Australian Banks: Headwinds And Tailwinds

Feature Stories | May 25 2022

The conundrum for Australia’s major banks is that the benefits of rising RBA rates could yet be offset by the reason for those rate rises, being inflation and subsequent cost pressures for households and businesses.

-NIM upside, at last, for the banks
-Offset by lower loan demand
-And rising costs
-And bad debt risk

By Greg Peel

Since ANZ Bank ((ANZ)), National Australia Bank ((NAB)) and Westpac ((WBC)) reported full-year earnings in November last, and Commonwealth Bank ((CBA)) provided a quarterly update, bank analysts were looking ahead to inevitable RBA rate rises as inflation reared its ugly head.

The year had been a tough one for the banks, given a near-zero cash rate provided little scope for a reasonable margin between what the banks could borrow at (deposits, offshore funding) and what they could lend at (mortgages, business and other loans), known as the net interest margin (NIM).

Australian banks generate some 80% of their total revenue from net interest income, and therefore are highly dependent on NIMs to drive revenues.

Adding to NIM pressures was not only fierce competition between each other, but growing competition from non-bank fintechs, which together had gone from being a slight annoyance to a growing force.

In short, analysts assumed back in November the NIM situation would only deteriorate further before things got better, and getting better was reliant on RBA cash rate rises. Yet by February this year, when CBA reported its first half earnings and the other three provide quarterly updates, inflation remained relatively low, the RBA was thus remaining patient, and indeed, the banks together posted again-lower NIMs.

At the same time, costs were rising, particularly to cover regulatory compliance, cyber security risk and technology upgrades required to keep up with the fintech upstarts.

The one saving grace was that having put away significant provisions against covid risk to the economy from 2020, the reopening that stuttered through 2021 and into 2022, until an eventual “living with covid” strategy emerged, and loan losses not being as bad as feared, meant the banks could return part of those provisions to the bottom line.

This allowed not just for a return to decent dividends, but for share buybacks as well.

Here We Go

Australia’s March quarter CPI numbers jolted the RBA into losing its aforementioned patience and ignoring the federal election to provide the first rate rise this month, of 25 basis points to 0.35%. Another hike is expected in June.

Given the March quarter wage price index indicated wage growth remained under expectation, consensus has the RBA hiking by another 25 points in June, to 0.60%, although some believe the board could still go a full 40 points to 0.75%.

Either way, what the banks, and bank analysts, had been waiting for had finally arrived. A higher cash rate justified higher lending rates, and there was no great rush to raise deposit rates, so NIM expansion was set to become a reality.

NIMs still had to turn around from weak levels before getting back to anything resembling pre-pandemic numbers, so analysts were surprised how quickly NIMs were stabilising as ANZ, NAB and Westpac reported first half earnings in May and CBA provide a quarterly update.

The banks were still able to return more provisions, and thus maintain solid dividends and buybacks. Increased NIMs offered the prospect of increased revenues, but would these translate into increased earnings?

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