Australian banking: the calm before the storm?

KPMG analysis finds that the Australian major banks (‘the Majors’) have reported improved financials for the full financial year 2022, driven by continued strong post-COVID demand and margin recovery supported by rising interest rates.

KPMG’s Major Australian Banks Full Year Analysis Report 2022 finds that the Majors reported a combined cash profit after tax from continuing operations of $28.5 billion, up 7.2 percent on FY21.

The Australian economy has continued its strong post-COVID recovery, with the impacts of the RBA’s seven successive interest rate rises since May 2022 yet to drive any material slowdown in business and consumer activity. As a result, the Majors have benefited from continued credit growth in their FY22 results.

Also behind the improved profit performance, we are starting to see the impact of rising interest rates, driving an increase in average net interest margin (NIM) of 3 basis points compared to 1H22. This is still however 9.5 basis points lower than in FY21, demonstrating that the benefit of rising interest rates is only just starting to flow through to bank profitability. This comes after over a decade of extremely low interest rates which have created prolonged pressure on the Majors’ margins, which are now beginning to rise from a low base.

However, there is a more challenging outlook for the Majors with inflation putting pressure on their cost bases and new provisions being taken for potential economic stress ahead.

The Majors have worked hard throughout the year to address their cost bases, however overall costs have increased only marginally, with the average across the Majors’ being 1.3 percent. All of the major banks have signalled that their cost targets will be either adjusted or abandoned as these inflationary pressures continue.

The average cost-to-income ratio decreased from 2021 by 30 basis points to 49.2 percent. A number of factors including continued regulatory compliance requirements, ongoing customer remediation (albeit declining) and increased labour and FTE costs are putting pressure on the overall cost to income ratios.

KPMG Banking Partner Maria Trinci added: “What will prove interesting is how the costs will play out, with inflation putting further pressure on the pace of transformation. With the backdrop of a tight labour market, competition for skilled resources will place pressure on staff costs as banks respond to attract and retain the right skillsets.”

Having recently weathered the pandemic from a credit perspective and written back a combined $925 million in provisions in FY22, the Majors have now returned to more normalised provisioning. While credit quality remains strong at this point with delinquencies at their lowest level since 2018, with interest rates anticipated to continue rising into 2023, the Majors are signalling a likely economic slowdown, increasing unemployment and falling house prices. These factors are expected to lead to raised provisions in the years ahead.

Of particular focus for the Majors and their mortgage books is the rolling over of a large volume of low fixed rate loans that were written during the COVID pandemic when residential valuations were at their peak. As these loans come up for refinancing, borrowers will be re-assessed at significantly higher interest rates, creating the potential for mortgage stress in some cases, which is expected to begin to materialise into mid-FY23 where $237 billion of loans are scheduled for roll-over across the Majors.

Balance sheet strength has remained a core focus for the Majors with average CET1 of 11.65 percent. This is down from 12.7 percent in FY21, however still above APRA’s ‘unquestionably strong’ benchmark.

Steve Jackson, KPMG Australia’s Head of Banking commented: “After over a decade of ultra low rates weighing on bank profitability, the recent rapid rises in interest rates are starting to provide some initial margin relief for the Majors.

However, the monetary policy tightening cycle is also introducing inflationary pressure which is working against the Majors’ efforts to reduce their cost bases and, depending on the pace and strength of rate rises, contributes to the potential for economic slowdown and a rise in bad debts.

Banks are signalling challenging times ahead for the economy and the big question is whether a ‘soft landing’ will be achieved that avoids the harsher potential outcomes.”

• The Majors reported a combined cash profit after tax from continuing operations of $28.5 billion for the year, an increase of 7.2 percent on FY21 and an increase of 65 percent on FY20. This result reflects strong growth in housing credit, with improved asset quality leading to reductions in provisions and increasing net interest margins compared with 1H22 on average across the four Majors.
• The average net interest margin (cash basis) increased by 3 basis points compared to 1H22, although it is 10 basis points lower than FY21. As such, the Majors’ FY22 results include early indications of the positive impact of increased interest rates.
• Cost-to-income ratios have decreased modestly from an average of 52.0 percent in FY21 to 49.2 percent. Excluding notable items, operating costs increased by 1.3 percent to $39.2 billion, reflecting lower remediation and provisioning costs, although offset by an increase in personnel costs and investment spend.
• The average ratio of impaired loans continued to decrease in FY22, down 8 basis points from FY21 to 0.23 percent. This is a result of a decline in delinquencies to the lowest levels since 2018, as well as a natural lag in the impact of interest rate increases on mortgage holders.
• The Majors continue to have strong capital buffers, although the average Common Equity Tier 1 (CET1) ratio decreased by 102 bps to 11.65 percent. The strong capital position saw each Major announce share-buy backs totalling $14.0 billion during the year, in a move to deliver stronger returns to shareholders.
• Dividend pay-out ratios remained steady at 71.0 percent, although this remains lower than FY19 of 81.3 percent.
• Continued growth in earnings have seen Returns on Equity (ROE) increase by an average of 67 basis points compared with FY21 to 10.58 percent, returning to the double-digit standards experienced prior to the pandemic. Maintaining shareholder returns in an inflationary environment will continue to challenge ROEs for the foreseeable future.

2022 saw growth across both housing (up 5.7 percent on 2021) and non-housing lending (up 13.2 percent on 2021). Much of this growth has been the result of strong increases in house prices in the first half of FY22 and the continued post-COVID economic recovery. The Majors are signalling they expect this growth to soften as we move into 2023.

“Now more than ever is the moment for the Majors to accelerate their digital transformation efforts, to reduce their reliance on (increasingly expensive) FTE and bring efficient, technology-enabled solutions to their core middle and back office processes, where much of the scale of their cost bases exist. The Majors will be striving to enter a potential economic contraction with strong credit quality, a lean cost base and a strong digital capability”, said Jackson.

Ash Pritchard
+61 411 020 680
apritchard2@kpmg.com.au