Competition has pushed returns on mortgages for the big banks below their cost of capital. Senior bankers face some tough strategic choices.
The big dogs of Australia’s banking sector arrived at The Australian Financial Review’s Banking Summit in Sydney on Tuesday with a clear message: this industry is unquestionably strong.
well managed and able to support the Australian economy if resilient conditions start to deteriorate.It was exactly what the community wants and frankly needs to hear. But the Summit also showed Australian banks have no room to relax. UBS estimates that the banks’ cost of equity is about 12.5 per cent. According to Storey’s numbers a mortgage that a bank sells through its own channel and is repaid over six years is still very profitable, with an IRR of 16.7 per cent.
It should be noted that loans the banks wrote in the past – this is known as banking as the back book – are still very profitable. CBA’s retail bank, for example, delivered a profit of $2.7 billion in the six months to December 31. Reducing costs to protect profitability is another option and one the banks are thinking about. Adjusting service levels in some areas, tinkering with the size of branch networks and going even harder on digitisation and automation are all ideas that the big banks are thinking about. Developing new sources of revenue could be another move, but after the banks have spent years hiving off unwanted assets this seems less likely.
But investors should recognise that while Australia’s backs are well-positioned to ride out turmoil in the global banking sector, the dynamics of the industry are changing. Increasing that profit pie could well get tougher.Mortgages, for so long the cash cow is the sector, are far less profitable than they were.
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