Big four on alert as foreign banks sniff an opportunity in Australia

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This was published 4 years ago

Opinion

Big four on alert as foreign banks sniff an opportunity in Australia

One of the more bizarre developments, among many, in the global financial system occurred earlier this month when Denmark’s Jyske Bank began offering home loans with a negative interest rate. Yes, the bank is paying home buyers to take out 10-year mortgages.

It is perhaps the most extreme illustration of the risk-aversion permeating global markets although, as discussed recently, there are, according to Bloomberg, now about $US16 trillion of bonds trading with negative yields.

Lenders like ABN Amro, who disappeared during the financial crisis, are re-surfacing in the Australian market.

Lenders like ABN Amro, who disappeared during the financial crisis, are re-surfacing in the Australian market.Credit: Reuters

The phenomenon is partly a function of fear, as the global economy slows and the US trade wars are seen as pushing it to the brink of recession. It’s also attributable to the ultra-low or negative central bank policy rates around the world.

The central banks have lowered rates, both by setting their versions of the Reserve Bank’s cash rate at low to negative levels and, in the case of the European Central Bank and Bank of Japan, also buying bonds and other interest rate securities to lower longer-term rates to encourage their banks into lending.

There is, therefore, a lot of near-costless liquidity sloshing around the globe.

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The actions of the central banks have squeezed bank profit margins. Banks borrow short and lend long and therefore need interest rates that rise over time to make money.

With yield curves flat and, in some cases (like the US, recently) inverting – where short-term bond yields are higher than those for longer term bonds – bank net interest margins and returns on equity are compressed.

The average return on equity for the four major Australian banks, while it has tumbled from the high-teens and above since their halcyon days before the financial crisis to low double-digit levels, compares more than favourably with the mid-single digit returns being generated by the big banks in Europe and the UK.

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In the first quarter of this year the average return on equity of eurozone banks was only 5.76 per cent.

In contrast, in their most recent half year results - which were studded with substantially increased compliance, risk and remediation costs, some of which will be transitory - the Australian majors had an average return on equity of 12 per cent.

It perhaps isn’t surprising that, with returns on equity lower than their costs of capital – the European Central Bank’s most recent survey of its institutions found they estimated their costs of capital at between 8 and 10 per cent – and with Europe slipping towards recession, those banks are looking elsewhere to avoid continuing to shred shareholder value.

Australian banks say that "names’’ that disappeared from this market after the financial crisis – banks such as ABN Amro and Barclays – have reappeared in the Australian business lending markets.

The major law firm, Minter Ellison, tracks foreign bank activity in this market. Its most recent analysis shows that European and UK banks grew their Australian assets 8.4 per cent last year, the fastest rate since the financial crisis.

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They aren’t the only foreign banks growing their Australian businesses, nor the fastest-growing.

Asian banks experienced growth of 15 per cent, with the Japanese presence growing 13 per cent and China’s 9.5 per cent. US and Canadian banks grew their Australian asset bases 13.8 per cent, also the fastest rate since the crisis.

The re-emergence of the foreign banks in this market isn’t surprising, given the settings in their home market and the relative health of the Australian economy.

At the big end of the demand for credit are the plethora of large-scale infrastructure projects being developed around the country. The major Australian banks have been tightening lending for property development, so there’s an opportunity there. Growth in demand for credit from small and medium-sized businesses (SMEs) might be modest compared to its pre-crisis levels but is still in the mid-single-digits.

The competition from players with low return hurdles and access to vast amounts of ultra-cheap liquidity makes for a very competitive environment on a playing field tilted against the locals.

From their more recent profit presentations, the big four banks appear to be prepared to cede some institutional banking market share and, to a degree, some growth in SME lending rather than take on low-returning business.

Given how volatile the global environment has become, with the growing risk of a recession in Europe, the impact of Brexit yet to come, the trade war producing a marked slowdown in China and threatening to export shock waves to the Australian economy in the process, there is no certainty the foreign bank presence in this market will continue to grow.

Most of the banks that operate globally are, however, more strongly capitalised than they were pre-crisis. The central banks’ responses to a global recession would be more and even cheaper liquidity.

Australia will still look a more attractive market – higher returning and safer – than most others and therefore the pressure on institutional bank margins and competition for the bigger end of the SME market is unlikely to subside quickly or easily.

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