Australian Banking Space Amidst Virus-Induced Volatility; Digitalisation Turning Over a New Leaf

Summary

• COVID-19 pandemic has kept Australian banks in the spotlight amid dividend deferral/suspension, loan deferrals and capital positioning.
• The number of bank loans deferred peaked near 780,000, totaling about $236 billion, by early June 2020, as per data from Australian Banking Association.
• A recent extension of repayment deferrals by another four months by APRA can help cushion the blow of pandemic on borrowers.
• The pandemic has fast-tracked an unprecedented transition to digital services across different sectors, including banking.
• A classic example to be seen is CBA’s digital application, which delivered a benefit of about $153 billion to customers in the past financial year.

With the emergence of COVID-19 pandemic, major Australian banks have drawn considerable attention for deferring/suspending their dividends, facing loan deferrals, and making capital provisions for potentially high credit losses in the challenging market.

In April this year, Fitch Ratings downgraded the long-term issuer default rating of each of the big four banks from AA- to A+ amid virus-driven economic effects.

Moody’s also downgraded the outlook for Australia’s banking sector to negative from stable in April this year, anticipating a rise in margin pressures and a considerable deterioration in asset quality.

Dividends and Capital Scenario

Amongst big four banks, Westpac (ASX:WBC) and Australia & New Zealand Banking Group (ASX:ANZ) deferred their 2020 interim dividends, while National Australia Bank (ASX:NAB) reduced it by 64 per cent. Commonwealth Bank (ASX:CBA) was the only one to pay 1H20 dividend payments.

According to S&P Global report, cash earnings of Australian banks fell sharply in the first half of FY20, as credit provision charges nearly increased fourfold with lenders bracing for the impact of the novel coronavirus pandemic.

Amidst crippling household incomes and mounting job losses, the number of bank loans deferred peaked near 780,000, totaling about $236 billion, by early June 2020, as per data from Australian Banking Association. Mortgage loan deferrals reached 485,063, surpassing business loan deferrals that were at 216,372.

Optimistic Signs for the Banking Sector Recovery

A recent extension of repayment deferrals by another four months by Australian Prudential Regulation Authority (APRA) can help cushion the blow of the COVID-19 pandemic on borrowers.

As per Australian Banking Association, APRA’s move will prevent a ‘cliff’ for bank customers in September providing them the much-needed breathing space required to work with their bank and recover financially.

As banks have already set aside billions of dollars in provisions for potential losses, investors with a long-term focus have an opportunity to wade back into bank shares trading at multi-year low levels.

Besides, Australia is emerging from a global crisis more swiftly and in better shape than most of the other countries, boosting prospects of banks’ gradual recovery from coronavirus downturn.

Digitalisation Charting Out Growth Prospects for the Banking Space

COVID-19 pandemic has fast-tracked an unprecedented transition to digital services, while Australia’s switch to financial technologies becomes a new normal amid social distancing norms.

Advanced digital shifts have been seen across the Retail and Information and Communications Technology (ICT), and the banking sector is no exception in experiencing a robust digital transformation.

Australia’s producer of circulating coins, Royal Australian Mint observes “virtually no demand” for coins this year due to a shift towards digital payments. Certainly, the rise of contactless payments and online shopping seems to be the driving factor.

As Australia enters cashless age, a continuation of digital payments’ trend can unfurl a slew of opportunities for neobanks like Xinja, 86 400 and Volt Bank, potentially bridging the gaps in traditional modes of banking.

A report released by IDC and Backbase in May 2020 highlighted that 63 per cent of customers in the Asia-Pacific region intends to switch to challenger banks and neobanks by 2025.

While Australia continues to experience the dominance of big four banks, the recent launch of open banking regime can flip the tables around, helping fintechs rupture big four’s market power in the financial sector.

Lately, Trend Micro announced the nation’s first automated open banking solution built on Amazon Web Services, for secure data sharing. The innovative solution is likely to make bank data sharing more convenient, bolstering open banking accessibility for fintechs.

While the digital transition appears promising for fintechs and neobanks, widespread adoption of digital banking can develop hurdles for traditional incumbent lenders. A report published by Accenture in February 2020 anticipated a displacement of USD 3 billion worth payments revenue from Australian banks with the growth of digital payments.

Accelerated Digital Adoption by Big Fours

On the flip side, a multi-billion-dollar opportunity can unfold for financial players willing to invest in new business models and technologies based on impending digital landscape.

A classic example to be seen is Commonwealth’s digital application, which delivered a benefit of about $153 billion to customers in the past financial year.

Commonwealth Bank attained a digital primacy in the banking market early this year, laying out a plan to introduce 25 new fintech startups within the next five years. As part of its digital transformation strategy, the bank also announced launch of Klarna app in Australia in January 2020, which is in the process of relaunch after coronavirus setback.

Besides, National Australia Bank is accelerating its digital transformation amid COVID-19 while building up its relevance, speed, agility and resilience. The bank has recently entered a new five-year strategic partnership with Microsoft to invest, co-design and develop NAB and Bank of New Zealand’s multi-cloud technology.

Though digital transformation appears to be a rescuer for banks along with bringing neobanks and fintechs in spotlight, risks persist in the banking space on potential loan defaults and lending margins. However, recent extension of repayment deferrals by APRA along with the extension of wage subsidy scheme can offer some relief to the system.

Nevertheless, income and unemployment levels, second wave of infections and economic growth levels need to be closely monitored.