Essentially, rates are normalising after a period of unusually low levels.”

“That said, increased competition and the quest for growth, particularly in the business and institutional banking arms, has possibly resulted in looser covenants for some facilities. After many years of operating in largely a benign credit environment, credit risk is likely to gain greater prominence around the board room table. This could test the banks’ credit functions in the future.”

Rebuilding trust
“Adding to the external pressures for this half of the year are the internal conduct and culture issues exposed by a series of high profile allegations affecting all of the banks,” Mr Dring said.

“With alleged conduct breaches around issues including bank bill swap rate manipulation, life insurance claims payment and financial advice, it is hardly surprising that the banks now face increased regulatory scrutiny around conduct and culture.”

“In April, the Federal Government released a $127 million reform package designed to strengthen ASIC – with a substantial bolstering of the regulator’s authority, resources, and surveillance and enforcement capabilities. The package will further focus the industry on its commitment to rebuild trust and confidence in banks.”

“The banks need to focus on, not just addressing the issues as they arise, but also developing a more customer and risk centric culture to help rebuild Australian consumers trust in the sector,” Mr Dring said.

“Responding to this external pressure should also been seen as an opportunity for the banks. The nature and extent of the response presents the prospect to differentiate – not only against their historic competitors, but also against new and emerging competitors in shadow banking and fintech.”

The 2016 half year results at a glance

  • $14.8 billion in cash earnings down from $15.2 billion in the 2015 half year results, a decrease of 2.5%.
  • Return on equity decreased by an average of 244 basis points from the prior comparative period, to 13.8%.
  • Average net interest margin remains stable on the 2015 half year results, at 2.02%.
  • Bad debt expenses have increased by 52% from the 2015 half year results, to $2.5 billion.
  • The average Tier 1 ratio increased from 10.9% to 11.9%, as the banks continue to strengthen their balance sheets.

-ends-

About EY

EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities.

EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organisation, please visit ey.com.

This news release has been issued by Ernst & Young Australia, a member firm of Ernst & Young Global Limited.

Liability limited by a scheme approved under Professional Standards Legislation.