Bank earnings rebound but revenue and profitability still under pressure

Tim Dring, Region Banking and Capital Markets Leader, Oceania, EY

Australia’s big four banks have delivered improved earnings in their 2021 full-year results, but underlying pressures remain with subdued revenue growth, low-interest rates and intense mortgage competition all having an impact, according to Ernst & Young Australia.

EY Australia’s analysis of the Australian major banks’ 2021 full-year results found aggregate cash earnings were up 55% from the same time last year, to $26.8 billion.

It’s underpinned by strong housing market activity, better than expected impairment outcomes that enabled the release of pandemic-driven provisions, and fewer notable expenses.

However, revenues and profitability remain under pressure.

Net interest margins declined on the prior comparative period and funding tailwinds have begun to fade, with the final drawdown of the central banks’ term funding facility.

In this environment, fixed mortgage rates are on the rise as the banks look to sustain margins.

EY Region Banking and Capital Markets Leader, Oceania, Tim Dring offered insights.

“Across the big four banks, key measures of asset quality remain resilient, with bad debt charges lower due to provision releases and low levels of write-offs.”

“While deferrals are lower than at the height of the COVID-19 crisis, banks need to keep an eye on this, with the recent lockdowns in Victoria and New South Wales likely to have put increased pressure on borrowers who were already facing repayment difficulty.”

“There is no doubt that the COVID-19 pandemic has certainly challenged the banks.”

“It has presented opportunities to speed up the transformation and cultivate the innovations to build a more successful and sustainable future for the Australian banking sector.”

“Continuation of simplification and digitization will boost efficiency and improve customer experience with increasing competition from fintech and bigtech disruptors in the payments space where we are seeing the rapid expansion of buy-now-pay-later options.”

“Climate change is high on the agenda in the wake of COP26 as banks participate in the Australian Prudential Regulation Authority climate vulnerability exercise assessment.”

Housing credit growing, but competition is steep

Strong borrower demand and low-interest rates have driven robust housing credit growth over the last year, with mortgage lending growth at a system-level almost doubling in the 12 months to September. However, competition in this space is intense.

“Not all the major banks have benefitted equally from the surge in housing credit, with strong competition and volume processing challenges resulting in a marked divergence in home loan performance between individual banks,” Mr. Dring said.

“We expect the mortgage market to evolve rapidly over the next few years, as open banking, big data and other digital innovations drive more personalized customer experiences.”

“Tailored, customer-centric value propositions, speed-reducing the time to yes – and simplicity will be key factors to winning new home loan customers in future.”

“Strong demand and limited supply have resulted in a rapid rise in house prices, which have increased by more than 21% over the year to October, according to CoreLogic data.”

“This has spurred renewed policy concerns over housing affordability.”

“To address rising household leverage, APRA has increased the minimum interest rate buffer it expects banks to use when assessing the serviceability of home loan applications.”

“While this can dampen housing market activity and price growth, it is expected to have a modest impact given most borrowers are already restricted by the floor rates used by lenders.”

Investment spends offset by productivity benefits

“Ongoing investment in digital transformation, risk and compliance initiatives and higher processing volumes have kept the pressure on expenses.”

“Additionally, customer remediation of historical wealth and anti-money laundering issues also continued to impact costs for some of the banks this period,” Mr. Dring said.

“With the pandemic accelerating digital transformation, banks have boosted their investment spend in technology like automation, cloud solutions, APIs and data science to improve customer experience, help with COVID-19 support measures and drive growth.”

“An increase in staff expenses and IT infrastructure costs led to support for flexible working.”

“Benefits of these initiatives and disciplined management of underlying operating costs and business simplification initiatives, have helped to offset some of the higher investment spend.”

“We expect continued digital investment by the banks, particularly as BigTechs and other market entrants look to expand their presence further into Australian financial services.”

Digital disruption challenging the status quo

Disruptions in the payment sector have picked up in the pandemic with consumers willing to embrace digital solutions and expecting newer, faster and more flexible experiences.”

“Fintech and bigtech players are targeting new revenue streams and customer acquisition, in order to facilitate them in challenging traditional banking,” Mr. Dring said.

“Solutions like contactless payments, P2P and mobile wallets offer opportunities for providers to be involved in consumers’ everyday life, not just the bigger occasional life-stage moments.”

“The latest EY NextWave global consumer banking survey found that 54% of Australian consumers would value their primary financial provider more if they partnered with other brands to expand their products and services, rising to 70% for Gen Z and millennials.”

“So, banks have a real opportunity here to become more relevant to their customers through strategic partnerships and collaborations with some of the newer market entrants.”

“To do this effectively, banks need to become more agile, innovative and responsive.”

“A digital-first approach, leveraging smart technologies and collaborations is key to reducing their cost-to-serve and delivering more personalized financial experiences for customers.”