Too big to behave badly

It’s difficult to imagine the landscape without them - indeed history has shown that they’re too big to fail. However, revelations from the Banking Royal Commission have certainly taken a toll on how we perceive our major banks.

As investors we’ve been long-term beneficiaries of the regular dividends they pay out and yet some of the conduct uncovered has been found reprehensible. So as investors, how should we be looking at banks moving forward? For me there are three key areas we need to consider:

1) The importance of managing risk

Since the Global Financial Crisis banks have done a lot to shore-up what were already strong capital foundations. Capital ratios have risen almost 3-fold in ten years to ‘unquestionably strong’ levels and liquidity management has also strengthened with banks switching to more stable sources of funding and increasing their holdings of liquid assets. As a consequence, return on equity (ROE) has slightly decreased to around 12% but still remains strong by international standards (around 8% for large US banks).1

Today we’re largely at the tail-end of this shoring-up process. Although as highlighted by the Royal Commission there’s still some work to do to mitigate operational risk stemming from poor culture. To date, the financial implications for ‘banks behaving badly’ has been relatively minor, but the consequences of reputational damage could considerably impact profitability if it were to continue.

2) A slowing credit market

 In the last 12 months the credit market has noticeably slowed. This is likely to continue, at least on the investor side, as a result of households being more cautious and banks having tightened their lending standards. With household debt at very high levels relative to global benchmarks, this isn’t altogether a bad thing however. In fact longer-term it will have a positive impact on our financial security as we’ll be more resilient to a down-turn.

Source: APRA, RBA

Shorter term however it does have a couple of implications for the majors:

  • Fewer loans means less profit.
  • Tighter lending practices have meant more stringent checks and balances which has in turn impacted the time it takes to process a loan application.

At the moment tighter lending standards have meant more paperwork and because it’s new, the process is still quite manual.  Over time however it will become increasingly automated making the process much faster and importantly cheaper. Going forward, we can expect to see the number of IT projects to replace people increase as the need to reduce the cost of labour intensifies.

3) Disruption from an intruder

In the last ten years we’ve witnessed some remarkable changes in market leadership. Established Goliaths have fallen as disruptors have swept in and completely sidelined their business models. So, could something like this happen to the majors?

There will continue to be smaller companies which pick off individual niches. For example OzForex in foreign exchange and AfterPay in payments. But when it comes to the core banking operations, Australian banks have invested heavily in technology particularly around service and convenience and a disruptor would have to offer something quite unique to displace them. Especially given the time it takes to establish the ‘trust’ many of us seek from our institutions, particularly financials.

Perhaps what strikes me most about Australia’s banks is their ability to adapt. Whether it be self-regulation to strengthen their financial health or investing heavily in technology to meet the changing needs of their customers they really are the ultimate market chameleons. And they’ll need to be. The Financial Crises proved they were ‘too big to fail’ but today the message from the Royal Commission is clear - they’re 'too big to behave badly.'

 

1 RBA Financial Stability Review – October 2018

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© 2019 FIL Responsible Entity (Australia) Limited. Fidelity, Fidelity International and the Fidelity International logo and F symbol are trademarks of FIL Limited.

This document is issued by FIL Responsible Entity (Australia) Limited ABN 33 148 059 009, AFSL No. 409340 (“Fidelity Australia”).  Fidelity Australia is a member of the FIL Limited group of companies commonly known as Fidelity International.

Investments in overseas markets can be affected by currency exchange and this may affect the value of your investment. Investments in small and emerging markets can be more volatile than investments in developed markets.

This document is intended for use by advisers and wholesale investors. Retail investors should not rely on any information in this document without first seeking advice from their financial adviser. This document has been prepared without taking into account your objectives, financial situation or needs. You should consider these matters before acting on the information.  You should also consider the relevant Product Disclosure Statements (“PDS”) for any Fidelity Australia product mentioned in this document before making any decision about whether to acquire the product. The PDS can be obtained by contacting Fidelity Australia on 1800 119 270 or by downloading it from our website at www.fidelity.com.au. This document may include general commentary on market activity, sector trends or other broad-based economic or political conditions that should not be taken as investment advice. Information stated herein about specific securities is subject to change. Any reference to specific securities should not be taken as a recommendation to buy, sell or hold these securities. While the information contained in this document has been prepared with reasonable care, no responsibility or liability is accepted for any errors or omissions or misstatements however caused. This document is intended as general information only. The document may not be reproduced or transmitted without prior written permission of Fidelity Australia. The issuer of Fidelity’s managed investment schemes is FIL Responsible Entity (Australia) Limited ABN 33 148 059 009. Reference to ($) are in Australian dollars unless stated otherwise. 

© 2019 FIL Responsible Entity (Australia) Limited. Fidelity, Fidelity International and the Fidelity International logo and F symbol are trademarks of FIL Limited.

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