Mortgage repricing a ‘balancing act’ for majors: EY

EY’s analysis of the big four banks' 2017 half-year results shows that average net interest margins were down by 7 basis points on the 2016 half year to 2 per cent.

The majors still managed to post strong profits, with combined cash earnings of $15.6 billion, up 6.25 per cent on the first half of 2016.

EY Oceania banking and capital markets leader, Tim Dring, said the “balancing act” of margin versus volume is a game the banks have become well-versed in as low interest rates, intense competition, funding cost pressures and moderating credit growth, particularly in their business books, all combine to constrain growth.

“At the same time, heightened economic uncertainty is taking a toll. Locally, this is being fuelled by high household debt, low wage growth and housing affordability challenges in Sydney and Melbourne,” Mr Dring said.

“A possible downgrade in sovereign and bank credit ratings and, further afield, lingering offshore geopolitical uncertainties bring an increased risk of volatility in wholesale funding costs,” he said.

“All these factors are combining to create a particularly challenging operating environment for the banks. As lower growth becomes the ‘new normal’, banks need to manage the inherent tension in two very different agendas: the need to improve financial performance versus the need to keep the bank safe.”

EY noted that the residential mortgage environment is “clouded by higher risk and increased scrutiny”, leading the big four to adopt a more cautious approach to growing their mortgage books by tightening lending criteria and repricing portfolios.

“While rate increases benefit the banks’ earnings and margins, they also have the potential to put additional pressure on an already highly-indebted household sector,” Mr Dring said.

“Looking ahead, the banks’ ability to extract additional margin through differential rate repricing on residential property lending will become even more of a balancing act. We are seeing mounting regulatory, government and public pressure to curtail housing price growth, particularly in the Sydney and Melbourne markets, and this is likely to continue to build.”

Against this backdrop, EY believes the major banks are going to have to innovate if they want to grow profitably and drive continued improvement in ROE, which increased by an average 8 basis points over the last half.

“Advanced technology adoption and innovation-based operating models should be central to how banks reshape their businesses and they will need to engage with an ecosystem of innovative, external digital partners,” Mr Dring said.

[Related: Major bank chief predicts inner city housing downturn]