Australian bank profits on loans are being crushed

Car crushed by bricks. Photo: Getty Images

The net interest rate margins of the big four banks, essentially the money they make on loans, have been squeezed to a record low of 2.03%, according to analysis of profit results by two major accounting firms.

While as a combined group the banks posted a 4.7% rise to $15.4 billion in cash earnings for the half year, net interest margins are down an average of 6 basis points over 12 months.

And the trend, driven by low interest rates and intense competition for new business and to keep current customers, is continuing down. The last low for bank margins was 2.05% in 2008.

The banks have been the darling stocks, a must have for personal portfolios and superannuation funds, because of the stability and always-growing fully franked dividends.

However, the big four banks have been hammered on the financial markets this week after posting disappointing profit results.

The plunge has been led by the Commonwealth Bank which reported a flat quarterly profit of $2.2 billion.

There are many factors at play but analysis by both EY and PwC shows the banks are getting a declining share on loans, are cutting costs to keep profits healthy and have a big job ahead to regain the trust of customers after the scandals involving bank financial planners giving poor advice.

“I think there is further squeezing to occur,” Tim Dring, EY’s Oceania Banking and Capital Markets Leader, told Business Insider.

“We’ve seen the gradual compression of margins over the last few reporting seasons off the back of intense competition, particularly in the mortgage sector.”

The banks managed to grow interest income but this was offset by the drop in net interest margins of between 2 and 11 basis points, as this chart shows:

Source: EY

“There are already early signs that the growth fuelled by the mortgage sector is tapering off,” Dring says. “Banks will need to work harder to retain customers by improving the customer experience.”

Hugh Harley, PwC Australia’s financial services leader, says the latest RBA cut in official rates adds pressure on margins.

“The banks are pulling every lever they can but it’s difficult to see margin pressure abating anytime soon,” he says.

He says the interest margin fall was partly offset by a 2 basis point increase in deposit margins.

Stronger lending volumes helped cushion the impact of the margin squeeze, with lending growth the highest it’s been since the financial crisis, up 6.2% to $2.4 trillion for the year to March.

“On the upside we’re seeing increasing credit growth, record low interest rates and stronger trading income. On the downside, there’s declining margins, capital uncertainties, and cost growth,” Harley says.

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