Bank watchers are split over whether the royal commission into financial services will deter banks from moving home loan interest rates out of step with the Reserve Bank in 2018, a practice credited with bolstering profits in recent years.
As the market continues to debate the potential impact of the high-powered inquiry led by Kenneth Hayne, analysts are poring over the many ways in which banks’ businesses may feel the sting.
Aside from an estimated $1 billion in legal fees across the largest listed banks, and the possibility of more scandals being uncovered, bank profits could also be weighed down by a weakening in the big four banks’ pricing power.
Pricing power refers to the banks’ ability to set prices rather than have them dictated by the market. Although it is hard to measure, many believe this is crucial to the major banks’ profitability in recent years, while such out-of-cycle interest rate hikes have also been a recurrent gripe of politicians.
CLSA analyst Ed Henning said the royal commission would likely make it much harder for banks to increase mortgage rates as a way of protecting their profit margins.
“You’ve got to think with this hanging over their heads, the pricing power of the major banks is going to be diminished,” Mr Henning said. “I think it’s going to get harder to do housing repricing.”
Mr Henning noted that Bank of Queensland had flagged a squeeze on margins in the second half of next year. The wider industry may also experience margin pressure from home loan interest rate discounting, which tends to occur when credit growth is slowing, pushing banks to compete more aggressively.
Regal Funds Management portfolio manager Omkar Joshi said the impact of the royal commission on the banks’ pricing power was probably more significant than the many millions that will be spent on legal fees.
“Whenever there has been a new cost, a requirement to slow their loan growth, or whatever it may be, repricing has been the response,” Mr Joshi said. “Now, it’s going to be very hard to do that.”
Mr Joshi said that if banks were unable to “reprice” loans as they had in recent years, it would potentially impact profit in future years, as well as during the royal commission, which the government wants finished by early 2019.
Political pressure does appear to have affected bank interest rate settings in the past; three of the four major banks last passing on the full value of last May’s rate cut, soon after Labor started campaigning for a royal commission into the sector.
However, others in the market point out that fierce scrutiny is nothing new for the banks, and it has not stopped the banks from moving interest rates on some home loans this year.
Principal at fund manager Alphinity, Andrew Martin, said there was no doubt the commission would generate a flow of negative headlines for banks, but this wouldn’t change how they ran their businesses.
“They’ve been under massive scrutiny from governments and regulators and everyone else for years now,” Mr Martin said. “The banks will continue to run the banks in the best interests of shareholders and their customers.”
Mr Martin said the uncertainty of a royal commission may deter investors from buying bank stocks, but this could also create opportunities if it failed to reveal a “smoking gun”.
As speculation of a royal commission mounted in recent months, banks have also been planning how to minimise the disruption on their businesses – and retail banking is the largest profit driver for each of the big four.
Velocity Trade banking analyst Brett Le Mesurier said he did not think the royal commission would affect banks’ pricing power, noting they had been under fierce scrutiny for years, and it had not stopped banks moving home loan rates. Mr Le Mesurier said the royal commission would probably not unearth new scandals that would be large enough to meaningfully damage the banks’ profitability.
“I suspect that from an investor point of view, there won’t be a lot that comes out of it, but you just cannot be sure where it’s going to end up,” he said.
Mr Le Mesurier was also sceptical about how much the distraction for bank management from a commission would erode returns. He noted that CBA had been embroiled in numerous scandals but remained the most profitable of the big four.
Debate over pricing power comes as the government is further developing its terms of reference for the inquiry. Draft terms of reference, unveiled last week, were criticised by some bank critics because they say the inquiry need not look at matters already before the courts or regulators.
This story Administrator ready to work first appeared on Nanjing Night Net.