For Small Banks, It's Get Bigger Or Get Taken Out
Sydney Morning Herald
Friday October 14, 1994
WHAT RATE is your bank charging you on your home loan? Customers of Westpac or ANZ probably still remember their irritation when they read the headlines that said their home loan rates were set to climb from 8.75 to 9.5 per cent.
But customers of St George Bank or Advance Bank or Metway could be excused for being unsure. These small banks waited several weeks after Westpac and ANZ lifted their home loan rates and then, in the shadow of the majors, quietly raised their own home loan rates.
It was a clever strategy, because few ever point out the contradiction between the banks' actions and the image customers have of them.
It's actually quite hard to believe that an institution that chooses to associate itself with a large green dragon would be close to the front of the pack in jacking up interest rates.
Mike Bowden, a researcher of consumer trends, points out that because most regional banks were formerly building societies, they are seen as much more closely aligned with consumer needs.
The regional banks, he says, successfully exploit this image advantage in their advertising campaigns. They're able to depict happy smiling customers and friendly, helpful staff. On the other hand, whenever the big banks try a similar approach, they're met with a very cynical reaction from consumers.
The tough imperatives of the banking world mean that regional banks must increasingly discard their traditional "warm and caring" image, because the regionals are in the first phase of what looks like being a severe squeeze on their profits.
In fact, many observers believe this squeeze will be so severe that in the next few years the regionals will be forced to take a close look at merging with each other.
St George's Jim Sweeney told the Herald yesterday: "I think mergers will happen. We certainly would have an interest in a merger with an appropriate regional bank in another State which has a market advantage which we don't. That to me is a very logical way to go."
BankWest's managing director, Warwick Kent, agrees: "I guess you'd have to say there'll be rationalisation ... you could imagine one scenario where perhaps banks from two or three States got together."
This, he says, would yield cost-savings in terms of head office expenditure, in advertising, and in computer and information technology systems. Also, many of the regional banks have started pushing their operations into other States, so a combination of the smaller banks could bring savings on this front.
The other main possibility is an amalgamation of regional banks within the same State, such as St George and Advance in NSW.
However, Sweeney cautions that when two institutions in the same market merge, "one organisation or the other has got to be slaughtered. There are massive staff layoffs and branch closures.
"And there's good evidence when merging financial organisations with strong banking facilities, the accounts tend not to be sticky, you get a massive run off. And the run off will be considerably larger if you merge like organisations in like markets."
In some ways, this looming shake-up among the regional banks is being driven by the increasing sophistication of their customers.
Consumers are now much more savvy about interest rates. They're also more willing to swap banks if it means lower interest rates on their borrowings, or if a rival bank is offering a higher interest rate on deposits.
It's the regional financial institutions - who have traditionally boasted of the loyalty of their customer base - that are suffering most from this increased consumer militancy.
Peter Jack, managing director of Wollongong's IMB Society, says his bank learnt the hard way that customers chase the best interest rates on their home loans, and for their term deposits.
IMB actually tested the idea of customer parochiality in 1985, after research commissioned by the building society showed the Wollongong-based institution had strong levels of support in the local community.
They found the feeling of loyalty did not extend down to the hip-pocket nerve.
In reaction to the research, IMB took a deliberate strategy to price itself out of the market by about half a percentage point on a range of products, arguing the loyalty factor would keep the business flowing in the door.
"The result was that our assets grew by 5 per cent during the year, but assets grew by 20 per cent across the industry," Mr Jack said. "The lesson is that the loyalty is such that they will stay with you if your rates and service are competitive. If not, they will cross the road."
This is exactly the problem the regional banks are confronting. How can they keep their rates and services competitive as the real struggle for the home loan market gets under way?
Most of the regional banks - such as Advance Bank, Bank of Melbourne, Metway, Bank of Queensland, Bank of Adelaide, and Challenge Bank - have evolved from building societies and have a high concentration of home loans on their books.
(A few regional banks, such as BankWest, which evolved from a State bank, have more balanced lending books. BankWest, for example, has about 55 per cent of its lending in the form of home loans, compared with as high as 90 per cent for other regional banks.)
This focus on home loans has meant that many regional banks have enjoyed a bonanza in the past few years.
As BankWest's Mr Kent said: "The home loan scenario has been great over the last few years.
"The margins have been good, the volumes have been good ... no-one could do it wrong."
But the halcyon days of home lending are coming to an end. With interest rates on the rise, National Australia Bank has decided to tighten the pressure on its competitors by keeping its home loan rates down.
