Bank gouging? Narev's profit provides solid clue
The particularly strong half-year result from Commonwealth Bank has ripped the Band-Aid off the festering debate around whether the customers are victims of gouging and whether there is sufficient competition in the Australian banking industry.
CBA's performance reflects some factors particular to it, but also suggests that its major competitors are lining up for strong profits this year, thanks to the fact that their cost of borrowing is coming down and these gains are not being passed on to customers.
For bank shareholders it's pretty clear. The stellar profit lifts the share price and this is a positive. It's even more obvious for the bank's board and management whose job it is to maximise returns for shareholders. To the extent their mandate involves looking after customers it is in order to retain or grow them - thus improving profits. This is why they give so much weight to customer satisfaction. If retailers could double what they charge for goods they would as long as the customers would wear it - so would insurance companies and airlines, car makers and communications companies.
It's just that the public expects banks to be different - in part because interest costs are such a big part of living expenses for such a large proportion of the community.
Some essential services have government regulated pricing, but not banks. They are subject to minimum capital levels to ensure they remain financially robust and they don't risk losing the money we deposit.
Governments are not prepared to regulate profits so they are not in a strong position to cry foul when banks attempt to maximise them.
For the past 20 years Australian banks have done a creditable job of remaining secure and making solid profits. Two of Australia's big four trading banks are among the largest in the world and the other two are not far behind. They all rank well on earnings and international ratings measures. It is a remarkable result for a country the size of Australia.
On the competitive front the post-global financial crisis consolidation certainly had a negative effect - one that never sat comfortably with the then head of the Australian Competition and Consumer Commission, Graeme Samuel.
But the large banks were given the green light to buy smaller and less financially stable competitors in order to avoid a crisis that would have been sparked if a smaller lender fell over.
While the Commonwealth Bank's chief executive, Ian Narev, received a vote of confidence in response to a stronger than expected profit performance, the result was controversial given the bank did not pass on in full all of the RBA's interest rate cuts. This was a factor in the bank's strong performance. The result for the six months to December 31 was 6 per cent up, despite the fact that the banking market generally is grappling with a weak lending environment.
Narev's strategy demonstrates he is prepared to sacrifice some market share in order to win back some profit margin.
As a result the CBA has grown at below-average market share [or system, as it is known in the trade] in both retail deposits and home loans, rather than become too immersed in intense competition with NAB, Westpac and ANZ.
Narev says CBA is not the price-maker in the sustained grab for deposit funds. Its loans to customers are already 63 per cent funded by deposits, so it is sitting in a reasonably comfortable position.
More importantly the recent fall in the cost of wholesale funding means it is now a vastly cheaper source of funding than deposits.
The funding mix is part of the reason the margin between the cost at which CBA borrows and the cost at which it lends - the net interest margin - has improved over the previous six months.
In part this is the result of the bank accessing cheaper wholesale finding and in part it is because a portion of the RBA's rate cuts were not passed on in full by the banks. These two factors allowed the major banks to claw back some margin.
The share price responded accordingly, moving to an all-time high of $67.11 - cementing its position as the third-largest company in Australia based on its market capitalisation of around $108 billion. (By way of reference this is larger than the combined market capitalisation of Germany's listed banks.)
Narev is prepared to wear criticism that his bank is too profitable because, as I said earlier, his mandate is to maximise earnings.
Most of the major business units improved their profits, led by the retail bank and the wealth management business, which grew 13 per cent 10 per cent respectively.
Narev will be under pressure from an election-preparing government to pass on any future RBA interest rate cuts.
There even have been suggestions that out-of-cycle interest rate cuts may be contemplated by the major banks in response to increasing competition from the second tier banks.
Given the tone of comments made by Narev, it would appear less likely that CBA would dive early into a war on loan rates. Instead the CBA would rather rely on enticing customers by providing an enhanced suite of products and hoping that its investment in technology over the past five years will give them a better service.