Higher costs slash profits of Australia's four major banks

Australia’s major banks saw a decline of more than 40% in their profits for the first half of this year, compared to the same period last year. This is according to an analysis by KPMG, which attributes the plunge to Covid-19 repercussions among other factors.

Commonwealth Bank of Australia (CBA), Westpac Banking Corporation (Westpac), Australia & New Zealand Banking Group (ANZ) and National Australia Bank (NAB) reported cumulative cash profit after tax of just over $8 billion for the first half of this year, marking a year-on-year fall of nearly 43%.

Costs, meanwhile, have jumped by nearly 15% in the same period. Of the $21 billion in operating costs for the major banks this year, special items accounted for just over $2 billion, leaving just over $19 billion in operating expenses. This represents an increase of $560 million from last year.

The result is that the cost to income ratio has spiked across all four banks, with the average increasing by nearly 880 basis points to reach just under 55%. According to KPMG, investments in tech and jumps in personnel costs are the primary factors responsible for the spike, and both cost bases have been boosted by the Covid-19 crisis.

“The initial focus of the majors has naturally been to keep their staff and customers safe. This required an unprecedented mobilisation of resources to service customers (and a surge of Covid-19 enquiries) via phone and digitally, while implementing split teams and remote working arrangements and dealing with (offshore) disruptions with their service providers. This initial response required an enormous coordination effort by the majors,” wrote the KPMG report.

Aside from this sudden and unforeseen spike, spending in the tech space revolved around regulation technology (RegTech), as banks look to stay within the compliance framework following a slap on the wrist for many in recent years. Cloud technology is also steadily picking up amongst banks.

On the personnel side, the shuffling of staff to meet temporary requirements during the crisis has been an expense, as has an overall increase in wages. KPMG reports that the number of full time employees has largely remained constant across the four banks since the first half of last year. Meanwhile, more temporary workers were drafted in.

The financial strain from these factors is evident from the dividends and payouts across the major banks. Both ANZ and Westpac deferred their interim dividend in light of the crisis, while NAB cut its dividend by 64% to 30 cents per share. Average returns on equity (ROEs), meanwhile, reached an average of 6.4% for the first half of this year, which marks the first time in the medium term that the average ROE has dipped into single digits.

Speaking to the Australian Financial Review, Partner at KPMG Strategy in Australia and co-author of KPMG’s major banks analysis Hessel Verbeek predicted that these single-digit ROEs are here to stay. According to him, the decline in profits – while accentuated by Covid-19 – is not expressly the result of the crisis.

A large cost base combined with regulatory brush-ups and increasing competition in the mortgage and lending space have been threatening the profitability of Australia’s major banks for a number of years now. Verbeek stated that incumbent banks were already being edged out, while “Covid-19 has drastically accelerated the speed.”

For Verbeek, the way forward for major banks is to cut their substantial cost base. Where banks across the globe have been increasing their digital presence and cutting their physical footprint in recent years, Australian major banks have been slow to do so. Some have been cutting staff, but few have been focused on reducing the brick and mortar presence. Since 2015, Verbeek points out that Australian banks have cut a total of 900 branches, as compared to 3,500 closures in the UK over the same period.

Prioritising product offerings and outsourcing infrastructure are other potential areas of costs savings. At a broader level, Verbeek suggests a “zero-based budgeting” approach, where funding is allocated on a program-by-program basis depending on value and importance.