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No respite from regulatory scrutiny for Australia's biggest banks

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No respite from regulatory scrutiny for Australia's biggest banks

After a first-half earnings season peppered with talk of the sector's need for cultural and governance reform, Australia's largest banks expect to continue grappling with the fallout from the government's ongoing banking public inquiry in the months ahead.

National regulators and government leaders alike have put Australian banks under the microscope amid misconduct allegations ranging from providing customers with faulty financial advice to rate-rigging. The inquiry, known as a royal commission, was launched in late 2017 and may uncover further evidence of banks' faulty governance and risk management during various hearings throughout 2018, culminating in a final report on the commission's findings in February next year.

The CEOs of three of the country's largest banks by assets — Australia & New Zealand Banking Group Ltd., National Australia Bank Ltd. and Westpac Banking Corp. — used their fiscal first-half earnings announcements in May to assess the fallout from the inquiry and what they expect in the months ahead.

ANZ CEO Shayne Elliott said banking in Australia is at a "watershed moment," acknowledging that "the revelations over the past few weeks from the royal commission have damaged the confidence of the community in our industry." He continued, "While we don't know yet the specifics, it is clear to me that there will be implications for who we bank and how we operate."

As the royal commission completes the hearings, banks can expect demands for tighter underwriting, documentation standards as well as for "responsible lending behavior," said Sharad Jain, a Melbourne-based credit analyst at S&P Global Ratings. The end result could well mean slower credit growth, putting pressure on banks' earnings, he added.

Jain also expects Australian banks will want to avoid further fines, and hits to their already-tarnished reputations, by proactively addressing any further shortcomings that the royal commission identifies with potentially costly reform programs and payouts to customers.

The banks are familiar with the high price of misconduct and regulatory breaches. In January, ANZ agreed to a A$5 million settlement with regulators and total remediation of about A$5 million over breaches in lending laws at its former car finance business. In February, ANZ and Westpac both agreed to refund customers more than A$20 million due to its flawed credit card processes.

Shortly before it announced its third-quarter earnings on May 9, Commonwealth Bank of Australia — another big Australian bank drawing regulatory ire — agreed to add A$1 billion to its regulatory capital requirement following a separate inquiry by the Australian Prudential Regulation Authority found, among other breaches, poor anti-money laundering oversight. Also in May, CBA agreed to pay A$25 million to settle a case with Australia's corporate regulator over alleged rigging of the country's benchmark interest rates, while conceding misconduct at its financial planning business in light of new findings by the royal commission.

Regulatory and compliance costs dragged down CBA's cash profit, or underlying earnings after the removal of noncash items, to A$4.87 billion in its fiscal first half from A$4.91 billion in the prior-year period. The bank, whose financial year ends in June, reported in February that cash profit dropped to A$4.74 billion from A$4.83 billion, after it took a A$575 million provision for potential regulatory fines and other compliance costs. The bank set aside A$200 million for potential expenses for "currently known regulatory, compliance and remediation program costs."

Omkar Joshi, a portfolio manager at Sydney-based Regal Funds Management, said: "The reality is compliance costs and regulatory costs are increasing."

ANZ said in its latest earnings release that it expects external legal costs for the royal commission to be around A$50 million for the 2018 financial year. Westpac reported a A$50 million rise in operating expenses for the 2018 first half, including A$34 million in costs associated with the royal commission. Meanwhile, NAB CFO Gary Lennon said during the first-half earnings call that royal commission costs came to around A$10 million for the period, and expects A$30 million in costs for the fiscal second half.

While these may be relatively short-term knocks to the three banks' bottom lines, the royal commission and other inquiries have added to their current pressures. Westpac was the only bank of the three to report higher first-half cash earnings year over year to A$4.25 billion from A$4.02 billion, while ANZ recorded a drop to A$2.88 billion from A$3.41 billion and NAB's cash earnings fell to A$2.76 billion from A$3.29 billion.

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