Andrew Yates

CEOs are increasingly optimistic on the growth prospects of the Australian economy over the next three years, despite a backdrop of global economic uncertainty, according to KPMG International’s annual CEO Outlook. The major study, now in its 11th year, covers 1350 CEOs in 11 leading economies, including Australia.

Australian CEOs were more confident in the domestic economy than their international counterparts, with 90% saying they were confident in Australia’s growth. That compared to 82% of CEOs globally who were confident in the growth expectations of their own domestic economies. Confidence in the growth prospects of their organisations remained high, with 80% of Australian CEOs saying they were optimistic over the next three years. Still, that optimism had softened somewhat, down from 86% a year ago.

“I’m not surprised that Australian CEOs are still feeling optimistic about the growth of our economy, given household spending has seen a recent uptick, and the RBA has cut the cash rate. While the global economy is still facing uncertainty, Australia is less impacted by tariffs than many other countries and so our export markets have remained strong,” said KPMG Australia CEO Andrew Yates.

When it came to the growth of the global economy, Australian CEOs were less optimistic than their US and Japanese counterparts, with 66% of Aussie leaders saying they were confident in global growth prospects over the next three years. That was an uptick from 62% a year ago, but lower than in the US, where 73% of CEOs were optimistic, and in Japan where 72% said they were confident.

AI and digital

Seventy-per cent of Australian CEOs indicated that AI was a top investment priority, up sharply from 58% last year. Still, nearly a third (29%) were committing less than 10% of their overall investment budget to AI. This was nearly double the proportion of companies globally (17%) investing less than 10% of their overall investment budget in AI.

The proportionately low investment levels among Australian CEOs were coupled with the fact that 40% of Australian CEOs admitted to learning as they go when it came to AI, compared to just 23% of companies saying they were ad-libbing globally. Still, Australian companies continued to tout their AI readiness, with 82 per cent of Aussie leaders saying their board was equipped to navigate the adoption of and strategic use of AI.

“Without a national plan and effective regulation around the responsible use of AI, Australians are unwilling to trust it, and without trust there will continue to be a lack of investment. Without investment, we won’t be able to reap the full productivity benefits,” Mr Yates said.

“Australia stands at a pivotal moment in harnessing the power of AI, but adoption requires more than just enthusiasm, it requires a strategic plan that builds trust and confidence in its use.

“By empowering businesses to invest in AI and equipping the workforce with the necessary training, we can not only drive innovation but also ensure that the benefits of AI are shared equitably across the economy.”

When it came to mitigating business risk, cybersecurity and digital risks resilience were the biggest area of increased investment with 36% of Australian CEOs saying it was a focus area.

Return to office/talent

Australian CEOs backflipped on their return to office expectations, with just 22% saying they now expected corporate employees back in the office full-time in the next three years. That was a sharp drop in expectations compared to a year ago, when 82% of Australian CEOs said they expected their workforce to be fully in office in the next three years.

Asked what the expected working environment was for their corporate employees, 74% of Aussie leaders expected a hybrid model to continue, compared to 66% globally. Forty-eight per cent of Australian CEOs expected hybrid with three days in the office, 8 per cent said hybrid with two office days and 18 per cent said hybrid with four days in the office. No Australian CEOs thought that roles would be fully remote.

“The majority of CEOs have said that they’ve found three days a week in the office to be the sweet spot, but I think ultimately it’s about what works for each business,” Mr Yates said.

“The numbers confirm what we have long suspected: a return to a fully back-in-the-office workforce in Australia is unlikely.”

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Brad Brown

In a landmark move, KPMG has enhanced the capabilities of its Digital Gateway for Tax incorporating generative AI (genAI) as an independent component to communicate directly with data, enabling powerful insights and enhanced levels of efficiency. This pioneering Software as a Service (SaaS) is designed to provide an end-to-end solution for all members of the tax department and marks a significant milestone in tax technology, integrating generative AI for organisations embarking on their tax digital transformation journey.

The KPMG Digital Gateway for Tax platform’s real strength lies in its content and transparent data enrichment capabilities. The solution empowers clients to use the Digital Gateway as their Centralized Knowledge Hub, where users can access company-specific documents through the unified genAI platform. The RAG approach (Retrieval Augmented Generation) is relied upon to effortlessly enrich models with additional content which helps ensure the information used to generate answers is both current and accurate. The proprietary KPMG solution provides an enhanced explainability feature that details how the AI generates responses, providing more transparency of the step-by-step actions undertaken by AI in the background, detailing the rationale behind the work delivered, integrating citations for increased trust in the process reflecting a paradigm shift in focus towards enhanced efficiency and transparency within innovation, solidifying KPMG’s position as a market leader in the industry.

“Digital Gateway for Tax is a tried and tested trusted platform where the AI component is now fully integrated and not an independent stand-alone function,” said Brad Brown, Global Head of Tax Technology, KPMG International. “Whereas many systems use the RAG approach we have moved beyond this revealing the thought process and step by step flow of what AI is undertaking in the background providing users with complete transparency and ultimately trust in the process.”

