Regional and digital banks gained the most from Australia's banking royal commission inquiry

The past 12 months have been a turning point for Australian banks. A regulatory crackdown in the aftermath of the banking royal commission’s findings in early 2018 exposed systematic failures and breaches of trust by incumbent banks. Their business model was far from being aligned with customer’s interest, focusing instead on revenue and shareholder profit and paying less attention to how those outcomes were achieved. Shayne Elliott, The Australia and New Zealand Banking Group Limited (ANZ) CEO, admitted to the banking royal commission that “teams inside ANZ had made decisions based on their own knowledge of their own world around them, rather than the greater group, and so they searched for and sought short-term tactical solutions when problems arose”. At the same time, banks extolled their community engagement activities to its shareholders.

This dilemma between balancing different stakeholder interests surfaced also in wealth management. The largest banks – Commonwealth Bank of Australia (CBA), ANZ, Westpac, and National Australia Bank (NAB) – cultivated a model that for years, was based on the provision of financial advice and the manufacture of financial products. Around this platform, they built a large pool of financial advisors to sell it. This modus operandi, called vertical integration, is being used across Australia and Asia in various forms to achieve economies of scale and reduce cost. As a result, they have offloaded their advice platform, superannuation and asset management businesses. The fallout from this crisis will have profound implications for the financial services industry not just related to customer compensation, fines, and penalties.

Australia’s major banks register record lows as a result of the country’s bank crisis

Figure 1: Net Promoter Score (NPS) of the 10 largest banks prior and after release of banking royal commissions’ findings in January 2018

Source: Roy Morgan Single Source (Australia). 6 months to January 2018, n=23,945. 6 months to February 2019, n=25,115

Consumer compensation cost, the Australian Financial Review shared, could hit $10 billion. The portion on overall IT spent in the banking industry allocated for risk and compliance jumped from 29% to 35% between 2017 and 2018, according to audit and accounting company KPMG.

In January 2018, immediately prior to the release of findings by the banking royal commission, the net promoter score (NPS) of the big four banks was 2.8 and this fell to -2.8 in November 2018, according to Roy Morgan. The latest figure for February 2019 has shown some recovery to -1.6 but this remains one of the lowest levels recorded since 2014, and much lower than the latest rating of 23.2 for banks outside of the big four.

Impact from crisis varies greatly by financial institution

The fallout from the crisis varies by financial institution, however. CBA is digesting the impact on customers and deposits better than peers, partially because of their strong digital platform. The bank is a market leader in mobile and internet banking, achieving a NPS of 37.8 and 31.3 respectively as of June 2018. CBA also achieved a retail deposit growth of 3% year-on-year between June 2017 and June 2018. By contrast, ANZ had an outflow of retail deposits of $1 billion between March 2018 and September 2018. Its growth was flat between September 2017 and September 2018. At AMP, the country’s oldest wealth manager, customers took away more than $5.5 billion of superannuation and other investments for FY2018 with the outflow expected to continue in the first half of 2019.

While smaller banks are currently growing their customer base at a rate faster than the big four, and some pushing aggressively into the market with more branches and better home loan services, they are still beset by their own transformational issues. Bank Australia, a customer-owned bank made up of 72 credit unions and co-operatives before 2015, grew its customer base by 35% year-on-year in FY 2018 from 25% year-on-year in 2016 and 30% year-on-year in 2017. These growth rates will put a strain on dated internal systems and processes, operations, customer service, and staff. Bank of Queensland (BoQ) and Suncorp are symptomatic for a class of players which struggle in modernising their core banking applications. BoQ’s unsuccessful execution on the digital banking front and the inability to attract new owner managers for its franchises have hampered its financial performance. With an intensifying competition and entry of new players into the market, those smaller conventional banks are likely to be the biggest casualties.

Long term impact

The fallout from the royal commission may also catalyse a long-anticipated change in the competitive landscape and the way regulators try to further break the cartel-like effects of the industry such as lack of transparency, price wars and associations. In 2017, a consortium of the largest banks sought the authorisation of the Australian Competition and Consumer Commission but ultimately lost its fight to collectively bargain with Apple and boycott Apple Pay. Despite the outcome, banks, with the exception of ANZ, have blocked Apple Pay as an option for mode of payment in the next two years. CBA customers have been persistently requesting Apple Pay for years. In January 2019, the bank said, “We heard you,” via social media and made Apple Pay available to personal customers resulting in a 400% increase in the number of payments made. NAB followed suit in May 2019 and Westpac is poised to follow as well.

The consumer data right, as part of the open banking reforms, will give customers unprecedented access upon request to their credit card, deposit and transaction data, enabling them to compare such data with other financial services providers. However, open banking to shared customer data, including the important mortgage data part, has been delayed to 2020. Currently, there are more than 25 new financial institutions seeking a licence with the Australian Prudential Regulation Authority (APRA) either through the sandbox regime or market entry. In an interview with local media, the CEO of Xinja – a neo-bank which anticipates a full banking licence in 2019 – said that the market may see four to five startup neo-banks over the next 24 months. Volt Bank is expected to be launched this year and has been granted a restricted authorised deposit taking licence from APRA.

The regulatory efforts to open up the banking industry, however, had only limited effects. Despite making it easier to switch accounts and lowering entry barriers for alternative financing, the big four banks’ market share to all household loans remained relatively stable between 2010 and 2017, shifting from 84% to 82%. Australia’s peer-to-peer (P2P) lenders, with SocietyOne and Ratesetter representing the largest ones, have failed to make any dent in the market so far. P2P lending contributes about $0.7 million (AUD 1 billion) to the $70 billion (AUD 100 billion) consumer finance market as of FY2018.