Australia’s major banks have been under pressure in recent months as investors re-rated expectations on earnings growth and return on equity, given the changed regulatory environment and need for banks to raise additional capital.
That means, even though the Commonwealth Bank stock rose 3.7% last week it’s still down 11.65% over the past three months.
A report last week from accounting and advisory firm PWC — “Regulatory capital – Growing shareholder value in a changing world” — says Australia’s majors remain among the best in the global business of banking when it comes to generating value for shareholders.
The report found that a survey of “the world’s largest internationally active ﬁnancial institutions”, what regulators call the G-SIBs, showed most of the 29 banks in this cohort “destroyed shareholder value in 2014, by failing to generate returns in excess of their cost of equity (CoE).”
That is an amazing statistic and it’s clear that Australian and Asian G-SIBs stand in contrast to European and North American institutions beset by weak underlying profitability and “material restructuring and remediation costs.” But the report highlights how strong the Australian banks are.
Only six of the 29 G-SIBs earned a positive Economic Spread (ES), being the difference between the return on equity and cost of equity. As a group the G-SIBs delivered a negative economic spread of -2.9% (refer ﬁgure 1).
By comparison the four Australian major banks, in aggregate earned an economic spread of 5.3%, placing them in the top quartile of the G-SIBs, ahead of all but four individual G-SIBs.
In the context of the debate about the impact of regulatory changes and the need to hold more capital on earnings, PWC says “increased regulatory capital may not always be bad for shareholder returns.”
“Conceptually reducing leverage (the impact of holding more capital relative to assets) lowers the cost of equity and so increased regulatory capital may not by itself be all bad for shareholder value creation,” the report says. Rather, “to impact shareholder value creation, there has to be a real change in the underlying risk-reward equation.”
Interestingly, and a nod to the profitability that flows from the government’s implicit too-big-to-fail support and the explicit guarantee of the first 250,000 for depositors, the report notes that such a change would be “regulators’ rationale for more capital, which is to wind back implicit taxpayer subsidies to equity holders.”
In essence, while PWC is lauding the performance of Australia’s major banks, they are equally highlighting that a large part of that performance comes from their status within the Australian financial system.