KGB Interview: CBA's Ian Narev

The Commonwealth Bank of Australia chief executive tells Alan Kohler, Robert Gottliebsen and Stephen Bartholomeusz:

-- How the government can help facilitate a smooth transition away from auto manufacturing

-- Why his outlook for the Australian economy is positive

-- CBA’s impairments are likely to rise from their current historic low

-- Australian banks continue to be careful with refinancing in the low credit growth environment

-- Why he doesn't view banking sector profits as excessive

-- How new technology is driving increased competition in financial services

-- How CBA’s focus on productivity is translating into higher dividends for shareholders

Alan Kohler: Well Ian, if I could just start with the Toyota decision, there’s a lot of debate about whether that’s good or bad for the economy. Some people say it’s going to reduce costs, it’s good for the economy. Others say all the redundancies of the closure of the car industry generally will be bad, even recessionary. Where do you stand? Does it make you more or less worried?

Ian Narev: Well, I’ve read what a couple of you have written on this topic. It’s an important topic of debate for the country. Number one, there are people who lose as a result of this and the number one focus for me and for our institution – some of them are our customers – is to make sure we look after them as well as we can.

We don’t think that the fate of Toyota and the automotive industry will in and of itself precipitate a recession. What I would say is that the country needs to look forward now and say, given that automotive manufacturing is not going to be a significant part of the economy in the near to medium term, the debate has got to continue about where Australia can be competitive and where capital and human resource has got to be deployed in order to make that happen and what policies are needed to support it.

AK: Do you think the government should have a role in this?

IN: Look, the government’s certainly got a role to play in industrial policy. Ultimately, what is going to make an economy go well is private capital deployed well. And the government’s made very clear that its view is that growth is going to come from private capital deployed well. But there are certain aspects of policy settings which over coming months and years, business, the government and Labor need to all engage together on it to make sure that the policy settings are conducive to good, new areas of growth.

Robert Gottliebsen: Ian, are you worried that this is going to happen at exactly the same time as the retail contraction and, more particularly, the mining investment contraction?

IN: Well I saw, Robert, some of the stuff that you wrote on this I think it was yesterday about a whole lot of things happening together and there are certainly risks in the economy. Countervailing that, if you look at the contribution housing investment is now making to the economy, it’s a little bit better. Some of the retail spending that we saw over Christmas was a little bit better. Business conditions and business confidence survey data are looking a little bit better. So we’ve got trends on both sides of the equation and as a result of that, as we said today, our medium-term view is pretty positive for the Australian economy but we expect improvements to be very gradual rather than dramatic.

Stephen Bartholomeusz: Ian, in contrast to those sort of gloomy questions asked by my colleagues, one of the striking aspects of your results was that the ration of impairments to your loan book is down to 16 basis points, I think from a peak of about 85 during the crisis. Is that as low as it’s ever been for the Commonwealth Bank and what’s the outlook for that?

IN: Yeah, it’s pretty close as it’s ever been, Stephen, so 16 against any historic measure is very low. It’s a function of the fact that post the global financial crisis businesses were more cautious, households were more cautious and we’ve been in a low interest rate environment, so those three aspects together mean that credit quality is a bit better and the credit cost is lower. When we measure our performance in the business we are very careful to use profit after capital charge which means we don’t use loan impairment number at the time – we use a through the cycle credit loss number, and those numbers are a bit higher than we’ve got today. So it’s fair to say that the kind of numbers we’re seeing at the moment against historical benchmarks are pretty low.

SB: But you expect that number to turn up?

IN: Based on the fact that it’s lower than historical averages at some point you would expect it to be turning up. If we look at what we can see in the book at the moment in terms of leading indicators – so 30-day arrears, 90-day arrears, ratios of upgrades to downgrades, all those sorts of things that you gentlemen know well – all those signs at the moment are either stable or trending positive. So the signs as at today are pretty good, but again given that these are low relative to historical benchmarks, you would expect a trajectory would be up.

RG: Are you seeing some of the loans that you reject being accepted by other banks?

IN: I know there’s a bit of a topical conversation given one big name credit the market. There’s always a dynamic you’ve got to be careful about, which is in environments where business credit growth is a bit lower. Some bad credits are being refinanced by banks. Are you going to take on the credit? We try to make sure through all parts of our business bank that we’re very careful on refinancing. We measure the credit quality of our refinances over their first six, 12, 18, 24 months very closely and our experience has been pretty good on that dimension.

RG: What about others – are you seeing a different view?

IN: Everybody – when you speak to any bank – they will always say ‘some of our bad loans were refinanced by bank X or Y’. The market is very competitive, but I think generally in the major banks of Australia people are managing the banks pretty prudently.

AK: I saw some customer satisfaction data the other day on the big four banks. What was quite striking was that ANZ Bank went from being last six months ago, to being number two, now to you. What’s going on there? And is that shift in customer satisfaction translating into market share?

IN: Well, we’ve been at number one in retail for 12 months – we have to with our market share gains etc. ANZ, like the other major banks, is a very formidable competitor and we think they’re doing a good job in many parts of their business. They’re clearly doing something to rebuild customer satisfaction and we’re happy to have that high level of competition because it just makes sure that our people don’t get complacent and keep realising that we’ve got to keep the standards here going up and up in order to maintain a market position we’ve worked very hard to gain.

AK: To what extent is customer satisfaction now becoming a function of your IT platform?

