Here is a prediction for 2017 you can bank on: after a decade of near oligarchy, the journey to a more competitive market in Australia’s banking sector will begin in earnest. Not before time.
The competition will come primarily from fintechs, which will use new technologies to disrupt personal banking and payments in a way we have never seen before, especially in a banking sector that can best be described as the most highly protected of any developed economy.
But there will also be competition from smaller, more agile lenders that will aim to capitalise on the lack of trust and shortage of goodwill many Australian business customers have towards the big four. I know because I am the co-CEO of a new, smaller lender, Judo Capital, based on the highly successful Challenger Bank model pioneered in Britain.
Judo will be a specialist lender purpose built to serve small and medium-sized enterprises: businesses with an annual turnover of up to $20 million.
It won’t be easy, of course. We live after all, in a highly regulated environment, with significant barriers to entry. But like others, we are confident that the time is right to give the big four a run for their money: not by competing head to head across all sectors but by competing on those areas where our major banks have dropped the ball, like lending to SMEs — businesses that employ close to 70 per cent of the Australian workforce and are, indeed, the very backbone of the economy.
Small businesses, in particular, have lost faith in our major banks and it’s easy to see why.
But rather than engaging in the great Australian pastime of bank bashing, let’s have a look at some figures. Over the past 12 months alone, the four major Australian banks — the so-called four pillars — made profits totalling more than $30 billion in a country of just 24 million people, which equates to approximately $1300 contributed by every single man, woman and child.
The money made by these banks from fees alone is a whopping $13bn a year, which means every Australian household is paying on average about $515 annually in bank fees.
Now, one could argue that we are lucky to have some excellent management running our big banks, but management expertise alone can’t explain an industry return on equity at 15 per cent when the cost of capital is closer to 8 per cent. Despite our relatively small population, our banks can generate profits that outperform much larger economies.
There is no domestic banking system in the developed world that earns such high economic rents, while enjoying privileges such an implicit “put option” on failure to the taxpayer and the related cost of funds subsidy, estimated at some $4bn a year.
And yet, the big four are now hugely distrusted by the community they are supposed to serve, and that lack of trust is clearly evident among SMEs, the market most impacted by the way many banks operate.
Small businesses rely on banks to make ends meet, to grow and to create jobs. And while our big banks pledge support through endless advertising campaigns, the reality is they have effectively industrialised their operating models to drive down costs, resulting in a major reduction of skills, judgment and meaningful service for SMEs.
Australian banking has also become highly commoditised, focused primarily on retail banking, with an insatiable appetite for residential mortgage lending driving up eye-watering levels of household debt.
For reasons fundamentally linked to RoE-based incentives, banks have pumped close to $1.6 trillion into mortgages. By comparison, lending to SMEs is just $250bn. Barely 15 years ago, mortgage lending was broadly at the level of SME lending today.
This concentration by the big four on household debt has some potentially serious consequences.
The risk of financing a potential asset bubble while underfunding SMEs represents a real cost to the economy which can partly be understood by the unmet demand for credit by SMEs, estimated to be between $50bn and $70bn.
This “credit gap” will be filled only in small part by fintechs, who are with some exceptions best placed to make an impact in the personal lending and payments market.
But SMEs crave a genuine relationship-based service from highly skilled bankers that take the time to understand their businesses to help them grow and manage risk. As one SME put it: “Banking as it used to be: banking as it should be.”
No matter how sophisticated a credit scoring algorithm, there is no substitute for judgment.
In lending to SMEs, at least three of the four Cs — character, capital, cashflow, collateral — have to be strong and the fourth cannot be weak, particularly if it is a judgment on character.
How these are assessed is as much an experience-based craft as it is a science and it has to be institutionally based, rather the domain of a few individuals. The challenges faced by SMEs somewhat reflects the dominant culture within major banks, evident in the language of “selling products”. In some professions, “selling” has a negative connotation, particularly where there is a relationship based on trust. Would you want your dentist or doctor to “sell” you more treatment than you need? The retail emphasis in banking has created a deeply ingrained sales culture, making banking no different to selling electrical goods or other commodities.
Competing with the major banks won’t be easy and we hope for the sake of SMEs and the economy that policymakers will consider the advice of economist John Kay to the British government on its banking sector: “Perhaps the most useful initial role of government is to promote the creation of new financial institutions directed to providing the mix of loan and equity finance and advice to help SMEs grow.”
Joseph Healy is the co-chief executive of Judo Capital.