Banks threatened by online competitors

With ANZ, National Australia Bank and Westpac expected to report record profits this week (Commonwealth Bank has a 30 June year end), everything is going swimmingly for Australia's banking giants. Their share prices are recovering from the recent pullback and recommendations from the Murray enquiry aren't expected to be as harmful as initially feared. Yet due to advances in technology, the future for traditional banks might not be as rosy as their share prices suggest.

In the 1990s, innovators such as John Symonds of Aussie Home Loans and John Kinghorn of RAMS introduced competition to the home loan market, slashing margins on the big banks' home loan business.

Now highly profitable personal loans and credit cards are being similarly threatened. Startups such as SocietyOne and Lending Hub connect borrowers with lenders via the internet, utilizing technology instead of an expensive retail branch network staffed by unionized employees to attract customers. Instead of being gouged by the big banks you can borrow at lower rates simply by jumping online.

To make matters worse, new competitors are also entering the payments business, with Paypal already operating in Australia and Square (founded by Jack Dorsey of Twitter fame) on its way.

I can't wait. Regulation has made Australia's banks some of the most powerful and profitable in the world and they have little incentive to change the status quo. Anything that gives you and I a decent shot at enjoying better or cheaper services should be welcomed.

The banks aren't standing completely still, though. Westpac recently took a stake in SocietyOne via a venture capital fund, while the Commonwealth Bank and Westpac now own disruptors Aussie Home Loans and RAMS respectively to mitigate increasing competition.

With Australia's consumer debt levels and property prices amongst the highest in the world, high valuations for Australia's banks already argued for careful portfolio limits in your portfolio. If the new breed of companies boasting better mousetraps grow quickly then prudence might dictate an even smaller weighting.

Our maximum recommended portfolio limit for the banking sector is 20%. Conservative investors might consider a limit of less than 10% at current valuations, particularly if you have other large exposures to residential property.