Australian Banking and the Recovery

Retail and Corporate Banking in Australia has experienced solid growth of 2.7% p.a. over the past five years, primarily driven by lending. However, the growth has been stunted by COVID-19, and the pandemic will continue to impact the banking industry.

Banking industry dynamics

Two different scenarios (Scenario 1: quick rebound; and Scenario 2: slower recovery) have been modelled for the industry over the next four years. While Australia’s economic outlook was expected to lean towards Scenario 2, high government spending under the 2020-21 Federal Budget, through measures such as extended JobKeeper payments and cash boosts for SMEs, is expected to shift recovery towards Scenario 1. Despite this, there continues to be significant uncertainty surrounding the pandemic, and Australia may face downside risks, such as subsequent outbreaks or disruption to global trade, which may see a slower recovery.

Banking revenue is expected to take 4 years to recover to 2019 levels under Scenario 1, and 5 years to recover under Scenario 2, with an average net growth of +0.4% to +2% p.a. from 2019 to 2024.

In an international context, Australia is expected to recover relatively quickly compared to peers: faster than the UK (-1.1% under Scenario 2) and the US (-1.5%), but slower than Canada (0.7%), due to some differences in pandemic intensity, product mix and historic trends.

Implications of COVID-19 for banks

COVID-19 has had significant implications for the industry in Australia. Among customers there has been a shift towards digital banking, with more than 17% of customers increasing their use of mobile banking apps during the outbreak. From the banks’ perspective, industry revenue is expected to decline by $8-10 billion, from $87 billion in 2019 to $77-79 billion in 2021. Looking across the big 4 and top 4 midsized banks, the banking industry has already seen a cumulative ~$7.5 billion in additional credit impairment expenses, roughly 45% of the peak seen during the Global Financial Crisis (GFC).

In response to these deteriorating market conditions, banks will have to transform fast enough to protect profits, with three levers available to manage the crisis:

1. Reduce cost to maintain flat cost-to-income (CTI)
2. Reduce dividends
3. Use their capital buffers

For banks to maintain the same CTI ratio through the crisis, the industry will need to reduce costs by a further 5 to 10% over the next three years, equivalent to a reduction of $0.4-1.1 billion for a big 4 bank, and a $20-130 million reduction for a top mid-sized bank.

While the COVID-19 crisis poses significant challenges to the banking industry, it also presents opportunities to grow during the downturn and to emerge stronger and more resilient by strengthening customer relationships, gaining market share not available during good times and initiating merger and acquisition (M&A) activities.

Five key strategic moves to prevail during the COVID-19 crisis

To succeed in the COVID-19 crisis, banks should address five priorities:

Reinforce the leadership, purpose and culture of the organisation to support the economy:

During the downturn banks have a vital role to play, working alongside government as part of the coordinated response to stabilise, reboot and grow the Australian economy. This unprecedented global crisis will test and provide an opportunity to reinforce every bank’s leadership, purpose and culture.

Double-down on risk and compliance:

As the downturn deepens, banks are experiencing increasing levels of market, credit, liquidity, business and operational risks. Banks will have to invest in technology to improve operational risk management, radically strengthen credit risk capabilities and help customers to be viable beyond government relief.

Accelerate digitisation of acquisition and servicing:

With the rise of digitisation, customer expectations have rapidly changed for greater convenience and digital, frictionless processes. While Australian banks have heavily invested in their digital capabilities over the past few years, they lag European digital leaders. In order to succeed, banks will need to accelerate their digital transformation agendas by either digitising their processes front-to-back or investing in a neobank/digital attacker and progressively simplify to migrate the core.

Consider inorganic growth:

Past experience (e.g. GFC, Recession in 1990) shows that during or soon after a crisis-driven economic downturn, M&A activity typically increases. In the current context, smaller players may struggle to compete and expand their balance sheets. Consolidation would help these players to better compete, expand their capabilities and scale to improve the customer experience and increase productivity.

Take share in priority segments:

Banks that understand customer needs, attract and retain customers with stronger service, pricing or products, while managing the risk of expanding lending will come out ahead in the COVID-19 crisis. Banks can employ three tactics: target existing and prospective customers to maintain and gain share in priority segments during the acute crisis period; deepen customer understanding; and build and develop customer orchestration engine capability to provide tailored offerings.