IN: It’s undoubtedly a contributor. I mean, when we break down our customer satisfaction performance against the metrics we committed to, a number of different factors are part of that. One of the aspects that we see we do very, very well are ease of doing business with, and technology aspects. So it’s certainly a very positive driver and we think it will be a long-term positive differentiator for us relative to our competitors.

RG: Ian, term deposit rates have been coming down. They were five-plus, four-plus, now three-plus and yet the money keeps rolling in. Do you think you can reduce it to two-plus? At what point will it stop, and how low can those rates go?

IN: Well, again, deposits have been a very competitive environment. Savings rates are still, as you know, 11-12 per cent which actually against long-term historic averages versus short term is not abnormal. In these sorts of environments people still want to keep a degree of their money in the bank. There is still a lot of deposit money out there and deposit rates have come down a bit as the cash rate has come down. But I would expect in any time horizon – short, medium and long term – that competition for deposits will remain pretty keen.

RG: So let’s assume a steady cash rate – do you think deposit rates have come down as far as they’re going to fall?

IN: I’ve got to be a little bit careful of what I say about forward price predictions for legal reasons. I do think that you’ve still got a situation where everybody in the sector wants to keep good rates of deposits and that’s going to make sure that there’s always a reasonably high level of competition in the sector.

SB: Ian, we’re about to embark on another financial services inquiry. You’ve just produced a result with a return on equity of nearly 19 per cent. Are you concerned that you’re giving ammunition to those who say banks make too much money and ought to be taxed for?

IN: Well, number one, we’re the third-biggest taxpayer in the country. And number two, as we pointed out in the analyst briefing, we’ve only got the 27th highest return on equity of the ASX 100. So if that’s a level of profitability which isn’t acceptable when there are 26 companies in the ASX 100 that are earning more than that in terms of return on equity…

People say, well, given your privileged nature etc, that’s not an apples for apples comparison. But you’ve got to realise that even where governments around the world have stepped in to help the banks, in every case equity has lost their money. So the argument that our cost of capital should be lower because overseas governments have stepped in to help banks just doesn’t hold merit. And therefore we believe that as the 27th most profitable company in the ASX 100 – and the most profitable of the banking sector – the profits of the banking sector are about where they should be.

SB: One of the issues that that inquiry will look at, or said it will look at, is the impact of technology on future competition. If you looked forward three, four, five years, do you think you’ll be competing with new technology-based companies which don’t have traditional financial services histories?

IN: We already are. Just look at the role that PayPal is playing in the payments value chain, some of the things being done by Google and others in financial services, what Amazon has started to do with financial services. We’re already seeing the signs of that happening and that is a trend that will only intensify.

RG: Your expense growth nominally was, I think, 6.4 per cent but the actual underlying expense growth was 1.7 per cent. Can you tell me why the difference took place?

IN: The 1.7 per cent is what we call the underlying growth and what we’re really saying there is we’ve got $234 million in productivity benefits over the last 12 months and that did a good job of offsetting basic inflationary pressures. The differences between the 1.7 and the 6.4 – number one, there’s a bit of a foreign exchange impact; number two, a bit more amortisation, a bit of investment, but then critically $68 million of it was our decision to write off 30-odd very small technology investments from a number of years ago that were under $10 million, and we decided just to accelerate the amortisation and write them off. So that’s one of the big differences between the 1.7 and the 6.4. I think that alone accounts for about 1.5 per cent of expense growth in the period.

RG: So 1.7 was actually a very small figure.

IN: Yeah, but we were very happy with that and that’s because the long-term focus we’ve had on productivity is really working well. For a number of years now, we’re not going to take short-term options like offshoring or just having head count reduction targets; we’re going to look at fundamentally re-engineering the business. Six months ago the 12-month run rate on that was $220 million. Now, it’s $234 million. So the culture change in productivity focus right across the group is paying very good dividends for shareholders and also making the customer experience better.

RG: Would you say as you look across the total Australian business season – and leave the banks out for a moment – that that sort of attitude is a bit rare? Mostly they go offshoring and do the short-term things.

IN: I think there are examples of people who are doing it that way and other people who are taking it very seriously in the way we think about productivity. As we were on the early stages as we went out to visit a couple of Australian companies (whose names I won't mention) as really good local examples of people doing what we’re aspiring to do and they were manufacturers who for some period of time have had challenges with their cost base relative to global cost bases, and they need to look fundamentally at re-engineering their processes. And I took a whole management team out and we went and had a look at what they were doing and there are plenty of examples of people doing that in Australia. We certainly don’t believe we are onto a recipe that no one else is following.

AK: But you can’t cut your costs to growth. Are you going to just sit there and let Google and PayPal pick you off, or what are you going to do about it?

IN: No, we’re certainly not. I mean we see a lot of opportunities and we see a lot of threats, and our view is, number one, we’ve got to get the fundamental technology platform right and that’s why we’ve spent over $1 billion upgrading the entire core. We’ve got to get the application development off the back of the core banking right and you can see in our investor material some of the examples we’ve got with the new CommBank app, the simplified online offering which has reduced the time to open accounts by 80 per cent. We’re now opening 1200 accounts per week online. So we’re taking these threats very seriously, but we also believe that if we respond in the way we can and need to, there’s actually an upside for us in doing well here.

AK: We’ll have to leave it there. Thanks very much, Ian.

IN: Thank you. To the three of you, thanks very much.