Small banks are forcing an industry sea change

Westpac’s Lloyds buy is a dress rehearsal for the cultural change big banks will increasingly need, with small contenders becoming a growing threat.

Few people realise that at least 10 new small banks have emerged in Australia in the past few years.  They are still small, and while they do not pose a threat to the majors at the moment, they hint at the shape of things to come.

That’s why the Westpac takeover of Lloyds' motor finance business will be a test for Westpac CEO Gail Kelly.  The Westpac plan is that its frontline management, which is familiar with funding small enterprises, can extend into financing cars by taking over the Lloyds business.

Financing cars is an entirely different business to bank overdrafts, many of which are secured on the family hone.  Many borrowers will want to keep their car finance very separate from their bank overdraft.  As a result, a totally different banking culture will be required if Westpac is to keep the Lloyds business.

At the same time, the emergence of the 10 new banks (with more to come) will require a cultural change in the banks over time.  For Westpac, the Lloyds motor business is a dress rehearsal for what is ahead.

Three events made it possible for 10 new small banks to emerge.

First, there were credit unions, building societies and co-operatives with customer bases and the ability to create the required banking capital base.

Second, the government will now guarantee bank deposits of $250,000 per client.  That means a small bank can offer the same security as a large bank.

And third, new technology has slashed the advantages of scale and at the same time reduced the need for elaborate and expensive branch networks to compete, particularly if your clients are young.

The 10 new banks that come out of credit unions etc are Bankmecu, BankVic, Beyond Bank Australia, Defence Bank, Heritage Bank. P&N Bank, Police Bank, QT Mutual Bank, Teachers Mutual Bank and Victoria Teachers Mutual Bank. To that list we can add the industry superannuation fund bank ME Bank, which was founded in 2001.  Coles is looking at starting a bank.

To illustrate how a group can slice out a market, I will choose one of the newcomers: the Defence Bank. Defence Bank supplies loans to service people wanting houses, so it has a young customer base with 83 per cent of its customers operating on line. It’s growing rapidly and has about  $1.5billion in assets.  

What is fascinating about Defence Bank is that it has captured a share of the industry superannuation deposit market by providing a banking term deposit service that provides flexibility for superannuation funds financing regular pensions.

No doubt as time goes on there will be other innovations and higher innovation will also be required in the other new banks as they expand existing markets or seek new ones.

Because they are still small, it will be some time before the majors will be required to take notice of the newcomers and develop flexibility to compete.  But the day is coming.