Rising interest rates boost big four banks’ coffers

Credit growth and rising interest rates have bolstered big bank profits, but inflation threatens to erode their cost bases, and provisions for potential economic stress present an added challenge, KPMG says in its comprehensive annual report.

The Major Australian Banks Full Year Analysis Report 2022, released by KPMG on Wednesday morning (November 9), confirms CBA, NAB, Westpac and ANZ enjoyed a combined cash profit (after tax) from continuing operations of $28.5bn, up 7.2% on FY21.

Continued credit growth was reflected in the banks’ FY22 results, which KPMG said was off the back of continued strong post-COVID recovery. The audit and advisory firm acknowledged that the effects of the seven official cash rate rises this year (May to November), had yet to drive any material slowdown in business and consumer activity.

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Rising interest rates were one of the factors behind major banks’ improved profit performance, KPMG said. This drove an increase in average net interest margin (NIM) of three basis points in the second half-year, compared to the first half.

However, NIM was still 9.5 basis points below FY21, which KPMG said demonstrated that the benefit of rising interest rates was only just starting to flow through to bank profitability. It followed over a decade of extremely low interest rates, which KPMG said created “prolonged pressure” on the majors’ margins, which were now starting to rise from a low base.

According to KPMG, as inflation puts pressure on cost bases, and with new provisions taken for potential economic stress, the majors are facing a more challenging outlook ahead.

On average, their costs have gone up by 1.3%, a marginal increase, KPMG said. The major banks had all signalled that their cost targets would be either adjusted or abandoned as these inflationary pressures continue, it said.

The majors’ average cost-to-income ratio fell 30-basis points from 2021, to 49.2%, KPMG said. Continued regulatory compliance requirements, ongoing customer remediation (albeit declining) and increased labour and FTE costs were exerting pressure on the overall cost-to-income ratios.

KPMG banking partner Maria Trinci (pictured above left) said it would be interesting to see how the costs play out, with inflation putting further pressure on the pace of transformation.

“With the backdrop of a tight labour market, competition for skilled resources will place pressure on staff costs as banks respond to attract and retain the right skill sets,” Trinci said.

Having weathered the COVID-19 pandemic from a credit perspective, major banks wrote back a combined $925m in provisions in FY22, and have now resumed more normalised provisioning, KPMG said.

It expected major bank provisions to rise in the years ahead, as interest rates continue to rise in 2023, signalling an economic slowdown, increasing unemployment and falling house prices.

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KPMG acknowledged that the roll-over of lower fixed rate loans, more widely referred to as the “fixed rate cliff”, was a particular focus for the big four banks.

As these loans come up for refinancing, borrowers will be re-assessed at significantly higher interest rates, creating the potential for mortgage stress in some cases, KPMG said. This is expected to begin to materialise into the middle of FY23, when it said $237bn of loans are scheduled for roll-over across the four banks.

Balance sheet strength has remained a core focus for the majors with average CET1 of 11.65. This is down from 12.7% in FY21, however still above APRA’s “unquestionably strong” benchmark.

KPMG Australia head of banking Steve Jackson (pictured above right)  said after over a decade of ultra-low rates weighing on bank profitability, the recent rapid rises in interest rates had started to  “provide some initial margin relief” for the major banks.

But he acknowledged that the monetary policy tightening cycle also introduced inflationary pressure, which he said was working against the majors’ efforts to reduce their cost bases. Depending on the pace and strength of rate rises, this contributed to the potential for economic slowdown and a rise in bad debts.

KPMG said major banks were signalling challenging times ahead for the economy and the big question was whether a soft landing would be achieved that avoided the harsher potential outcomes.

Key highlights of major bank FY22 results:

• The majors reported a combined cash profit after tax from continuing operations of $28.5bn for the year, an increase of 7.2% on FY21 and an increase of 6.5% on FY20. This result reflects strong growth in housing credit, with improved asset quality leading to reductions in provisions and increasing net interest margins compared with 1H22 on average across the four majors.


• The average net interest margin (cash basis) increased by three-basis points compared to 1H22, although it is 10-basis points lower than FY21. As such, the majors’ FY22 results include early indications of the positive impact of increased interest rates.


• Cost-to-income ratios have dereased modestly from an average of 50.2% in FY21 to 49.2%. Excluding notable items, operating costs decreased by 1.3% to $39.2bn, reflecting lower remediation and provisioning costs, although offset by an increase in personnel costs and investment spend.


• The average ratio of impaired loans continued to decrease in FY22, down 8-basis points from FY21 to 0.23%. This is a result of a decline in delinquencies to the lowest levels since 2018, as well as a natural lag in the impact of interest rate increases on mortgage holders.


• The majors continue to have strong capital buffers, although the average Common Equity Tier 1 (CET1) ratio decreased by 102-basis points, 11.65%. The strong capital position saw each major bank announce share-buy backs totaling $14bn during the year, in a move to deliver stronger returns to shareholders.


• Dividend pay-out ratios remained steady at 71%, although this remains lower than FY19 of 81.3 per cent.


• Continued growth in earnings have seen Returns on Equity (ROE) increase by an average of 67-basis points compared with FY21 to 10.58%, returning to the double-digit standards experienced prior to the pandemic. Maintaining shareholder returns in an inflationary environment will continue to challenge ROEs for the foreseeable future.

Over 2022, there was growth across both housing (up 5.7% on 2021) and non-housing lending (up 13.2% on 2021), KPMG said. Much of this growth was the result of strong increases in house prices in the first half of FY22 and the continued post-COVID economic recovery, it said.

The major banks are signalling they expect this growth to soften moving into 2023.

Jackson said it was now important for the major banks to accelerate their digital transformation efforts, to reduce their reliance on full-time employees and bring efficient, technology-enabled solutions to their core middle and back office processes, where he said much of the scale of their cost bases exist.

“The majors will be striving to enter a potential economic contraction with strong credit quality, a lean cost base and a strong digital capability,” Jackson said.