• Australian bank returns are now lower than they were in 1997.
• Analysis from Credit Suisse shows key drivers of bank returns have shifted through four distinct periods.
• Looking ahead, the analysts said major banks will have to focus on costs amid limited revenue opportunities.

Australian banks now have a lower return on equity (ROE) than in 1997, research from Credit Suisse shows.

But it’s been an interesting journey for bank returns in the meantime, which peaked in 2007 before commencing a steady decline:

“Bank returns on equity (ROEs) are nearly 2% lower than they were 20 years ago, with similar leverage but substantially lower income contributions offset by better expense ratios,” Credit Suisse said.

The analysts broke the 20-year time-frame down into four distinct five-year earnings periods.

Each period had a different prevailing theme, beginning with a “margin crunch” from 1997-2002 which was defined by increased competition and higher bad debts.

That gave way to a golden era between 2002 and 2007, when aggregate ROE rose by 4.6% to a peak of 20.4%.

Credit Suisse said the gains in that period were largely driven by Basel II lending rules, which allowed the banks to significantly increase their use of leverage.

Borrowing money is usually both cheaper — and riskier — than raising capital via the issue of shares. So banks utilised the period of easy money in the lead-up to the global financial crisis (GFC) to supersize their returns.

The gains in ROE came despite a fall in percentage contribution from major income streams, slightly offset by a corresponding decrease in bad debts.

“The strong expansion of the banks’ balance sheet over this period shows how the banks were not focused on the quality of revenue,” Credit Suisse said.

Then came the financial crisis in 2008, which gave rise to a “GFC hangover” as industry ROE fell by 4.4% to 16%.

“This was the start of the post-crisis capital build which would see the regulatory de-leveraging thematic dominate for the next decade,” Credit Suisse said.

This time, the banks raised capital predominantly via the issue of shares. It was less risky, but it also meant banks had to make more money to achieve the same return.

In the fallout from the GFC, Australian banks were required to have capital buffers that were deemed “unquestionably strong” by global regulatory standards.

To achieve that, the majors have raised more than $90 billion in capital over the past five years, driven by a sharp increase in 2015 when total capital rose by over 20%. As a result, industry ROE fell by 1.9% to 14.1%.

Looking ahead, Credit Suisse said the banks will have to focus on costs, with limited growth opportunities amid falling house prices in Australia’s major markets.

“Despite the end of the deleveraging, the opportunity to expand margins appears limited,” Credit Suisse said.

“With bad debts at cyclical lows the banks will need to focus on capital optimisation and the expense line if they are going to hold current levels. And with regulatory and compliance costs on the rise, this appears to be an ever increasing task.”

Among the big four banks, the analysts favour NAB, with neutral ratings on Westpac, Commonwealth Bank and ANZ.

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