Solid earnings for the big banks as they navigate the challenges ahead

Doug Nixon, Oceania Banking and Capital Markets Leader at EY

Australia’s major banking providers have delivered another solid set of results for the 2022 full year, with increases in the cash rate since May helping second half margins and loan revenues for most of the banks, asset quality remaining strong and return on equity continuing to trend upwards, according to the latest analysis from Ernst & Young, Australia.

What were the research insights of EY’s survey?

The big four banks reported combined cash earnings of $28.5bn, up 7% from the same time last year. However, signs are pointing to increasingly challenging conditions ahead. In the face of a highly uncertain global economic environment, the banks are reviewing their potential future loan losses and increasing forward-looking adjustments to account for ongoing risks, including inflationary pressures and the impact of rising interest rates on loan payments. 

Doug Nixon, EY Oceania Banking and Capital Markets Leader said: Deteriorating economic conditions suggest that short term windfalls from interest rates will be offset by a more challenging medium-term outlook than might have been expected at this time last year.”

“Significant and interconnected global threats and tightening of global financial conditions could result in a slowdown in economic activity relatively quickly, fueling a growing likelihood of global recession that would have spill-over effects in Australia,” Nixon further commented.

“However, the resilient 2022 full year performance from major banks’ finds them in a strong position to navigate the path ahead. Those that can manage the margin opportunities from rising interest rates have an opportunity to capture the upside in the competitive market.

Competition increasing as the housing market slows

While asset quality remained strong, looking forward we can expect to see some volatility in the back book for at-risk borrowers as cost-of-living pressures take their toll. Demand for residential mortgage and business credit remains robust at present, but residential mortgage growth is slowing, with rate increases working as intended to slow the pace of borrowing.”

“Credit availability is likely to be more constrained over the 2023 financial year, on the back of anticipated further rate increases and tightened loan serviceability hurdles for borrowers, presenting a significant challenge for the sector. On a more positive note, net interest margins improved in the second half for all the major banks with 30 September year-ends, as mortgage rate increases outpaced deposit rate increases,” Nixon further commented.

“But the housing slowdown is intensifying the competition for customers. New borrowers are being wooed with responsiveness, significant discount pricing and cashback incentives from lenders seeking to grow their mortgage books, and this increasing competition is likely to lead to some erosion in the banks’ margin benefits over the medium-term,” Nixon said.

Inflationary pressures are a counterweight to cost management efforts

Despite the major banks’ strong management of operational expenses, these expenses have increased for the majority of them over the year. Although they are maintaining their focus on productivity and simplification initiatives, costs seem unlikely to fall further any time soon given wage and other cost inflation pressures, and the technology investment needed for customer experience and productivity improvements to support growth strategies.”

“In this challenging operating environment, banks need a new cost transformation approach, one that can eliminate complexity and drive operating effectiveness in process, data, systems and controls. While tactical and incremental cost reduction still has its place, banks will need to become more strategic in their overall cost transformation journeys,” Nixon said. 

Driving the digital and cyber agenda

“In today’s competitive market, providing digital capabilities is the bare minimum entry requirement for financial services providers, as customers expect convenient, personalised and innovative experiences like the ones offered by big tech providers,” Nixon said.

“With competition increasing, the banks are accordingly investing in data and analytics to enhance their digital platforms, make full use of data analytics for better real-time customer insights and personalised experiences, and modernise operating models,”Nixon added.

“Developments in cloud services and open banking are making it easier for banks to pull trusted data for analysis as they seek digital solutions that will create easy and frictionless customer journeys, with end-to-end digital mortgage origination a current focus.”  

“In light of recent incidents, the banks are also focusing closely on cyber resilience – incorporating additional controls and enhancing monitoring to protect customer data as they ramp up their digital transformation initiatives. Boards have also increased their attention on cybersecurity and have a critical role to play when it comes to banks’ risk management.”