Australian bank profits are heading south

Gabe LHeureux/ Getty Images
  • The banks have come to the end of a long run of growth.
  • Morgan Stanley says bank profitability is falling and earnings growth prospects are modest.
  • And the banks will need to place more emphasis on governance to address community concerns following the financial services royal commission.

Australian bank profitability is falling and earnings growth prospects are modest as they come to the end of a strong run and now face increased community scrutiny.

Part of the problem are the issues revealed in a series of scandals involving misconduct and poor behaviour by the banks, now being investigating by the financial services royal commission, including fees charged for services not delivered.

The banks will need to focus more closely on governance factors given current scrutiny on culture and conduct, according to research by Morgan Stanley.

“In our view, the Australian bank ‘supercycle’ is over,” write the analysts in a note to clients.

“We think the operating outlook for the major banks is clouded by the end of the mortgage bull market, growing margin headwinds, downward pressure on fees, a reinvestment burden, bottom-of-the-cycle loan losses and rising capital intensity.

“As a result, profitability is declining and earnings growth prospects are modest.”

Morgan Stanley sees growing importance of ESG (Environmental, Social and Governance) as a key measure of sustainability.

“In our view, investor focus on these factors for Australian banks will continue to increase given recent developments relating to culture, conduct, compliance, risk management, customer and community expectations, accountability and remuneration,” says Morgan Stanley.

“A reduction in profitability may be required over the next few years in order to win back the support of key stakeholders and enhance long term sustainability.”

The forecast for return on Net Tangible Assets:

Morgan Stanley

“Initially, scrutiny of bank conduct had little impact on shareholder returns,” says Morgan Stanley.

However, the major bank levy has reduced earnings by 3% to 4% and there is growing evidence that misconduct is leading to civil proceedings, more customer remediation, and fines.

Examples include action by corporate regulator ASIC on the bank bill swap reference rate (BBSW), responsible lending and fees for no service.

Morgan Stanley estimates $835 million of charges in the 2018 financial year, including the Commonwealth’s $700 million settlement of anti-money laundering rule breaches.

“We think the Royal Commission will lead to further action and we factor in another $500 million of charges in FY20E,” says Morgan Stanley.

“While this has not had a material impact on valuations, there is a risk that fines and/or customer remediation could emerge earlier and be greater than we forecast.”

Scrutiny of the banks’ conduct has escalated since late 2016.

“We believe their reputations have been damaged by the Royal Commission and other inquiries,” says Morgan Stanley.

“While the major banks have been making progress on social and governance factors over a long period of time, we think recent scrutiny will lead to more emphasis on governance in order to address community concerns, and there will be changes to their strategies and conduct.

“We expect banks will need to increase their efforts to address community concerns and win back public trust in order to protect their market share and mitigate the risk of adverse political and regulatory outcomes.”

Business Insider Emails & Alerts

Site highlights each day to your inbox.

Follow Business Insider Australia on Facebook, Twitter, LinkedIn, and Instagram.