What are the prospects for the wave of digital start-up neobanks in Australia? Tom Ravlic assesses their chances of taking on the incumbents
Challenger banks are yet to gain sufficient foothold in Australia to be considered serious contenders in the domestic market place. The new entrants into the Australian market pose a threat over time. In particular as the larger financial institutions are still smarting from the whipping they received from criticisms in the royal commission. And you can add in legal action arising from misconduct as well as continuing media scrutiny over the manner in which banks engage with external consultants.
While the major banks such as the NAB undergo further parliamentary scrutiny over the manner in which they use Big Four accounting firms to undertake reviews required by regulators, five new entrants have been granted licenses during 2019.And now they are advertising their services online in an attempt to gnaw their way into the market share currently in the hands of the ANZ, NAB, CBA and Westpac.
The Australian Prudential Regulation Authority (APRA) regulates the banking sector. It has waved through several challengers into full-blown bank status with APRA acknowledging that 86 400, Judo Bank, Lutheran Laypeople’s League of Australia, Volt and Xinja faced challenges taking a chunk out of the banking business currently held by the large institutions.
APRA: encouraging new players
A speech delivered by APRA’s general manager of regulatory affairs and licensing, Melisande Waterford, in October 2019 stressed that APRA needed to treat challengers in a slightly different way. In particular, it needed to encourage new entrants into the market space while not sacrificing protection for consumers.
One of the mechanisms it put in place was the ability for a challenger bank to obtain a limited license from APRA. Two of the challenger banks, Xinja and Volt received restricted licenses in the first instance but those limits have been lifted. Xinja was granted a full licence in September 2019 after being given its ‘training wheels’ in December 2018. Volt got its full licence in January 2019 after being granted the restricted status in May 2018.
Waterford says the regulator has been focused on looking closely at product launches and capital raising as interrelated issues.
”We believe that launching products should be a top priority for applicants. We believe that an applicant must have sufficient capital to get itself to product launch date, which in turn will provide the best prospects for raising the additional capital necessary for medium-term success,” Waterford observes. “If we insist on high standards and ask challenging questions, then this is a manifestation of ‘tough love’.”
APRA is equally aware that aspiring financial institutions need capital to do what is required and that convincing people an idea is worth backing. This means that new banks using phone apps and similar kinds of programmes to help customers control their banking experience needs testing.
“Good ideas alone have not proven to be persuasive. Investors want to see proof-of-concept. Where an entity has not commenced business, it has no customers,” Waterford notes. ”It cannot demonstrate customer traction or the efficacy of its systems and processes. Leading-edge technology is only a market advantage when it works and is seen to work.”
The technology Waterford refers to is epitomised by the apps and web-based application software used by 86 400 to deal with loan approvals, which the challenger bank asserts approves loans six times faster than the application processes of the major banks.
86 400 chief executive officer Rob Bell has told Australian media outlets that the company had “thousands” of customers testing the app when the bank was launched.
New entrants: no immediate threat to the Big 4
While the presence of these new players is acknowledged by observers in the market, their start up status causes people to reflect with some caution on their likely impact in a market place where banks have a government guarantee and the share prices of the various banks have maintained relatively buoyant despite bad news.
EY Oceania Banking and Capital Markets Leader,Tim Dring, says that the challenger or neobanks might mature over time but at this point they are embryonic and are unlikely to pose a threat to the major banks for some time.
The major banks continue to be strong despite being buffeted by the winds of royal commissions and other scandals, Dring says, but profits have been declining and the intense focus on banks by regulators caused the previously more generous banks to play Scrooge.
“Growth in the critical home lending segment remained subdued during 2019, with tighter lending standards appearing to be the new world order. While there have been early signs of turnaround – with some markets showing an increase in loan applications and approvals in recent months – declining market share and a squeeze on margins as interest rates fall point to continuing housing credit growth challenges for the major banks,” Dring says.
“Pricing in the front versus the back book is under scrutiny too, with banks under pressure to close the gap. Banks have traditionally benefited from higher margins in their back books, while offering heavy discounts form new borrowers.
However, the government has recently directed the ACCC to investigate the banks failure to pass on official rate cuts in full, and margins will face further compression if this gap is narrowed or closed.”
Dring says that there are a range of services that are creating an irritant for the major banks in the personal credit space. “We can expect to see further disruption in this area over the next few years, as the rollout of open banking and changes to consumer data rights make it easier for customers to switch products and providers,” Dring notes.
A partner in rival Big Four firm, Deloitte, Steven Cunico, agrees that the underlying performance of the Australian banks during the 2018-19 financial year was down. According to Cunico, this downward slide in results cannot be blamed on billions paid to people in refunds and remediation.
He points to the rate cuts that took place over the past year and notes that the banks are expecting that this will hit their net interest margin in coming years. “The effects of the last three rate cuts are yet to make their way through to the bank’s NIM due to hedging, however according to the banks it will impact NIM in future years by around 3-5 basis points,” Cunico says.
“In terms of home lending, ANZ’s gross home lending picked up in Q4, and Westpac is also optimistic on its lending volumes despite the margin squeeze.”
Cunico also observes that the major banks in Australia have face the reality that their return on equity has halved over 15 years.
Governance and internal control problems within Australia’s financial institutions have been reported globally and trawled over by investigative journalists and the royal commission.
Cunico says that the banks are striving to uncover what went wrong but finding out what made them lose client monies is itself costing a pretty quid.
What went wrong was trawled through in some detail by the year-long royal commission with evidence of exploitation of elderly people, the disabled, gambling addicted individuals as well as vulnerable members of the indigenous communities in remote parts of Australia.
Australian banks share prices resilient
“With all the resources pouring over past control and conduct issues, some 1,000 people at Westpac, and similar numbers at NAB, by the time the 2020 results come about in 12 months’ time, the past issues should be well understood,” Cunico observes. “And hopefully there won’t be too many more unknowns; although it will take longer than 12 months to fix the historic issues.”
Watchers of the Australian banking scene have wondered why bank share prices have not been hit as hard as those in other parts of the world such as the UK as a result of banking scandals. Cunico offers a pithy, poignant observation.
“The reality is that Australia’s major banks’ cost-to-income ratio and capital levels – i.e. how safe they are – are still world class. There is a lot to like about our banks,” Cunico asserts. They are going through a rough patch at moment, but they will get through it and come out the other side simpler, leaner and more customer-centric.”
86 400 becomes first Australian neobank to roll out home loans
In November, 86 400 launched an entirely digital home loan offering. This makes 86 400 the first provider in Australia to offer digital mortgages through brokers, and comes just nine weeks after the public launch of the new bank.
The 86 400 offering provides brokers with a fully digital solution. And it delivers a faster time to a home loan decision, with next to no paperwork. According to 86 400 the approval process is up to six times quicker than the Big Four banks , with just a single piece of paperwork needed for a purchase – the contract of sale.
In May 86 400 agreed a partnership with Vow Financial and has since signed a partnership deal with Specialist Finance Group. This strengthens its national distribution of home loans, with a network of 2,800 brokers.