Australia’s big four banks just posted a record $30 billion in combined cash profit, a rise of 5.4%.
While that’s a healthy return in the current business environment, analysts believe there are hard decisions ahead if the banks want to continue to get results like these and keep paying strong dividends to maintain shareholder love.
“Slowing growth and declining returns are a clear signal that we’ve reached the end of the banks’ golden era,” says Tim Dring, a banking expert at EY.
Behind the headlines about record profits are some weaker numbers pointing to problems ahead.
Across the four banks, return on equity (ROE) is down to 15% from 15.5% and this is expected to deteriorate further once the latest round of capital raising, needed to meet stricter capital rules, flows through in the current financial year.
And net interest margins (NIM) — the different between interest income and the cost of providing loan money – are at a record low of 2.02%, down from 2.07% a year ago.
Dring, Oceania banking and capital markets leader at EY, told Business Insider the banks face further challenges around productivity.
“The banks reported strong results for 2015 but there are significant headwinds facing them,” says Dring.
“Despite all the efforts around innovation that the banks are taking, including increased technology spend, they are still struggling to improve their cost to income ratios. They are spending more to get the same income.”
Overall, cost to income ratios are 44.08%, up from 43.93% in the prior year, a 15 basis points rise.
The ANZ’s cost to income ratios increased 70 basis points, Westpac’s by 90 basis points, NAB’s fell 90 basis points and CBA’s fell 10 basis points.
The banks are also seeing intense competition in business and institutional banking.
“There’s a lot of competition and you are also seeing low levels of investment in that part of the economy,” Dring says. “Institutional loans are highly competitive at this point in time.
“Loan growth is going to be critical for ensuring that banks can grow and at least match the reported profits in prior years.”
The decision by Westpac, Commonwealth, ANZ and NAB to raise home loan interest rates may help margins with existing customers but there is still strong competition for new business, with most offering low introductory rates.
Andrew Dickinson, Asia Pacific head of Banking for KPMG, says revenue and margin headwinds, rising costs and capital levels, with a deteriorating credit quality outlook, all mean the majors will face challenges in reversing declining returns.
“Recent increases in home lending rates have shown that the banks do have some market power to improve margins,” he says. “But careful balancing of shareholder and customer interests will be required in future to ensure disruptors are not further emboldened to attack established lenders’ business models.”
Dickinson says banks face more competition from fintech disruptors, increased lending losses and a need to generate returns to shareholders.
“Real courage will need to be shown by bank management over the next few years, and if banks push too hard on maintaining short term return to shareholders, they risk significantly damaging their long term franchise value and reputations,” says Dickinson.
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