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Speaker 1: Welcome to the Fear and Greed Business Interview. I'm Suan Alma.

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Speaker 1: The big banks this year reported total cash earnings of

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Speaker 1: almost thirty one billion dollars. While that's down more than

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Speaker 1: five percent from last year's record high, it remains one

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Speaker 1: of the sector's best results in years. The banks are

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Speaker 1: obviously a key contributor to the strength of the local

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Speaker 1: share market, so I wanted to take a closer look

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Speaker 1: at the results as well as what we can expect

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Speaker 1: from the majors in the near future. Sam Garland is

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Speaker 1: the Banking and Capital Markets leader at PwC Australia. Sam,

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Speaker 1: Welcome to Fear and Greed.

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Speaker 2: Thanks Sean.

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Speaker 1: Hello, you've looked at the health of the big four banks.

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Speaker 1: Where do you put them? How healthy are they?

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Speaker 2: Yeah, that's right, Like you said, they've just ruled off

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Speaker 2: FY twenty four and nearly thirty one billion dollars in

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Speaker 2: cash profit. That's down about five percent. As you said,

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Speaker 2: it's nearly a record. Last year was a record. But

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Speaker 2: it's interesting because you know that the benefit of the

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Speaker 2: margin had a tailwind that they had coming into that

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Speaker 2: year has faded pretty quickly and so you know, our

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Speaker 2: big theme here was that the result was squeezed by

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Speaker 2: competition and costs in particular. So while it's a great

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Speaker 2: result and comparable to many banks around the world, really

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Speaker 2: great results, it does reveal the reality of Australian banking today.

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Speaker 1: Okay, so let's go through cost revenue and then net

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Speaker 1: interest margin in that order. What's happening with costs obviously

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Speaker 1: on the rise any particular I know some specific banks

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Speaker 1: might talk about it. Costs was a big one for

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Speaker 1: one of the banks. So generally, you know, where are

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Speaker 1: the costs coming in?

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Speaker 2: Yeah, yeah, you're right. So I mean total costs were

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Speaker 2: actually a record and when you take out some of

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Speaker 2: the lumpy stuff, forty three point two billion dollars across

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Speaker 2: the four The big drivers of growth six and a

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Speaker 2: half percent growth for the year were technology costs. As

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Speaker 2: you said, you know, items like property and personnel generally

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Speaker 2: have been pretty well managed and tightly managed. But the

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Speaker 2: compound growth rate of technology costs is well over six

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Speaker 2: percent at the moment. And what the puts the banks

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Speaker 2: in a position is that the cost to income ratio,

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Speaker 2: and we'll talk about income in a moment is as

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Speaker 2: high as it has been for you know, over fifteen

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Speaker 2: years in the sector, and so, you know, to put

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Speaker 2: that into context, I remember, you know, ten years or so,

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Speaker 2: there was a talk of a forty percent cost to

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Speaker 2: income ratio for banks being in within reach. To get

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Speaker 2: to that, today the majors would have to shed over

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Speaker 2: twelve percent of costs or you know, over seven billion

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Speaker 2: dollars of costs to get to that.

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Speaker 1: Is this a fact? Why are the technology costs so high?

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Speaker 1: I mean, technology costs are always high, But are the

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Speaker 1: banks being particularly hit because of legacy issues or is

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Speaker 1: it just AI? I mean, what's the reason that technology

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Speaker 1: costs to sell high? Now?

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Speaker 2: Yeah, I think it's more about the dealing with legacy

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Speaker 2: and modernizing I suppose would be the summary of that.

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Speaker 2: There's a huge amount of investment happening across the majors

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Speaker 2: and banks around the world to bring systems up to

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Speaker 2: kind of modern standards, and also you know, dealing with

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Speaker 2: cyber you know, the risk side of technology as well.

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Speaker 2: So you know, I generally say it's about investment to

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Speaker 2: optimize and modernize the business more so than it probably

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Speaker 2: is yet about the more futuristic stuff like like AI

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Speaker 2: and that sort.

