Consolidation for small banks?

Regional bank performance over the last year suggests consolidation would bring many benefits and little downside.

As the landscape of the global banking system continues to evolve, Mike Hirst, chief executive of Bendigo and Adelaide Bank (BEN), thinks there will be some consolidation of smaller banks.

The performance of the big four in comparison to their regional bank counterparts over the past two years suggests bigger is better. Historically, subordinates of the big four banks have returned substantially less in terms of dividend and share price gains.

While having multiple offerings outside of the big four keeps the regional market competitive, consolidation of this sector of the market could be beneficial for both end users of bank services and investors. The current market cap of Bendigo Bank is only a measly 5% of National Australia Bank – the smallest of the big four – making it difficult to compete when size matters.

And competition concerns shouldn’t be a problem, with little chance the regionals would be able to corner a particular section of the market. The regionals – Bendigo Bank, Bank of Queensland (BOQ) and Suncorp (SUN) – are each tilted more strongly towards household deposits than the big four. All up, they each make up less than 3% of the overall deposit market.

Bendigo Bank is the most exposed to retail deposits of all the regionals. A concentrated deposit base doesn’t offer any diversification benefits and leaves Bendigo, and other regional banks, susceptible to pressures facing mum and dad depositors.

Other risks facing the community banking model include the costs to attract and retain depositors, particularly in comparison to the big four, which have greater brand strength and recognition. In a quest to keep net interest margins healthy and remain competitive with the larger banks, Bendigo had to chop the trailing commissions for deposits paid to community banks by 0.125%, to 0.25%, in the financial year gone.

Meanwhile, the global depression of interest rates means net interest margins are being compressed as it is, crimping bank profitability (see Cliona O'Dowd's Collected Wisdom). In banking, scale of economies can help keep profitability measures ticking along.

With a cautious outlook for the global financial system keeping funding costs higher than banks would prefer and a healthy competition for deposits, net interest margins are going to remain under pressure and no doubt a focus for banks. A cut to trailing commissions could be just the beginning of moves taken by community-focused banks.