Bank battles drive a depositor's dream

If Phil Chronican is right bank shareholders and borrowers are both going to be losers in the new post-financial-crisis environment, with only depositors better off.

The chief executive of ANZ's Australian banking business told an American Chamber of Commerce lunch today that banks were now operating in a fundamentally different environment.

"Striking an appropriate balance is the challenge – offering attractive interest rates for borrowers, value for depositors, returns for shareholders and support for the community, all the while remaining a healthy and competitive business. The reality is only the depositors are going to be better off," he said.

Before the crisis, the banks, their shareholders – and their borrowers – experienced something of a golden era. Credit was cheap and plentiful, the banks' funding costs in offshore markets were low and they were able to leverage the volume growth in their lending and offset net interest margin contraction by running near-continuous capital management programs.

As Chronican said, Australian bank balance sheets grew at 15 per cent compound annual rates for more than 25 years – until 2007.

The crisis impacted almost every significant element with the banks' balance sheets. Corporate and household credit growth shuddered almost to a halt, to 30-year lows, while household savings rates reached 30-year highs.

Wholesale funding became less available and significantly more expensive and the banks responded to the fright they received during the worst of the crisis, when funds weren't available at any price, tightened and re-priced their lending and shifted the focus of their funding to deposits.

As Chronican said, when wholesale funding became more expensive the competition for deposits – and their cost – increased. With all the majors now sourcing a majority of their funding from deposits, it is depositors now holding the upper hand.

The whole system is steadily shifting its emphasis from pumping out credit to pulling in deposits. The deposit pool is relatively finite so, unless the banks can attract or create a new source of deposit funding – the superannuation system might provide part of the answer – the competition for and relative cost of that funding can only increase.

As he also said, whereas changes to the cost of term funding can take years to flow through to a banks' overall cost of funds, changes to the cost of deposits flow through very quickly, generally within three to six months. There is going to be a continuous and permanent battle to retain and grow those deposits.

Combined with the regulatory response to the crisis – more regulation, more capital and more liquidity – banking will, Chronican said, become more expensive and, because the banks won't be able to leverage their balance sheets as they did pre-crisis, it would be much harder for them to achieve the kinds of returns on equity, above 20 per cent, that they once enjoyed.

At the moment the majors are producing returns in the mid-teens, but that has been aided by continuing falls in impairment charges and the full impact of the new regulatory regime has yet to be felt.

If Chronican is right (and there was nothing controversial in his assessment of the state of the sector) the lending rates and policies of the banks may not be any less of a political issue but the banks won't be able to be accused of oligopolistic profiteering.

In fact, while his depiction of the sector's outlook was sombre, it could be worse if Wayne Swan delivers his promised horror budget amidst the restructuring being forced on the non-resource side of the economy by the strength of the Australian dollar and the cautiousness of Australian consumers.

In the low-growth, low-returns environment they are experiencing, the last thing the banks would want is a reversal of the trend in impairments that has generated much of its earnings growth in the past two years.