Big four post improved headline earnings – but challenges remain

Subdued revenue growth, a cutthroat lending environment and low interest rates had a big impact in 2021, new report says

Big four post improved headline earnings – but challenges remain

Australia’s big four banks posted significantly improved headline earnings in their 2021 full-year results, but underlying pressures remain, according to a report by Ernst & Young Australia. Subdued revenue growth, low interest rates and cutthroat mortgage competition all had a big impact in 2021, the report said.

Aggregate cash earnings for the big four banks were up 55% from the same time last year by $26.8 billion, driven by strong housing-market activity, better-than-expected impairment outcomes that enabled the release of pandemic-driven provisions, and fewer notable expenses, EY said. However, revenues and profitability remained under pressure. Net interest margins fell three basis points from the prior comparative period, and funding tailwinds slackened thanks to the final drawdown of the Reserve Bank’s term funding facility. With these factors in mind, fixed mortgage rates have begun to rise as banks try to sustain margins.

“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,” said Tim Dring, EY region banking and capital markets leader for Oceania. “While deferrals remain significantly lower than they were at the height of the COVID-19 crisis in mid-2020, the banks will need to keep a close eye on this in the coming months, with the recent lockdowns in Victoria and New South Wales likely to have put increased pressure on borrowers who were already facing repayment difficulty.”

While COVID-19 challenged banks over the past 18 months, the pandemic also presented them with an opportunity to speed up their transformation journeys as they look to become more innovative and sustainable, Dring said.

“Immediate priorities include the continuation of their simplification and digitisation strategies to improve efficiencies and improving customer experience in the face of increasing competition from fintech and bigtech disruptors – particularly in the payments space, where we are seeing the rapid expansion of buy-now-pay-later options,” he said. “Climate change risk is also high on the agenda in the wake of COP26, particularly as the major banks participate in the Australian Prudential Regulation Authority’s first climate vulnerability assessment.”

Housing credit

Strong borrower demand and low interest rate have spurred housing credit growth over the last year, with mortgage lending growth at a system level nearly doubling in the 12 months to September, EY said. However, competition in the sector is intense.

“Not all the major banks benefited 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,” Dring said. “We expect to see the mortgage market evolve even more rapidly over the next few years as open banking, big data and other digital innovations drive more personalised customer experiences.”

Strong demand and limited supply have spurred a rapid spike in house prices, which skyrocketed by more than 21% over the year to October, according to data from CoreLogic. The rapid rise has fueled new policy concerns over housing affordability, according to EY.

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

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High investment spends reap productivity benefits

Ongoing investment in digital transformation, risk and compliance initiatives and higher processing volumes have kept the pressure on expenses,” Dring said. “Additionally, customer remediation of historical wealth and anti-money laundering issues also continued to impact costs for some of the banks this period. With the pandemic accelerating digital transformation across the economy, banks have been forced to boost their investment spend in key technology areas such as automation, cloud solutions, APIs and data science in order to improve customer experience, help with COVID-19 support measures and drive growth.”

Dring said EY also noted an increase in It infrastructure costs to facilitate and support flexible working arrangements.

“However, the productivity benefits of these initiatives, coupled with disciplined management of underlying operating costs and business simplification initiatives, have helped to offset some of the higher investment spend,” he said. “We can expect to see continued digital investment by the banks over the next year, particularly as bigtechs and other new market entrants look to expand their presence further into Australian financial services.” 

Digital disruptions

“Disruptions in the payment sector have picked up throughout the COVID-19 pandemic, with consumers increasingly willing to embrace digital solutions and expecting newer, faster and more flexible experiences,” Dring said. “Fintech and bigtech players are targeting new revenue streams and customer acquisition, challenging traditional banking.”

The most recent EY NextWave 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. That number rose to 70% among millennial and Gen-Z consumers.

“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,” Dring said. “To do this effectively, though, banks will need to become more agile, innovative and responsive. A digital-first approach, leveraging smart technologies and collaborations, will be key to both reducing their cost to serve and delivering more personalised financial experiences for their customers.”