Dependence on lending to dampen big bank profits

Moody’s Investor Service has released a new report in which it has assessed the financial outlook for Australia’s big four banks.

Moody’s noted that the major banks are under pressure from low interest rates, weak credit growth and “intense” competition, as well as structural challenges that risk “eroding” their competitive advantages in the long term.

“The low interest rates are pressuring the banks’ profitability amid an already challenging operating environment, with the potential to turn the once very profitable industry into a lower return business,” Frank Mirenzi, Moody’s vice president and senior credit officer said.

“We expect it will become increasingly difficult for the banks to retain their competitive advantage, with reduced room for differentiated pricing and ongoing competition in particular in the digital arena, although economies of scale remain a significant strength for the major banks.”

Moody’s added that such pressures would be more pronounced in light of the major banks’ growing reliance on domestic lending for revenue growth off the back of their divestments from the wealth space.

Moreover, the ratings agency stated that greater competition in the marketplace would make it more difficult for the major banks to preserve margins and generate interest income through differentiated pricing strategies for lending and deposit rates.

Moody’s also pointed to regulatory reforms designed to enhance competition and improve the banks’ financial resilience, which it said would add to pressure on profitability.

“The impact on the major banks will be particularly significant because advantages in capital and funding costs and a favourable industry structure, which have helped them have superior profitability compared to the rest of the sector, will continue to diminish over time,” Moody’s stated.

Looking ahead, Moody’s said it expects evolving technologies to “level the playing field” across the banking sector and “erase the major banks’ competitive advantages”.

Moody’s report follows an analysis of the big four banks’ financial results from consultancy firm EY, which revealed that the collective cash earnings of the banks fell $2.3 billion (7.8 per cent) to $26.9 billion in the 2019 financial year (FY19).

Return on equity decreased by an average of 125 bps to 10.9 per cent, while average net interest margins fell by an average of 9 bps to 1.94 per cent.

EY also reported that collective customer remediation costs totalled $5.7 billion, up $2.7 billion from FY18.

[Related: Major bank woes ‘showing no signs of abating’]