KGB: ANZ's Mike Smith

ANZ Bank's chief executive says the bank's returns on income will not fall as it grows in Asia, and a lower cash rate will not boost economic confidence.

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ANZ Bank chief executive Mike Smith tells Alan Kohler, Robert Gottliebsen and Stephen Bartholomeusz:

Returns on income will not fall as the bank grows, despite currently lower ROI in Asia than Australia.

– Reduced Reserve Bank rates are unlikely to boost Australia's economic confidence.

– Efforts to create a level global playing field through Basel III have not succeeded, fragmentation is now as bad as he’s seen it and national interests have taken over.

– In addition to an offer to run Barclays Bank, he’s been approached for “all sorts of things”.

– Banks have got to get much better at using capital than they have been.

– He is not aware of any price fixing in the interest rate swap market.

– Chinese GDP growth will be over 7 per cent and probably closer to 8 per for 2013, and come in at similar levels over the next few years.

Alan Kohler: Well Mike, thanks for joining us. Mike, the cost to income ratio in the latest period was down from 47.3 to 44.4. How much further can that go?

Mike Smith: It will continue to drop. You know, I think we’re about five years through changing our whole operating model and basically moving our operations and technology to offshore hubs. And we’re now beginning to see the benefits of that coming through on the cost-income ratio. And I think we have another five years to really finesse it and really make it work for us. 

AK: Do you have the target for the cost to income ratio at the end of that five years?

MS: No, I don’t. I’ve got one until the end of next year – which was a two per cent drop from the end of last year and, as you’ve seen, we’re about 70 per cent of the way through that. So, when I get there, we’ll create another target.

AK: Is there some kind of natural limit to how low costs can go?

MS: Yes, there is. And each bank is different because it does depend very much on the mix of business. You know, a retail bank traditionally with a big branch network would have a relatively high cost-income ratio. A merchant bank in the old days, you know, the old investment bank style bank which had very, very high salary costs would have a higher cost-income ratio than a retail bank. But technology is changing things. There is no doubt that the cost of operating is reducing courtesy of technology.

Stephen Bartholomeusz: So you’re saying this is not just about offshoring and cheaper labour, this is actually about real change and productivity gains?

MS: Oh absolutely. And it’s about technology. You know, if you think about the average channel by which people touch the bank now, most of it is done on the internet or through mobile phones. It is not done through the branch network. So this enables you to take out quite a significant amount of cost.

SB: Would this be happening anyway or has the expansion of ANZ into Asia created a basis and a platform for you to do these sorts of things?

MS: Well, I think the expansion into Asia has been made possible by the fact that we can support the business in Asia through these hubs. So it is very much an integrated part of the strategy and therefore this has worked for us, probably much more easily because it’s easier to see than if you were a purely domestic play.

Robert Gottliebsen: Are the other banks in the same situation? Will they reduce their costs by a similar amount?

MS: Well, again I have to look at their operating models and quite clearly they are doing that. We’re seeing all three of the banks working on productivity and efficiency and indeed, you have to do that. In fact, other industries have to do it as well. Pre-crisis, we were used to a high growth environment. Your top line every year grew significantly. That meant that you could have a cost model that anticipated that. 

Now, you’ve got a lower cost environment, so therefore your costs have got to be far more finessed. Also, of course, when you have high top line growth it does hide a multitude of sins and you certainly aren’t as efficient or as productive as you need to be.

RG: In Asia you get a much lesser return on your income than you do in Australia and yet you continue to expand in Asia.

MS: Yeah.

RG: Does this mean that down the track your actual returns on income will fall as you get bigger?

MS: No, because while you’re in an investment phase in any place your returns are bound to be lower. The issue is that you are basically building in future growth in terms of not only volume but return. So, I’d rather have a low return business that has the ability to grow than a high return business that can’t grow.

AK: Have you had to slow down your ambitions in Asia and the pace of your expansion in Asia? And is that why you increased the dividend – to distract everybody from that?

MS: No, not at all. Basically, our whole Asian strategy, or the super regional strategy, is based on organic growth and that organic growth we push as hard as we can. Obviously if there were acquisitions around, if there were suitable targets, of course we would be very happy to look at those. Right now there’s just very little around, so the organic growth is the best option. But we continue to grow. I mean we were growing at about between 20 per cent and 30 per cent across most businesses for the year, so that’s not bad growth.

SB: Mike, one of the things that came out of the commentary within your interim results was that within Asia there’s been a shift in emphasis from traditional lending to other products and services. Is that a response to competition or perceived risks?

