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Overview
Statutory earnings:
Increase of 8.2% (total of all four major banks)
Net interest margin:
Increase of 11 basis points
Return on equity:
Increase of 125 basis points
Credit impairment charges:
Increase of $2.96 bn (from a net write-back of $0.13bn at the 2022 full-year)
Notes:
Figures throughout this report are calculated on the prior corresponding period (PCP), unless otherwise stated.
ANZ, NAB and Westpac’s full-year reporting periods ended on 30 September 2023. CBA’s full-year reporting period ended on 30 June 2023.
Unless otherwise specified, references to ‘the banks’ or ‘the major banks’ in this article refer to the ‘big four’ Australian banks: ANZ, CBA, NAB and Westpac.
In 1H23, Westpac ceased reporting cash earnings and cash earnings excluding notable items and used net profit as the key measure of financial performance. Comparatives have been revised accordingly. The figures above incorporate core NIM and return on equity as reported by Westpac.
The Australian major banks have posted strong full-year earnings. Despite highly competitive pricing during the year, cash rate rises and the net interest margin (NIM) peak flowed through to higher revenues. These increased earnings also underpinned improved return on equity (ROE) for the banks.
However, multiple signs suggest future revenue and earnings are likely to moderate, including:
- Slowing mortgage and business credit growth: while competition in the critical home loan segment has eased, the market is likely to remain highly competitive.
- Inflationary pressures driving up operating expenses: the cost of staff and technology, including cyber, continues to rise.
- Modestly deteriorating asset quality: higher interest rates and inflation are squeezing household finances, and businesses are dealing with higher input and labour costs.
- Peaking NIM constrained by the intense competition for mortgages and deposits: NIM declined in the second half compared to the first half for all of the banks.
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1
Economic headwinds
A challenging road ahead for banks and consumers
Inflation seems to have peaked, suggesting the Reserve Bank’s 425bps of rate hikes are working. However, it is still unclear whether inflation is falling fast enough to get back to the Reserve Bank of Australia’s target band within a period that is tolerable to the central bank. Services inflation has proven to be sticky and a reason the Reserve Bank remains on alert. New risks are evident in conflict overseas, while domestically, the consumer price index (CPI) is being pushed up by high rental price increases which reflects strong population growth as well as high price growth across a range of other domestic services, such as insurance and dentistry.
Many households therefore face ongoing challenges due to inflation eating into their disposable income, while borrowers face higher mortgage repayments and therefore lower disposable income. Household consumption is falling in real terms. Offsetting this though, is a still-strong labour market, with the unemployment rate not far above 50-year lows. The Reserve Bank has also kept the door open for further tightening should it look like inflation will not return to target by the end of 2025. In this environment, the industry is hunting for sources of growth.
2
Credit growth
Loan momentum continues to slow
Credit growth continues to be dampened as the slowing economy and tighter serviceability requirements reduce demand. Adding to affordability challenges, house prices are recovering and remain on an upward trajectory. Although the pace of increases is slowing down, population growth and lags to new housing supply could keep a floor under house prices for some time.1
Amid these tighter financial conditions, demand for both residential mortgages and business credit slowed significantly over the 12 months to September.2 Total housing credit grew just 4.2%, well down from its most recent high of 7.9% during the first half of 2022. Refinancing, which has been a key driver of mortgage growth, appears to be slowing too.3 Business credit growth - still a robust 6.8% - was also well down from its high of 13.8% in October 2022.4 To support lending growth, most of the banks are easing serviceability criteria for borrowers with good credit history and substantial equity.
Mortgages have long been the traditional banking growth engine. But the challenging environment has put business lending firmly back on the agenda. To gain a competitive edge, banks must also do more to close the customer expectation gap. Consumers expect banks to provide similarly engaging, hyper-personalised and frictionless experiences as e-commerce platforms. Research by EY teams in Asia-Pacific found that for 80% of customers, the expectation of an experience was as important as the product, yet only 8% received the experience they wanted.
Much of this expectation gap comes from banks’ inability to generate the detailed customer journey data needed to extend personalisation from a single product to the whole of the customer relationship. Banks need to re-think their data strategy and architecture with the right platform tooling to enable real-time data intelligence. Integrating progressive technologies with existing platforms and data will empower banks to monetise insights by delivering event-based personalisation.
3
Operating costs
Inflationary pressures make cost management difficult
In recent years, banks have faced major cost pressures on multiple fronts, squeezing both profitability and investment in transformation programs. Balancing potential impacts to revenue, customer service and risk while managing rising costs is crucial, as is taking a multi-year lens to ensure the cost reduction implemented today does not impede the needs of the future business. To address this challenge, institutions need effective cost management strategies, operational efficiencies and to effectively funnel investment towards the more profitable parts of the market.
Operating cost challenges include wage inflation, especially due to the need to attract scarce (and therefore, expensive) tech talent and increasing IT vendor costs. Regulation costs are still significant, especially in cyber and scams, with one bank noting a more than fourfold increase over the past six years in the cost impact of new regulations. Increasing losses related to scams and frauds are not only expensive but are also driving investment in cyber security and fraud prevention.
Despite this, cost-to-income ratios improved for most of the banks, thanks to the positive impact of interest rate increases on revenues and the banks’ strong focus on expense management.
4
Funding costs
Mortgage competition eases but margins remain tight
Banks have been increasing mortgage and deposit rates as they tackle rising funding costs driven by cash and bank bill swap rate increases. Following a period where some banks offered mortgages below their cost of capital, eroding profitability, most of the majors have withdrawn cash-back offers and moderated rate discounting.
That’s not to say the mortgage wars are over. If market share suffers due to prioritising profits and return on capital over volume, we may see a renewed bout of intensified competition.
Overall deposit growth has slowed since its pandemic-driven surge.5 But the banks continue to compete for deposits, which are a major source of stable and cheap funding amid rising costs. As the low-cost funding of the central bank’s Term Funding Facility expires, the funding mix is being adjusted to minimise more expensive wholesale issuance.
5
Balance sheets
Strong, with modest asset quality deterioration
Confident that asset quality will weather the challenging economic environment, the banks continue to provide sound returns for shareholders, enabled by robust capital ratios. Three of the banks have announced share buybacks.
Mortgage stress among the major banks’ borrowers has risen only modestly so far. However, the full impact of rate increases on credit quality is still to play out. According to central bank data, the proportion of borrowers rolling off fixed-rate mortgages has peaked at around 5.5% of outstanding housing credit and is expected to decline in 2024.6
Accumulated household savings are helping to cushion the impact of high rates, but the effect is wildly uneven. People in their early 30s are reported to be feeling the cost-of-living squeeze particularly acutely.7
Other areas of exposure include the troubled construction sector and retail trade. Commercial real estate exposures have been well-controlled by progressively tightened lending criteria for higher-risk developments, low loan to value ratios and the use of loan covenants.
As arrears and defaults increase, the banks will need to make full use of their front line and collections capabilities. ASIC has made it clear it expects lenders to step up their support for customers grappling with financial hardship.
Summary
Banks remain unquestionably strong. But economic headwinds mean banks, like consumers, face some challenging times ahead. With mortgage profitability continuing to tighten, the banking sector is hunting for growth outside retail lending, such as business lending, and looking to optimise funding and operational costs. To compete, banks also need to improve the consumer experience and effectively manage increased cyber and regulatory compliance investment.