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Speaker 1: So, so in a sense, I suppose I'm getting to

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Speaker 1: with that is it's almost table stakes money as opposed

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Speaker 1: to investing for growth.

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Speaker 2: Well, look, I mean these are big programs of work

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Speaker 2: for sure, so they are transformative in terms of what

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Speaker 2: they're trying to achieve. But yeah, I think it's you know,

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Speaker 2: it's probably more about modernizing. Certainly. I think banks would

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Speaker 2: argue that the consequence of doing that is it creates

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Speaker 2: more flexibility for the future to do more interesting things.

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Speaker 2: But we're not talking kind of big, big investments into

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Speaker 2: generative AI at this point. But I think we all

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Speaker 2: see that coming. But at this point, okay, let's go

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Speaker 2: to the income side. Then where's revenue coming from? Where's

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Speaker 2: the growth? Yeah, So, as I said, you know, the

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Speaker 2: result overall was down year and ear and actually at

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Speaker 2: the net interest income level. So if you like the

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Speaker 2: kind of the deposits and lending side all rolled up,

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Speaker 2: it only he just rose. And the reason for that

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Speaker 2: is margins, which we might get to in more detail,

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Speaker 2: you know, continued to compress, and lending growth was actually okay,

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Speaker 2: it was slower than that the prior half. It grew

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Speaker 2: at about three and a half percent for the major banks,

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Speaker 2: but mortgage growth was down and they losing share in mortgages,

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Speaker 2: while business credit growth is actually really strong, as it

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Speaker 2: has been for the last few years, so that the

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Speaker 2: income side really for the majors these days is very

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Speaker 2: much about balance cheap less so about other fee income.

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Speaker 2: And that's the point that we talk about quite a lot,

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Speaker 2: is that Australian banks, like many around the world, are

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Speaker 2: now very simple focused onto a core product set. They're

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Speaker 2: no longer earning. You know, thirty percent of income if

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Speaker 2: you go back ten to fifteen years, came from non

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Speaker 2: interest income. Today it's about seventeen percent. It's a very

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Speaker 2: concentrated pool of earnings for the banks.

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Speaker 1: Say with me, Sam, we'll be back in a minute.

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Speaker 1: I'm speaking to Sam Garland, Banking and Capital Markets leader

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Speaker 1: at PwC Australia. Okay, so when you go to mortgages,

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Speaker 1: is that because of competition. I know that there was

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Speaker 1: a period there where Commonwealth Bank, which is a market

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Speaker 1: leader and mortgages didn't chase market chair. I think they're

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Speaker 1: probably back doing that now. Without commenting specifically on any bank,

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Speaker 1: is it about the competition the mortgage market, which is

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Speaker 1: where they've been hurt.

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Speaker 2: Yeah, I mean the margin side of that is very

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Speaker 2: much a competition story and so very happy to get

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Speaker 2: into the detail. On the margin side, I think there's

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Speaker 2: also an element there of mortgage credit growth has just

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Speaker 2: been a bit slower over the last two years or so,

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Speaker 2: but competition has really been the big driver of the

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Speaker 2: income pressure in mortgages. But also, you know, there's more

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Speaker 2: people after mortgages. You know, we've got disruptions from other

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Speaker 2: banks playing into that a little bit on the tech side,

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Speaker 2: but more from other banks who are choosing to deploy

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Speaker 2: capital into mortgages and have been doing that very successfully

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Speaker 2: over the last few years.

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Speaker 1: People like me always talking about mortgages, people like you

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Speaker 1: probably talk more about business banking and stuff like that

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Speaker 1: because margins are actually higher in business banking. Why is it,

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Speaker 1: I mean, three of the four, off the top of

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Speaker 1: my head, of the three of the four mags have

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Speaker 1: talked about the success they've had in business banking. Is

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Speaker 1: that kind of the new battlefield for banks? How do

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Speaker 1: you characterize it?

