Australian banks: first shocks absorbed, bigger tests to come

Australia’s four major banks have played a critical role in absorbing the initial shocks of COVID-19 - but tougher tests which will define the trajectory for the economy and the banking system for the next decade are still to come.

PwC’s Australian Banking and Capital Markets Leader Colin Heath said: “This is the kind of moment banks are made for - where they are called upon to fulfil their role. Banks will be asked to transition from 'shock absorbers' to laying the foundations for the post COVID economy. This will demand a careful balancing of different priorities for customers, shareholders, government and business.”

Analysis of the half-year financial results reflects long-standing headwinds that have been building across the sector for years, accentuated by ongoing remediation and restructuring costs, and an increase in credit provisions for the impact of the pandemic in Australia.

Hard work and difficult decision making are still ahead for the banking industry and wider economy, as the full impact of the COVID-19 pandemic becomes clearer in the coming months.

PwC’s Banking Matters reports that the major banks delivered combined cash earnings of $8.3b, down 43% on the prior comparable period, the lowest since the GFC, while Return on Equity (RoE) fell to 6.5% - its lowest level since the 1990s.

Notable items rose to $4.3b reflecting ongoing remediation and restructuring costs, while credit impairment expenses rose to $5.7b, a level not seen for some time in Australia.

Extremely challenging half even before crisis began

Mr Heath said: “These results were not just about the impact of COVID-19. Underlying trends were already difficult for the major banks before the crisis hit - the provisions taken have just made tough results much tougher.”

While a lot of focus has been placed on the initial credit charges related to the pandemic, the sharp reduction in earnings have also come from long-standing headwinds on margins and lending growth, alongside the costs of remediating historical issues and restructuring the business model.

The immediate focus for the majors has been dealing with bank customers in financial distress. However the sector is now preparing for the unwinding and resetting of unprecedented levels of government and financial support for individuals and businesses.

“As Australia emerges from its COVID-19-induced economic and social hibernation, the real challenges for the major banks will become much clearer and may drive a recalibration of expectations about the banking system's role. This will likely involve some tough decisions regarding the extent of support for Australian business and mortgage holders.

"Credit costs are yet to reach the levels experienced in the financial crisis of 2008 and nobody knows what it will look like in the coming months. What is likely is that the crisis as experienced by many Australians may well feel far more demanding than it has been to date."

Outlook

“At this early stage in the crisis, the environment is one of considerable uncertainty. In this context, three areas are clearly important for future bank performance: credit, capital and the completion of remediation that has been underway for some time,” Mr Heath said.

“As the crisis progresses and its economic consequences evolve, there is some chance that the second half of 2020 will be no better, making challenges for the full year outlook as substantial as we have seen in decades.

“At the same time the crisis could also be the catalyst for the banking system to be seen in a very different light from recent history.

“They have absolutely stepped up to date with loan deferments and other forms of financial support. Some may see this crisis as an opportunity for the industry to reset its reputation for years to come. It’s quite a turnaround from where we were even three months ago,” Mr Heath said.

“The crisis has also opened eyes to the banks’ own capacity for change as they reflect on the speed with which they have transformed their customer service and workforce to accommodate the lockdown. The opportunity now is to retain that momentum (and focus) for the transformation imperatives ahead.

“Longer term, by effectively fulfilling core responsibilities, Australia’s banks have the opportunity to demonstrate the indispensable role they have to play, alongside government and the wider community, in supporting Australians as they navigate this period of profound change.”