Major banks enjoy structural advantage
Australia’s largest four banks dominate an oligopoly that gives them a durable structural competitive advantage, ensuring they’ll earn excess returns over the very long term.
This enables the banks to prosper compared with major banks elsewhere in the world and gives Morningstar’s analysts confidence that the banks will have global sector-leading returns on equity for the foreseeable future.
Thus Morningstar has upgraded the banks to having a wide “economic moat”, joining only one other bank in its global bank coverage universe and two other companies in its Australian stock coverage.
An economic moat is a “sustainable competitive advantage that allows a firm to generate positive economic profits for the benefit of its owners for an extended period of time.”
Unlike other banks in the world where cost advantage is the main source of their favourable competitive position, efficient scale is what gives the Australian banks their edge.
The efficient scale arises from the highly profitable and regulated major bank oligopoly. They’re well established and efficiently service and control a market of limited size so potential competitors have little incentive or financial means to compete on an equal footing because it would cause poor returns for all players.
The analysts spoke of the banks’ strong pricing power that comes from their dominant market positions within a limited and regulated market, high-entry barriers, large-scale and low-cost operations, access to lower-cost funding, a large sticky customer base and high-profile brands.
Those advantages are likely to be retained, partly due to government control over competition and acquisitions. The four pillar policy prevents a merger between any of the banks, making it impossible for one mega-bank to emerge with greater scale and competitive advantages.
Effective prudential regulation and anti-competitive policies mean long-term profitability is unlikely to be damaged by bad lending decisions and overly ambitious acquisitions.
Also playing a role in preserving their strong position are large domestic branch networks, strong balance sheets, implicit government support, financial capacity to invest in modern cost-efficient technologies, as well as high switching costs that are underpinned by improving product cross-sell rates.
Cost advantage, coming from a combination of low funding costs, low operating costs and low credit losses, comes a close second to efficient scale in lifting the banks’ competitiveness.
The major banks enjoy a 50 basis point funding cost advantage over the smaller domestic banks thanks to strong balance sheets, strong profitability, tight risk management and high credit ratings.
Their increased investment in technology, product innovation and business simplification will see their cost-to-income ratios improve from around 43 per cent to 40 per cent over the next five years, while their broad range of activities means their operating costs are spread over a wide variety of products.
Brands are a strong intangible asset
The banks’ strong and trusted brands also support their “economic moat”, and the underlying ingrained perceptions of safe banking and high customer satisfaction ratings.
“The pricing power of the four major banks reflects the strength of their brands and their dominant market positions.”
The big banks charge more for loans and less for deposits than smaller banks, hence their average interest margin is 2.2 per cent, compared with the 1.8 per cent margin of the regional banks.
The banks have low customer turnover due to meaningful switching costs, high customer satisfaction and the fact that most retail customers hold an average of three products including long-dated home loans.
In Morningstar’s opinion, the banks are considerably stronger than before the financial crisis as their dominant market position has been reinforced by long-term industry consolidation on market share gains and merger and acquisition activity.
Morningstar’s forecast for a seven per cent increase in profit to $47 billion in 2014 means the banks could withstand a sharp recession without having to raise capital to cover any losses on bad loans.
- Marion Williams, email@example.com
- Article Posted:
- October 02, 2013
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