Bank rally post Royal Commission

Thursday, February 7th, 2019

The Royal Commission’s (RC) final report was incrementally positive for the major banks because there were no unexpected, material or adverse outcomes and the core business of taking deposits and making loans was untouched. This explains Tuesday’s powerful relief rally, which was also driven by short-covering. Short interest in banks had risen in previous weeks ahead of the final report.

Wisely, and probably under some pressure from the regulator and government, the report did not recommend any further tightening of bank lending standards, where banks moved ahead of the Commission’s recommendations and are now under public pressure from APRA and government to lend more liberally. The Commissioner continues to think benchmarks for living costs are not the same as verifying the customer’s actual costs. However, he said the ASIC vs. Westpac proceedings on this matter should determine whether there is “some deficiency in the law’s requirements,” so the RC has not recommended any change to relevant legislation. Despite this, banks probably won’t relax their lending standards near-term.

The RC also did not recommend major structural change, for example to WBC’s ownership of both advice and platforms, and many of the actual recommendations were expected. The four areas of focus (access to banking services; roles and responsibilities of intermediaries; responsible lending; regulation and the regulators) were widely known.

But even though there were no major surprises, some of the recommendations will still restrain revenue and add to costs, as they address the imbalance between sales, profits and customer service. In short, the old model of maximum sales incentives is over. The recommendations will increase compliance costs and thus the cost of doing business, inflate remediation charges and reduce revenue in selected product areas. Remuneration models will have to change to increasingly incorporate customer outcomes, which in the short term is likely to result in lower returns but in the long term makes the industry more sustainable.

The removal of trailing commissions paid to mortgage brokers would add around 1% to earnings. However, the response of government and the broking and banking industries make it too early to conclude lenders also won’t pay brokers upfront commissions given concerns about sending smaller brokers out of business and reducing competition. The medium-term effects on market share, the volume/margin tradeoff for banks, and borrower churn will depend on how brokers react to their new ‘best interests’ obligation and the removal of trail commissions, the rate of front book discounting, and customers’ adoption of open banking.

Litigation, refunds, remediation and fines are still likely. The final report concludes says those responsible for misconduct should compensate those harmed and be held to account. While difficult to quantify, refunds and remediation will be a recurring cost into FY20 given the RC identified cases of criminal or civil misconduct and the banks want to restore community trust. We have seen estimates of $2.5bn of further charges by the end of FY20.

So banks enjoyed a relief rally earlier this week. Now the RC’s final report has been released the debate about bank earnings will move on to the economy, house prices, capital, bad debts, lending growth, retail bank pricing and interest margins. The RBA downgraded its economic growth outlook on Tuesday and there will be more detailed forecasts in tomorrow’s Statement on Monetary Policy. CBA reported its 1H19 result yesterday and NAB gives a 1Q19 trading update tomorrow. We are doing extensive valuation modelling and expect to make any necessary change to the portfolios’ bank positions soon.

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3 Responses to “Bank rally post Royal Commission”

  1. Marc Bouten says:

    Banks reflect Society,what about the Right Of Entitlement and Greed in Australian Society??

  2. Kenneth Beer says:

    I, like most other Australians, am appalled at the behaviour of some banks in their dealings with their customers, which was revealed during the hearings of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry. The behaviour of some employees in some banks certainly do not reflect the behaviour of a majority of Australians who volunteer their help without reward and generously give financial support to other Australians in their hour of need, be it floods, bushfires, droughts and other natural disasters. I am confident that ASIC will commence civil and criminal court actions against banks which were identified for misconduct by the Commissioner, the Honourable Kenneth Madison Hayne AC QC, in his final report to the Governor-General on 1 February 2019. The concern I have is that the legal penalties may be inadequate to deter future misconduct.

  3. Jeff Vaughan (bank victim) says:

    What is missing from current conversations is the major role the banks and mortgage brokers have played in transforming real estate ownership from a status of being affordable to average wage earners to a gigantic Ponzi scheme. Since the nineties the banks have devolved into institutions that churn trust into maximum short term profit.
    Those stocks of trust, that were the very spine that their businesses were founded and sustained by, are now depleted. As they now realize their spines are suffering from a case of severe fiscal osteoporosis, their only concern is to regain trust.
    What is not acknowledged by the 4 majors is that if they do operate entirely within ethical guidelines profits will still be very healthy and trust will naturally ebb its way back into their industry, just like the good ol d
    Will the banks act responsibly and take action to correct the distortion of the property market that they were the prime driver of ?
    History tells us the answer to that question is an emphatic ‘NO’.
    Attempts to encourage banks to operate within ethical guidelines are akin to trying to make your car run on water.

    No faith, less trust in banks.

    JBV

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