As the economy enters a new phase, here’s how banks can still shine bright

Astronomers recently discovered an ‘overweight’ neutron star which defied all astronomical theories. According to NASA experts, the hypermassive star somehow failed to “notice” how huge it became as it entered a new phase and so, instead of collapsing instantly into a black hole, it burned spectacularly bright for a record length of time.

Back on earth, Australian banks are enjoying their own shining moment in FY22, delivering their strongest result in years. PwC’s latest Banking Matters analysis found cash earnings exceeded $28 billion (up more than $1 billion), driven by falling notable expenses, growing balance sheets (increasing net interest income), and sustained low credit expenses.

And yet, while that monster star didn’t realise it had entered a new phase, banks can hardly miss the fact that the macroeconomy has entered a contractionary period, and mortgage market dynamics are changing. 

Listed below are four prudent, practical and ’no regrets’ actions that banks can do to prepare. But first, let’s look at what’s on the horizon for mortgage market lenders.

What does the future hold for the mortgage market and lenders?

Stargazers and crystal-ball owners only need to look at the current market to know that things are changing. Inflation is high (7.3%, the highest level since 1990);¹ interest rates continue to rise (expectations firm on the Reserve Bank’s cash rate hitting 3.6-3.85%); and households are facing a historic fall in living standards. Meanwhile, in housing, the cash rate is 2.85%, with most standard variable home loan rates now above 5%. 

This is placing downward pressure on house prices across the country.

We have seen a decline in first-home buyers entering the market. As a result new-build financing is likely to fall, while refinancing activity is likely to rise as mortgage holders shop for a better deal to ease cost of living pressures. (The ABS already reports high construction costs are driving increased prices for new dwellings.)

While it is highly debated whether there will be a bump, spike, or cliff, it is inevitable that there will be increased stress as rates rise. In fact, the number of distressed housing listings has risen almost 15% since interest rates began to rise. Pandemic-era savings will provide a partial buffer to this stress. However, Australia’s relatively high debt-to-income ratios mean some market segments will struggle as their savings diminish.

Four ‘no regrets actions’ for banks and lenders

While a range of possible scenarios lie ahead, considered and deliberate action is needed by banks and lenders to prepare. The more proactive banks will use this period as an opportunity to improve productivity, reduce costs, and improve automation, while focusing on growing and protecting their mortgage portfolios. 

Practical steps for banks to consider:

1. Prepare for the possibility of an increase in defaults (and hardships)

During the pandemic, banks supercharged their preparations for customer hardship. Now, it’s time to prepare again. 

To ensure you’re in the best possible position to support your customers, ask these questions:

• How are you rethinking your early arrears detection strategies? From staff training awareness to customer engagement at a pre-arrears stage, banks should revisit early arrears management. Existing detection measures may not cut it in the coming months.
• Are you operationally ready? Do you have the right people and processes to support your clients? Do you have capacity? (At PwC, we create a digital twin for our banking clients, allowing them to monitor their systems, and diagnose strengths/weaknesses/customer bottlenecks using work and process flow simulations.)

Anyone experiencing financial difficulty can speak with a free, independent financial counsellor in their state or territory.

2. Protect your customer base

Banks know the importance of protecting their customer base, especially when the market dynamics are shifting. Key things for banks to consider:

• Are your early-warning monitoring systems up to scratch? Are you identifying red flags fast enough? (e.g. customers requesting payout figures or validating interest rates/monthly repayments.) 
• How are you actively retaining customers? Do you have a clear customer-retention strategy? Are your staff trained and equipped for retention conversations with customers?
• What about a strong pricing strategy to target existing customers and attract new ones? Do you have well-defined upper/lower boundaries on pricing? Is there consistent messaging around this? Are refinancing propositions easy for staff to enact?

3. Grow market share

With refinancing comprising an increasingly large slice of the lending pie, banks should think strategically about maximising opportunities and growing market share. 

So, what do customers want? Right now, borrowers want a bank that can refinance their mortgage for a competitive price, while making the customer experience a good one. Banks and lenders should ask: 

• Can you digitise the lending process for a seamless customer experience? Can you accelerate automation of services, especially refinancing services?
• Can you boost productivity and efficiency by digitising other processes? Anything that can be digitised, and that improves customers’ lives, should move to the top of your to-do list. 
• On efficiency, do you need to reassess your lending process? Can you remove excessive compliance for customers? 
• Have you got clear online propositions in the marketplace? Are you investing in products/services (think: digital) that make for easy customer transitions?
• Are you strategic about which market segments you want to attract and retain? Are you using segmentation and portfolio analysis to inform strategy and approach?   

4. Securitisation

Finally, with mortgage delinquencies and defaults potentially to rise, banks need to think differently about securitisation. Certainly, there’s substantial rigour around securitisation to regulate the risk classification of mortgage asset classes. But a changing economy is likely to impact segments of the securitisation market.

Banks and lenders should:

• Understand the possible impacts of increased mortgage defaults on securitisation. Do you have a strategy to manage this now, and in future?
• Review securitisation thresholds. How do you determine what portion of the mortgage book should be securitised if defaults increase?   
• Preserve quality. How will you define and implement the governance needed for ongoing quality of the securitisation tranches?  

These four ‘no regrets actions’ are prudent steps that banks can take right now to get themselves into shape. Unlike that overweight neutron star.

^Reference:

^{1. Consumer Price Index, Australia, September Quarter 2022.}