MS: It’s a bit of both, but I think the key rationale here is use of capital. Banks have got to get much better at using capital than they have been previously. I mean prior to the crisis, banks were generating 20 per cent ROEs without really having to do much because it was being driven by volume growth – by that top line growth. And you’ve got to remember that since 2007 we’re actually holding about 60 per cent more capital on a like for like basis than we were at that time. So you’ve got to make your capital far more efficient and you’ve got to manage it far more efficiently. Therefore, products and particular debt capital market, for example, the debt capital market side is obviously much more important to us now than it was pre crisis. And the loans which eat up capital have got to become less important.

AK: Do you have to have that much capital? Could you get it back and still be above the requirement?

MS: Well, you know, that’s what we have to do. We have to be much more disciplined on using capital and I think you’ve got to be able to flex it a little bit. What we have done is tended to build it up in anticipation of needing it for regulatory reasons and I think we’ve got to manage that much more tightly, be more disciplined around it. 

Quite clearly the regulatory regime has not yet finished in terms of imposing additional capital requirements on banks, but I’d like to see some degree of stability as we go forward. I think, you know, there has been so much change and while Basel III was laudable for trying to create a global level playing field, quite clearly that hasn’t happened. And now the fragmentation is probably as bad as we’ve ever seen it. Which basically means that national interests have taken over and I think we have to be very careful that we don’t get too far ahead of the game.

RG: Just widening the discussion, do you think that it’s unhealthy for a stock market like Australia to have more than 30 per cent of its capitalisation in the top banks – and just over half the top ten companies are the four banks? That’s a huge concentration in one industry of four companies. I don’t think anywhere else of comparable size where that’s taken place. Do you think it’s healthy?

MS: Well, I mean it’s where we are, isn’t it? We are where we are. The fact is that in Australia four of the five largest companies are banks and have been for many years. Look, I think any deepening of the market, any improvement to increase the number of larger companies in Australia would be a healthy development. Certainly we should be encouraging inward investment into Australia.

RG: Why do you think it is that this country has ended up with such a huge proportion of banking in its capital and business structure? No other country’s done that. Is it the nature of our banks? Is it the nature of our society? Why do you think this has happened to us?

MS: That’s an interesting question, not one I must admit I’ve given much thought to. I think that traditionally this country was based very much on the large miners. That was the big end of town. I think that the agri side has probably been purchased by overseas interests and I suppose some of the mining interests have as well, but the banks have stayed national champions, if you like. 

I guess the issue for me in terms of what banks are here to do is, how do we have an Australian bank –how do we create an Australian bank – which can actually support the Australian interests on a regional basis? Because quite clearly if you look at the terms of trade and look at the investment flows between Australia and the region, that has to be oiled – lubricated, if you like – and that requires banking expertise. And at the moment far too much of that flow is driven by either global banks or banks up in the region, not by Australian banks. And I think for us to move into the region is a critical development actually for the benefit of Australia.

AK: Just on another subject, Mike, if I can. Last year we heard about the fixing of Libor or the allegations of Libor was fixed. A lot of stuff going on at the time and presumably that’s still a matter for regulators to investigate, and just the other day there was another story that the interest rate swap market has also been fixed. But do you know anything about that? Have you been aware of any price fixing in the interest rate swap market? And obviously, have you been involved in any?

MS: Not that I’m aware, no.

AK: If there has been, how would you feel about it?

MS: Well, I’m not really sure what they’re referring to here because if it’s BBSW, I mean that’s basically...

AK: No, no. This is global, not the Australian BBSW.

MS: Okay. Well, the important thing is that any market which is driven by actual transaction and not just quote is always going to be much more resilient and hold up to scrutiny much better – which of course is what we’ve got here in Australia. In terms of the global swap markets, I haven’t been aware that there had been any major issues. You know, pricing for a swap is basically generated by the two counter parties involved and that should be basically to both advantages, so it’s hard to see where there would be a problem.

SB: Mike, a little earlier you referred to the fragmentation of the regulatory discussion occurring around the globe. Surely you’re very aware that in the US and Europe, but particularly in the US, there’s been a lot of discussion among regulators and politicians about leverage ratios and 15 per cent to 20 per cent equity against unweighted assets. Given that our banks are full of lowly risk weighted mortgages, if that were to become sort of the global standard by de facto, what would that do to us?

MS: Well, it would have an impact, there’s no doubt, on Australian banks. In fact, ironically it would have less impact on ANZ than it would on the others because of course our mortgage book is that much smaller. 

But, you know, the talk of leverage and leverage caps has been around for a long, long time. As I say, the first move was to actually create a proper tier one capital ratio. The argument seems to have stopped there. Then you had the issue with global SIFIs, you know, significant institutions. Then there’s been the argument about domestic significant institutions and whether or not they should have higher capital. The Canadians have just introduced such a rule where they put a 1 per cent additional capital requirement on their domestically important institutions. 