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Speaker 2: Yeah? I think that a very consistent theme over the

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Speaker 2: last three or four reporting periods has been this redirection

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Speaker 2: towards business lending growth. You know, on the really plus side,

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Speaker 2: Australian business credit growth has been outperforming mortgage credit growth

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Speaker 2: for two and a half years, three years. Maybe that

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Speaker 2: is the signe of a normal economy really, but there's

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Speaker 2: not been the case in Australia for a long, long, long,

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Speaker 2: long time, and so that's a very positive thing. But

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Speaker 2: as you rightly point out, the margins are higher in

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Speaker 2: commercial lending and in business banking. You know, that's partly

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Speaker 2: driven by risk and we should never forget that that

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Speaker 2: is partly why. But it's also driven by the fact

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Speaker 2: that it's you know, I think you can make, you know,

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Speaker 2: deliver more value through relationship and through the service model.

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Speaker 2: It's probably less commoditized as a part of the sector

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Speaker 2: at the moment, but if everybody moves there, there's a

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Speaker 2: really valid question around is it going to become, you know,

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Speaker 2: just another hot area of the market and margins will

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Speaker 2: feel some compression. But we don't see that yet.

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Speaker 1: Okay, So cost and came ratio, high need interest margins

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Speaker 1: across the board, what are they looking like.

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Speaker 2: Yeah, so margins it's a really fascinating story and quite

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Speaker 2: different in Australia compared to around the world. Actually, so

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Speaker 2: margins for the year were down about six basis points,

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Speaker 2: marginally up in the second half actually because I think,

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Speaker 2: as you said earlier, Sean people were being quite careful

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Speaker 2: around some of the decisions they were making in the

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Speaker 2: second half. But if you look at the margin position,

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Speaker 2: one point eight one percent is you know, the overall

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Speaker 2: margin for the majors at the end of the year

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Speaker 2: that is now only about four basis points higher than

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Speaker 2: the record low margin that was the position coming into

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Speaker 2: the rate tightening cycle. So rates have gone up four

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Speaker 2: hundred and thirty five basis points and the major's margins

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Speaker 2: have gone up four basis points. That shows you how

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Speaker 2: quickly this margin benefit snapped back through competition. And it's

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Speaker 2: not just about mortgages, you know, it's deposits as well,

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Speaker 2: has been very very hot over that period. Contrast that

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Speaker 2: to some other markets. You know, the UK has seen

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Speaker 2: nearly twenty thirty percent growth in bank earnings because of

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Speaker 2: margin expansion.

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Speaker 1: Wow.

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Speaker 2: And so they're all temporary, you know, in time they'll

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Speaker 2: you know, they'll correct back. But it really does show

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Speaker 2: the fact that competition in Australian banking is very very

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Speaker 2: very tight and margin benefit of rate rises has not

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Speaker 2: been significant. Big question as rates start to fall, which

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Speaker 2: will happen who knows. When you know, is that going

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Speaker 2: to represent an opportunity for some kind of holding on

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Speaker 2: of some margin through that period. Traditionally it wouldn't be.

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Speaker 2: But we'll see, I suppose how that will play out.

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Speaker 1: Okay, So looking forward, where are the areas of growth

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Speaker 1: should be worried about, be worried about sort of loan areas,

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Speaker 1: about credit books, that type of thing.

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Speaker 2: Yeah, look, I think starting with credit and that the

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Speaker 2: kind of credit loss situation, it's still very very benign.

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Speaker 2: So you know, credit expense in the period actually went down,

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Speaker 2: and most banks signaled that there was some uptificate in areas.

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Speaker 2: And I saw even today there was some published numbers

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Speaker 2: that the number of customers in you know, in some

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Speaker 2: trouble has risen quite significantly, but it's still very low

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Speaker 2: in absolute terms, very low. So I think the banks

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Speaker 2: would say, you know, this is what they expected. They've

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Speaker 2: got provisions held for this type of performance and more

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Speaker 2: because of the economics that the economy that they see.