Commonwealth Bank is strong enough to follow suit. This has resulted in a vicious squeeze in the home loan market.
MOST of the regional banks are particularly vulnerable because home loans make up such a large part of their book.
Because regional banks have a lower credit rating than big national banks, it costs them more to borrow in the wholesale money markets. This puts their interest rate margins under more pressure.
And their troubles don't end there. In recent times, a range of new lenders have emerged - including the big insurance companies, such as AMP and National Mutual - which are targeting the home loan market.
The managing director of Metway Bank, Mr Trevor Steel, said: "I think it is inevitable there will be a tightening of margins, it's one of the consequences of increased competition."
The managing director of the Bank of Queensland, Mr Graham Hart, said the bank has not been affected by Commonwealth and National Australia Bank pegging their home loan rates. But the bank didn't pass on the full three-quarters of a percentage point rise in official rates. It's home loan rate rose by half a percentage point to 9.25 per cent.
Of course, the regional banks have come up with some strategies to cushion the blow.
In particular, they're competing aggressively for new business by offering attractive "honeymoon" rates for new business, while slugging their existing borrowers with higher rates.
But these strategies carry some risks. Existing customers could become so annoyed that they are subsidising new customers that they may refinance their loan with another financial institution.
And this very enthusiasm for the home loan market presents a different threat. Some regional banks have been aggressively lending up to 95 per cent of the value of residential property.
As home loan rates increase, some of these lenders will witness rising default rates.
With competition in the banking market threatening to reach an unsustainable level, it's no wonder that most of the regional banks are looking to widen their range of banking activities.
As a result, most regional banks have begun to show an interest in the small-to-medium-sized businesses.
Sweeney said banks that have a single focus on one line of business, such as housing, are vulnerable to "the sort of thing that is happening now, where a powerful organisation, which is extremely strongly capitalised, runs its operations in such a way as to damage all but other extremely strong organisations".
St George decided some time ago to diversify its balance sheet so it was not so exposed to one line of business. "That was part of our long-term planning strategy and remains part of it."
This was the main reason for St George's decision to buy Barclay's $2 billion commercial loan book.
SWEENEY says buying the book meant St George got a commercial business whose size and range of business lines would have taken the bank years to build up. "The competition in and compression of the market mean that you don't have that time to build it up."
Other regional banks are also voicing their intention to get into business lending.
But unless a regional bank follows the St George lead and buys a commercial loan book from another lending institution, the desire to get into small-tomedium business lending is more aspiration than reality.
Business borrowing has been sluggish, the market is competitive, and most small companies face significant costs if they want to transfer their banking business between banks.
There are also some doubts as to whether the regional banks have the right culture to develop profitable commercial lending operations. There is a huge gap between the skills required to be good at home lending and those required to be successful in commercial lending.
There's little doubt the squeeze on margins will force regionals to look at driving down their costs. They have traditionally enjoyed a lower cost base than their big competitors. For instance, managing director of Bank of Melbourne, Mr David Airey, says he believes the bank's low cost-to-income ratio gives it an advantage that will benefit it in a rising interest rate environment.
But mergers still look to be the most likely outcome.
If two or more regional banks in different States team up, they'll be able to reap significant cost savings on their advertising, research and computer spending.
BankWest's Kent believes "economies of scale must be a factor in the profitability of smaller banks".
He says that although his bank is relatively large, with assets of $10 billion, "we can see the impact, for example, of information technology expenditure on our income statement".
And, he notes, the smaller banks would have to outlay significant sums on product development and research, even though their lending levels were lower. This means "their relative costs in those areas could be higher than the bigger banks".
ANOTHER area is advertising. "We're comparatively modest advertisers. There are smaller banks that spend a lot more money than we do on advertising. And how long can they carry on?"
The big problem with such an arrangement, however, is that inevitably each bank will want to locate head office in their home State. And merging two regional banks would make many of the senior management jobs redundant, a proposition that is unlikely to be welcomed by either institution.
Of course, the biggest cost savings will come from mergers between institutions operating in the same market.
NSW, Queensland and Western Australia all have two regional banks. A pairing between, for instance, Advance Bank and St George, or Metway and Bank of Queensland, or Challenge Bank and BankWest, could achieve significant cost savings through a large reduction in staff numbers, and widespread branch closures.
If they have a choice, the regionals will definitely choose to amalgamate, rather than be swallowed up by the big four banks because that would mean their annihilation.
© 1994 Sydney Morning Herald