An analysis of major bank profitability issued by the Bank of International Settlements earlier this week helps put the profitability of the major Australian banks into perspective.
The analysis, contained in the annual report of the BIS, has been seized on by critics of the big four banks as evidence of their excessive profitability.
What it actually shows is that most of the comparators within the developed world are less profitable than major banks ought to be. The title of the world’s most profitable banking system has as much to do with the weakness of banks in the other developed economies than with excess profits within the Australian system.
The BIS analysis looks at bank earnings over three periods: 2000 to 2007; 2008-2011 and 2012.
In that initial period the Australian banks’ pre-tax profits equated to 1.58 per cent of their total assets. In the post-crisis period of 2008-2011 earnings slipped to 1.07 per cent of total assets before recovering modestly to 1.18 per cent last year.
In the US major bank profits pre-crisis represented 1.74 per cent of total assets, falling to 0.42 per cent over the 2008-11 period but then climbing back up to 0.96 per cent in 2012. In the UK the starting point was 1.09 per cent, dropping to 0.19 per cent but barely recovering to 0.20 per cent last year. In France the sequence was 0.66 per cent, 0.29 per cent and 0.19 per cent while in Germany earnings went from 0.26 per cent of assets to 0.06 per cent to 0.09 per cent. The rest of Europe was, as one would expect, worse.
What’s striking about the Australian banks’ performance is that their earnings yield is 40 basis points lower than it was in the pre-crisis period when they faced significantly more competition and competitors than they do today within a system that became far more concentrated because of the impact of the crisis on their competitors.
It is also notable that, over the three periods chosen by the BIS, their net interest margin, which started at 1.96 per cent, edged up only one basis point between the period post-crisis and 2012, from 1.81 per cent to 1.82 per cent. The US banks, incidentally, had a net interest margin of 2.34 per cent last year.
The lower earnings yield and net interest margin relative to the pre-crisis era makes it difficult to argue that the BIS study provides confirmation that the banks are using their post-crisis dominance to profiteer. In relative rather than absolute terms they are less profitable than they were during that supposedly more competitive era.
BIS also looked at the loan loss provisioning of the banks, which showed that after a blip post-crisis the Australian banks’ provisions had fallen back to 0.21 per cent of total assets, compared with the 0.19 per cent level pre-crisis.
That’s not out of kilter with banks in Canada (0.19 per cent) but is materially lower than the banks in the UK (0.33 per cent) and US (0.41 per cent), which would obviously be a reflection of the relative strength of the economies. Southern European banks, as would be expected, are carrying far higher levels of loss provisioning – the Spanish banks, for instance, have provisions which represent 1.49 per cent of assets.
The other set of statistics that stands out in the analysis is a comparison of the banks’ operating costs.
In the 2000-07 period the Australian banks’ operating costs equated to 1.99 per cent of total assets. That fell to 1.20 per cent in the 2008-11 period and then to 1.19 per cent in 2012.
The UK costs started at 2.02 per cent of assets, fell to 1.24 per cent and have risen to 1.37 per cent, the US banks went from 3.58 per cent to 3 per cent to 3.06 per cent and Canada’s system (regarded, with the Australian banks, as the other outstanding banking system in the developed world) went from 2.73 per cent to 1.87 per cent to 1.77 per cent.
That 80 basis-point fall in operating costs relative to their total asset bases over the course of the analysis is obviously one of the major factors in their continued strong profitability despite the weak demand for credit since the crisis and therefore only modest volume growth.
Among the developed world’s banks, the Australians aren’t the lowest cost (France, Japan and Sweden are shown by the analysis to have lower costs, although BIS noted that cross-country comparisons might be limited by differing accounting standards) but they are at the lower end of the overall sample.
With all four of the big banks having relatively recently embarked on another round of significant cost-cutting and job-shedding, costs relative to their asset bases should continue to fall. Already one of the more efficient systems (which is a good thing for both shareholders and customers) they will become even more efficient.
With total assets of about $2.8 trillion within an economy with GDP of about $1.5 trillion it is clearly vital that the majors, all four of which are too big to be allowed to fail, should be solidly profitable, well capitalised and well-regulated – as they have been since their brush with disaster in the early 1990s, which was a wake-up call for the banks, their regulators and legislators.
One only has to look at the snapshot of the condition of most of the other developed world banking systems to get a sense of the unsettling alternative.