So, you know, there are all sorts of things out there and they have been out there now for some time, to say nothing about the liquidity requirements which of course continue to bubble away as well. But I think that the reality of the situation is that the banks, particularly the banks in Europe just are not able to meet many of these requirements. They just cannot possibly conform. So, until such time as I think some of this gets worked through, I think we’ve got to be careful we don’t get ahead of ourselves, that we don’t become effectively uncompetitive by being too boiler plated, if you like.

RG: Mike, in the theoretical situation of the Reserve Bank lowering interest rates by half a per as this year progresses – do you think that would stimulate the economy or do you think that the interest rate stimulation is just about run its course?

MS: Look, this is a personal view. I don’t see the information that the Governor of the Reserve Bank does, and that’s not a job which is an easy one. For me, interest rates at the moment are, you know, at effectively an all-time low in Australia, well particularly in recent memory in the last 20, 30 years. Is it going to make a big difference to drop interest rates another half a per cent? I don’t think so. I think the issue right now is business confidence. If business confidence returns – and business confidence returns because of government stability, government consistency, government policy which is consistent – you will find I think a bounce in the economy. So I think business confidence is critical because that creates consumer confidence.

RG: So, do you think if Tony Abbott wins and he’s able to restore confidence, you’ll see a bounce in the economy?

MS: Yeah. I think, well, whoever wins. I think the important thing with the election is that whoever gets in next, they have a clear mandate to govern.You know, in terms of minority governments, I think we’ve had that experiment. It’s time to move on.

RG: One more thing on interest rates. Do you think that if deposit rates are lowered further as official rates come down – if they do come down – it will switch even more money into bank shares, away from deposits, and perhaps make Australian banks much more dependent than they have been on wholesale markets overseas?

MS: You know, I think there is an element of risk in that. There’s no doubt that as sentiment has improved and investor confidence has returned a little bit people are beginning to look for yield. That has been exacerbated by the sheer amount of liquidity in the system. You know, I was pretty concerned about the bond markets and as to where they were going. It seemed to me they were overpriced and that that was the next problem waiting to happen, but then the Japanese government opened the tap with their own easing policy and, of course, bonds have rallied enormously.

So, who knows what will happen? I think that that search for yield, while there is so much liquidity, is going to continue and I guess the big problem is that there is probably not enough high quality assets out there which are providing good yield.

AK: But actually you’re supposed to know how it’s going to end. So, how do you think it’s going to end? I mean, with all the quantitative easing, do you think the Fed and the Bank of Japan are going to be able to exit smoothly or not?

MS: Look, I think that the US probably will be able to finish its easing in a relatively benign way. I think the issue is more ‘what is the impact on other countries?’ I think the US itself is probably okay but some of the developing countries may well struggle.

I think that for Japan, their record in terms of economic management over the last few years has probably not been the best. This is certainly the most significant thing that they have done in many years. Let’s see what happens there, but it can’t go on. Somebody has to draw a line in the sand at some stage and hopefully the economies are on the move by that time. If they’re not, you’re running out of options.

 So, I tend to think that the US will be the first to recover and certainly will start to move. You know, there are still obviously political issues in the US and it’s hard to get anything done or agreed, but definitely the economy is moving the right way. And if you look at the long end of the curve in US dollars right now, you’re already seeing a kick up in rates. So the anticipation that interest rates will go up in the States is there. The market is beginning to price it in, so I think that’s a good sign.

AK: Hey Mike, were you offered the job of running Barclays Bank last year?

MS: Well, you know, you get approached for all sorts of things. Would I want to go back to the UK and that political environment to run a bank? I don’t think so.

AK: It sounds like you were offered the job though – were you?

MS: Yeah. Look, you know, I get all sorts of things across my desk. You’d be amazed.

SB: Mike, you’ve had vastly more experience at the coalface in Asia than any other single Australian banker. Where do you think the Chinese economy is right now and do you think they can actually manage the transition from that sort of export oriented model to a consumption oriented model?

MS: Look, I think they can. They do think this stuff through very, very carefully. I think that the size and scale of that transition is staggering. And I think that the issue that has to really be managed well is the social change – the social adjustment that will go on in the country. 

Look, I believe that the new leadership is a very different breed from the last leadership. That was very much technocrat and bureaucrat driven. The new leadership has got a much more common feel with the people as well and I think that that is probably a very good way to make that transition start to happen, as well as being incredibly competent administrators. 

So, look, from what I’m seeing in China, it will have its ups and downs and whatever, but the trend is still pretty positive. And I would expect the growth to be over 7 per cent, probably nearer 8 per cent for this year, for 2013, and I suspect that that will be maintained fairly consistently in the next few years.

AK: Thanks for joining us, Mike.

RG: Thanks, Mike.

MS: Great to talk to you. All the best.

SB: Thank you, Mike.

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ANZ Bank chief executive Mike Smith tells Alan Kohler, Robert Gottliebsen and Stephen Bartholomeusz:

Returns on income will not fall as the bank grows, despite currently lower ROI in Asia than Australia.

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