Competition to squeeze Australian bank profits in 2024 as COVID-era subsidy ends

Australia's biggest banks face declining net interest margins and intense competition for deposits in 2024 as a pandemic-era program of subsidized funding comes to a close.

The so called big four lenders — ANZ Group Holdings Ltd., Commonwealth Bank of Australia, Westpac Banking Corp. and National Australia Bank Ltd. — are expected to post a decline in net income, according to mean estimates of analysts on S&P Capital IQ.

"Net interest margins [NIM] are under pressure as funding costs and deposit rates rise. Profit will be under more pressure, due to funding mix costs and competition squeezing NIM," Martin North, principal at Digital Finance Analytics, told S&P Global Market Intelligence via email.

For example, ANZ's net income is expected to fall to A$6.48 billion in the fiscal year ending Sept. 30, 2024, from A$7.41 billion in the prior-year period. Commonwealth Bank, Australia's largest lender by assets, is expected to report net income of A$9.58 billion for its fiscal year ending June 30, 2024, down from A$10.16 billion in 2023.

A three-year term lending facility provided by the Reserve Bank of Australia helped banks obtain A$188 billion in subsidized funding by the time the window closed for new drawdowns in June 2021. The facility was provided to banks to allow them to access cheap capital during the COVID-19 pandemic and allowed lenders to offer loans at lower interest rates. Once the last of the funds are returned to the central bank by June 30, 2024, banks will see their average cost of funds increase.

"Banks will gradually re-finance their funding mix towards options with higher funding costs, which will further exert downward pressure on NIMs," Ryan Tan, an analyst at research firm IBISWorld, told Market Intelligence.

Mortgage lending, which had long been a growth engine for the big four banks, stalled in 2023 as borrowers moved to refinance their fixed-rate loans. That led to banks rushing to compete for these loans through aggressive pricing.

Commonwealth Bank CEO Matt Comyn called out the stiff competition for home loans during the bank's full-year earnings call Aug. 9, saying it "really weighed on margins" across the whole market.

One of the biggest challenges for banks in the past year was the "massive wave of refinancing that triggered the mortgage war," IBISWorld's Tan said. "This war has brought with it enticing loan discounts, cashback offers and other incentives, making it challenging for the big banks to balance between profit margins and market share," Tan said.

The big four lenders adopted different strategies to grow profits in 2023, Tan said, noting that Westpac aggressively pursued market share, while Commonwealth Bank chose to focus on drawing savers toward term deposits at the cost of giving up market share in mortgages. ANZ chose to get aggressive in the home loans market, offering cashbacks to customers and growing the bank's mortgage book faster than its rivals even at the cost of margins.

ANZ CEO Shayne Elliott defended the bank's mortgage strategy. "ANZ operates in a more diversified portfolio than our peers, so we're not just an Australian retail business," Elliott said during the bank's Nov. 12 earnings call.

Elliott noted that ANZ is smaller than, and different from, its peers, and that it is operating on a more long-term view to create a competitive advantage.

"A critical challenge facing the big four banks in 2024 is sustaining profitability amidst economic deceleration, surging inflation, and escalating costs," My Nguyen, senior lecturer in finance at the School of Economics in RMIT University, told Market Intelligence in an email.

The banks will need to balance their growth and risk strategies amid the cooling mortgage market, which is still the largest and most important market for the lenders, accounting for about 60% of their loan portfolio. While banks have turned toward business lending for growth, even that segment carries risks.

Banks face "higher loan impairments, lower loan growth, and increasing competition from the nonbank financial institutions" in business lending, Nguyen said. "The banks will need to carefully assess the creditworthiness, profitability, and sustainability of their business borrowers," she said.

The big four banks will also contend with a possible slowdown in Australia's GDP growth, which, coupled with a rising cost of living, could be a key risk for businesses' ability to service their debts. Banks' asset quality may be impacted if borrowers are pressured to repay their loans.

Banks will need to prepare for a more uncertain environment in 2024 and "they will need to demonstrate greater conviction and agility to thrive in this new reality," Nguyen said.