Submission to the Inquiry into Competition within the Australian Banking Sector 1. Overview

Over the past 25 years, Australian borrowers have enjoyed ready access to credit. There has been a continual expansion in the products available to both depositors and borrowers. Competitive forces have compressed the margin between lending rates and funding costs. These factors, combined with the lower interest rate environment associated with lower inflation and a gradual easing in lending standards, have provided a growing number of Australian households and businesses with access to credit that they would not have been able to obtain previously.

Throughout most of this period, funds were readily available to financial institutions and competition was mainly focussed on lending money. The global financial turmoil has reduced the availability and increased the cost of funds to financial institutions. Some business models, such as those based on securitisation, which benefitted greatly during the period when funds were readily available, are now facing a particularly difficult environment. There has been some lessening in the degree of competition on the lending side but competition to attract funds has increased.

The composition of funding has shifted towards higher-cost sources of funding as a result of changed attitudes to risk among banks, investors and regulators. In turn, this rise in funding costs, along with a repricing of risk margins, has seen lending rates increase relative to the cash rate. As a result, the two-decade long decline in banks' net interest margins has ceased and margins have fluctuated in a fairly narrow range over the past few years.

Notwithstanding these recent developments, the supply of credit in Australia, particularly lending for housing, has generally remained adequate. There has been a tightening in credit conditions for businesses, particularly in relation to commercial property. However, some part of the decline in business credit reflects a reduction in demand.

Unlike their international peers, Australian banks have not suffered a large fall in profitability over the past couple of years, which largely reflects better outcomes in terms of bad debt expenses. Australian banks' profitability is in line with other large Australian companies and the experience of their international peers before the crisis.

This submission is organised as follows. Section 2 describes the broad trends in lending over recent decades. Sections 3 and 4 provide details on banks' funding costs and lending rates, while Section 5 details developments in banks' net interest margins. Section 6 discusses banks' fee income while Section 7 discusses the profitability of Australian banks. Section 8 concludes with a brief discussion of some regulatory reforms and their potential effect on the banking industry.