RBA Downbeat On Outlook For Major Banks

By Glenn Dyer | More Articles by Glenn Dyer

With three big banks reporting interim results in early May, it will pay investors to look at the first Financial Stability Review of 2019 from the Reserve Bank and remarks on the profits and earnings.

And the outlook is not very upbeat about the chances of higher profits.

“Overall, there appears to be greater-than-usual uncertainty about the future profit outlook for banks because of the increased scrutiny on banks and the weaker outlook for property prices and housing credit growth,” the central bank said in the Stability Report on Friday.

The ANZ, Westpac and NAB are all due to report their March 31 first half figures and in the wake of the weak performance of the Bank of Queensland’s interim results last week.

Investors are looking for flat figures and will again concentrate on the level of dividends. The Bank of Queensland cut its interim by four cents a share saying the decision “reflects the challenging revenue and cost environment that BOQ and the industry face.”

The RBA pointed out in its report that the banks’ “resilience and capital generation has been underpinned by high profits over many years. However, profits have remained broadly steady since 2014.”

“The absence of growth mainly reflects a fall in non-interest income as banks have sold or scaled back a number of their fee-generating activities, while the contribution from falling bad and doubtful debt charges is less than in the past.

“More recently, a narrower net interest margin (NIM) due to pricing competition and higher funding costs has reduced interest income growth.

“In addition, operating expenses have increased due to higher compliance, IT and customer remediation costs. As profits and capital have both steadied, so too has banks’ return on equity (ROE). ROE is now a few percentage points lower than its historical average but remains high compared with international peers.

“Analysts expect minimal growth in bank profits over the year ahead. Net interest income growth is expected to be below average as credit growth slows further and NIMs remain under pressure. Bad and doubtful debt charges are also expected to pick up a little from their current very low level.

The final cost of remediation for misconduct identified over recent years is uncertain and could exceed existing provisions, while spending on compliance and IT may remain elevated in order to address some of the recommendations of the Royal Commission.

This is costing the banks with their funding costs bumping up:

“Heightened uncertainty about future profitability has raised Australian banks’ implied cost of capital, as measured by the forward earnings yield on their stocks. Earnings yields have moved higher for bank stocks globally, suggesting that a reduction in global risk appetite for banking stocks has also been a factor,” the RBA said.

“The rise in banks’ forward earnings yields has been about a half percentage point more over the past year than forward earnings yields for other Australian stocks. This widening gap continues a pattern of the past four years. Banks’ current forward earnings yields are now above their pre-crisis average, despite a large decline in risk-free rates. ”

And then there are the costs flowing from the Hayne Royal Commission:

“Responding to the Royal Commission’s recommendations will also increase financial institutions’ costs, but will increase system resilience in the long term. In a sense, this corrects past underspending on systems or unfair revenue collection. In the near future, firms will incur further remediation costs relating to the charging of ‘fees for no service’ in the wealth management industry; these already exceed $1 billion. Revenue in the life insurance industry could also be significantly impacted (see below).

“Costs will also rise as firms correct for underspending on information technology (IT) systems in the past, compliance requirements increase and legal fees rise as regulators take more legal enforcement. There could also be payments resulting from lawsuits. The Australian financial system is well placed to manage these challenges, given it is well capitalised and generally starting from a position of strong profits,” the RBA said in the report.

That’s an assurance most of the worryworts on falling house prices seem to ignore when they forecast a financial disaster.

Glenn Dyer

About Glenn Dyer

Glenn Dyer has been a finance journalist and TV producer for more than 40 years. He has worked at Maxwell Newton Publications, Queensland Newspapers, AAP, The Australian Financial Review, The Nine Network and Crikey.

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