Earlier this week, Treasurer Josh Frydenberg announced that the Australian Competition and Consumer Commission (ACCC) has been commissioned to conduct a Home Loan Price Inquiry.
The inquiry has been launched amid criticism of the banks from Mr Frydenberg for their failure to pass on the RBA’s full 25 basis point cuts to the cash rate.
Following the launch of the inquiry, Westpac Group CEO Brian Hartzer dismissed suggestions that the bank has placed its own financial interest ahead of the best interests of its home loan customers.
Speaking to the media, Mr Hartzer defended the bank’s decision not to pass on the RBA’s cuts to the cash rate in full, citing cost pressures in wholesale funding markets.
“The thing that’s different about banks than perhaps a lot of other industries is that we’re continuously balancing the demand from borrowers with the availability of funding from our depositors and our wholesale borrowers,” he said.
“To just look at the margin on loans is to miss the fact that there’s also a cost associated with the funding.
“As interest rates approach zero, the ability to move all those funding costs becomes constrained [because two-thirds of our costs come from depositors].”
According to Mr Hartzer, competitive dynamics in the lending industry have already placed significant downward pressure on the big banks’ net interest margins.
“I think the assertion that it’s only been about shareholders is just not supported by the facts,” he said.
“If you look at the net interest margin over the last 10 years, it’s been coming down. If you look at the return on equity, which is ultimately one of the big drivers of shareholder returns, that has reduced by about 50 per cent over the last 10 years.”
He continued: “[Our return on equity] is significantly lower than any other major industry in Australia. It’s lower than supermarkets, it’s lower than technology companies, it’s lower than airlines, it’s lower than a lot of retailers, and it’s average by world standards.”
Mr Hartzer claimed that Australia’s big banks “operate overall on a fairly thin profit margin”, which he said places the industry at risk in the event of an economic downturn.
“If you look at the return after the costs, after our credit losses, and after the tax we pay, we make about 1 per cent profit margin on our overall balance sheet,” he said.
“Another way to think about that is in a downturn, when there are significant credit losses, it doesn’t take much to completely wipe that profit out.
“In a time when credit losses are low right now, you would expect returns to be reasonably high so that we can absorb a credit downturn.”
The Westpac CEO added: “If that rate of return is too low, you don’t have the ability to absorb credit losses. That puts your debt rating at risk and that raises the cost of borrowing for us on wholesale markets, which ultimately does flow through to mortgage prices.”
However, the Customer Owned Banking Association (COBA) has rejected Mr Hartzer’s claims, pointing to the findings of the Productivity Commission’s (PC) inquiry into competition in the financial system.
Smaller bank joins defence of rate-setting policies
The Westpac CEO’s comments were echoed by MyState chair Miles Hampton at its AGM in Hobart on Thursday, criticising the government’s verbal lashing of the banking sector over interest rates.
Mr Hampton said that banks have a delicate balancing act to play in the competing interests of borrowers and depositors, and that criticism of lenders not passing on RBA rate cuts in full fails to recognise this.
“Borrowers want the lowest possible interest rates on loans, depositors want the highest interest rate on their deposits and shareholders have a right to expect a reasonable return for their capital that facilitates the whole banking process,” he said.
“At the end of the day, our borrowers, depositors and shareholders decide if we have got it right. If our loan rates are not competitive, borrowers will go elsewhere; but we continue to see strong growth in our loan book.
“If our deposit rates are uncompetitive, there will be an outflow of our most important source of funding. Our innovation and competitiveness are helping to secure strong growth in retail deposits.”
The chairman added: “Without a reasonable return to shareholders, our access to capital will reduce, diminishing our ability to facilitate the important intermediary role we play in the Australian economy. Our shareholders have endorsed our balance of competing interests with a relatively stable share price and strong participation in our dividend reinvestment plan.
“If the market tells us we’ve got it wrong, we make appropriate adjustments.”
Debate over anti-competitive tactics
Speaking to My Business sister publication Mortgage Business, COBA’s director of strategy, Sally Mackenzie, said the banks have exerted their market power to the detriment of competition.
“The Productivity Commission’s report last year on competition in the financial system found that the banking sector is an ‘established oligopoly’, where the four major banks hold substantial market power over their competitors and consumers,” she said.
“This structure is supported by regulatory settings which contribute to the major banks’ advantages.
“The PC found that the major banks have the ability to pass on cost increases and set prices that maintain high levels of profitability — with minimal loss of market share.”
Ms Mackenzie added: “The PC found evidence that the high concentration of market power among a very small number of institutions is resulting in poor consumer outcomes in Australia.”
However, Westpac’s Mr Hartzer said he does not expect the ACCC’s latest inquiry to uncover new evidence of anti-competitive pricing behaviour.
“It’s interesting; the ACCC completed a review of mortgage pricing as recently as December of last year,” he said.
“There have been 57 different inquiries into banking and many of them have covered mortgages. I don’t anticipate that there’s going to be any big revelation.
“What it will reveal, though, is that it’s complicated and we make a very complicated set of choices and balancing of the needs of our borrowers and the needs of our depositors and the reasonable return expectations of our shareholders.”
The ACCC is expected to hand down a preliminary report by 30 March 2020, with a final report due by 30 September 2020.