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Speaker 2: So look for now when we all touch with when

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Speaker 2: we say these things, the credit outlook looks okay, there's

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Speaker 2: decent questions like where is that risk if it's not

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Speaker 2: on the bank balance sheets, and that might be a

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Speaker 2: regulatory consequence that's on the credit side. Sean, I think

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Speaker 2: on the broader outlook, we need to start with the

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Speaker 2: good news is these banks are very high performing banks

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Speaker 2: compared to most markets around the world, and so we

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Speaker 2: should be very happy about that. But they've got the

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Speaker 2: challenge of exactly what we've been talking about. They're squeezed

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Speaker 2: on both ends a little bit competition and costs kind

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Speaker 2: of squeezing the current result, and they've got a lot

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Speaker 2: of work to do around modernization of technology. You know,

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Speaker 2: a fair amount of demand around spend on tech, on

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Speaker 2: rag etc. In an environment where they're very competitively concentrated.

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Speaker 2: So I think in the short term, short term outperformance

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Speaker 2: probably comes from those that can execute the best on

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Speaker 2: those programs of work and just get them done and delivered,

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Speaker 2: and who are really kind of operating with a lot

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Speaker 2: of discipline around pricing and where they choose to play, etc.

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Speaker 2: It's a kind of optimized play in the short term.

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Speaker 2: The medium term, I think then we get into the

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Speaker 2: really interesting stuff, and so who would want to be

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Speaker 2: a bank exec right now? Because you're trying to do

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Speaker 2: that optimize what you've got and then think about what

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Speaker 2: the future holds. And I think that's where you get

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Speaker 2: into really interesting things around you know, is they're going

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Speaker 2: to be more diversification in banking. Are we going to

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Speaker 2: see banks trying to get back into fee income generating

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Speaker 2: businesses who could even contemplate wealth management? And you know,

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Speaker 2: we have a country that is going to be retiring

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Speaker 2: and needs these types of services and you know our

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Speaker 2: banks have selected out of that understandably so over a

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Speaker 2: period of time. And then much bigger things like you know,

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Speaker 2: the impact of technology and you know all of the

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Speaker 2: things that that will bring for customers.

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Speaker 1: Yeah, it is fascinating. If you use westpeging example, the

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Speaker 1: outgoing CPD king has spent all his time simplifying the bank.

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Speaker 1: And see him earlier on you said that the secretor

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Speaker 1: is becoming much more simple now he's going And it's

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Speaker 1: not necessary specific to WESTPEG, but what how do they

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Speaker 1: find and how do they find revenue growth in the

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Speaker 1: next ten years if they stick to their knitting only.

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Speaker 2: Yeah, we absolutely agree, and you know that has been

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Speaker 2: understandably the theme of banking around the world, and definitely

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Speaker 2: in Australia has been reading investor presentation, it's been focus core, simplify.

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Speaker 2: It's all that language around really getting clear and you

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Speaker 2: can understand why. Then the question becomes, okay, where does

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Speaker 2: growth come from now? And if it's not going to

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Speaker 2: come from credit growth the margins, which it probably isn't

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Speaker 2: certainly in the short term, then you start to think

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Speaker 2: about some really interesting things about well, okay, you know,

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Speaker 2: what are the value pools that a bank needs to

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Speaker 2: think about going after the income etc. And I think

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Speaker 2: what we'll see is that banks will be much more

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Speaker 2: intentional about the parts of the market that they serve

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Speaker 2: and where they think they've got advantage because there are differences.

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Speaker 2: You know, some banks have a more international view, you

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Speaker 2: have deeper in payments, some are bigger in retail. There

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Speaker 2: are differences and so I I think we'll just see

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Speaker 2: people be much more intentional about what they choose to

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Speaker 2: be and where they choose to be. It it's going

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Speaker 2: to be fascinating because it's an open question where is

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Speaker 2: growth going to come from?

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Speaker 1: Sure? Well, Sam, thank you for talking to Fear and Greed.

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Speaker 2: Thanks Sean, I appreciate the time that was.

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Speaker 1: Sam Garland, Banking and Capital Markets leader at PwC Australia.

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