The KPMG Digital Gateway Tax platform is equipped with an array of advanced functionalities and features designed to meet the complex needs of modern tax departments including:

• Personal document upload capability: Empowers users with the flexibility to upload documents instantly for generative AI analysis, streamlining the tax documentation process.
• Ai-generated export: Allows for the seamless export of AI-generated data directly to emails and PowerPoint slides, with an exclusive feature for premium users to employ branded templates.
• Innovative virtual assistants: Offers both pre-configured and customisable virtual assistants for a range of tasks, from regulation exploration to personalised learning aids, showcasing the platform’s adaptability to various tax functions.
• Customisable solutions for teams: Collaborate with KPMG to develop bespoke virtual assistants tailored to the unique requirements of your tax department, ensuring a tailored experience for every user.
• Training and onboarding: KPMG’s specialised training programs helps users maximise the platform’s potential, fostering proficiency in leveraging AI for tax-related tasks.

The KPMG Digital Gateway for Tax is utilised both by KPMG professionals and clients, facilitating a continuous cycle of improvement and innovation. This collaborative approach allows users to benefit from KPMG’s substantial investments in AI technology, accessing a platform that remains at the cutting edge of tax technology solutions.

The KPMG proprietary tax technology provides clients with access to the full suite of KPMG tax and legal technologies via an integrated platform within a secure Microsoft environment, designed so no client data is compromised or leaves the secure parameters.

“KPMG Digital Gateway for Tax is not just a tool, but an evolution in tax technology. Our generative AI component is now fully integrated, offering a level of transparency and trust that I believe is industry leading! We are not just using AI, we are revealing its thought process, providing users with a better understanding of how it works. This is a significant step forward in tax digital transformation, and we are proud to be leading the way,” said David Rowlands, Global Head of AI, KPMG International.

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Briallen Cummings

Australia’s life insurance industry doubled its profits to $1.2bn in the 12 months to 30 June 2023, KPMG’s annual market review reveals.

The cost of premiums for individual-advised disability income life policies rose by 10-12%, consistent with recent years, as insurers tried to staunch losses and boost profitability.

The average costs of combined individual and group disability insurance and TPD increased by just 4% and 3% respectively over the past year after the huge hikes of 34% and 45% seen in the previous two years as a result of the Protecting Your Super (PYS) and Putting Members interest First (PMIF) legislation which took many young people out of default insurance in super. The result was that premiums increased significantly for the mostly older people who remained in the schemes.

Industry premium income rose 4.1% to $17.9bn, although much of this was due to inflation and price increases across the market, some age-related but partly in response to rising claims costs and losses over recent years.

The lapse rates for policies arranged through Independent Financial Advisers rose, but overall the number of lives insured by the market has stabilised after falling for several years.

Briallen Cummings, KPMG Actuarial partner, said; “We can see the impact of the decline in the number of IFAs, with a drop in the amount of people buying death and disability income insurance policies through advisers. The economic pressures on consumers and rise in premium costs has contributed to lapse rates starting to increase. Having said that, the lapse rates in 2022 were still lower than in 2019, which shows a resilience in the industry.

“The figures are mixed, with some areas increasing in profitability and others declining. Profitability on non-risk products surged by $1.3bn from last year although much of this was due to more favourable investment markets. By contrast, profitability on risk products declined by $0.8bn from 2022 and profits on individual disability insurance and lump sum business fell substantially, reflecting increases in claims and the absence of one-off items such as the release of the reserves companies held for COVID-19 claims, which largely did not eventuate.

“But following the sustained period of unprofitability for the industry from 2019-21, we can see the impact of insurers repricing existing business.  We expect to see an ongoing focus on costs and expenses and embedding business efficiencies to further improve profit levels. We also hope to see innovation in the industry as companies look beyond traditional IFA channels for growth. Overall, after some bleak recent years, the industry will be gratified to have had its second year of profits, especially given the uncertain economic backdrop and ongoing changes in the regulatory environment.”

The report also observed that the group life market remains highly concentrated with a few providers. The focus by APRA on consolidating superannuation funds has a similar impact on group insurance and is potentially further adding to the market concentration. This market shrank considerably following the PYS and PMIF regulatory changes but has been stable over the past 2 years.

Detailed findings from the KPMG review:

• Statutory fund profits doubled at $1.2b in FY2023 from $0.6b in FY2022.
• Risk Products reported profits of $0.4b, down from $1.2b in FY2022, but higher than the loss of -$20m observed in FY2021. All product types other than retail lump sum products were profitable after tax, although Group Salary Continuance recorded a loss before tax.
• Non-Risk Products reported profits of $0.7b in FY2023 a recovery from losses of -$0.6bn in FY2022 and similar to profits of $0.6b in FY2021.
• Retail Risk Disability Income was the only product where paid claims as a proportion of premium decreased in FY2023 compared to FY2022. Retail Risk Lump Sum has the lowest ratio of claims to premium of all the benefits, although it experienced the highest level of paid claims as a proportion of premiums received this year compared to the past the last 4 years.
• Group Risk Products paid claims as a proportion of premiums received increased from FY2022, returning for lump sum products to levels similar to FY2018 and FY2019.
• The annual reported profits (noting that year ends differ by company) had the reinsurers reporting losses after tax of $0.3b with 5 of the 7 reinsurers experiencing losses. By contrast direct insurers reported profits of $0.8b with 14 of the 18 insurers reporting profits.
• The overall capital position across the industry remains strong, noting that the published APRA statistics do not include any supervisory adjustments imposed by APRA as part of their IDII sustainability measures (or for any other reason) and therefore the capital position shown is likely substantially stronger than the true underlying capital position.

Read the report.

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Brendan Rynne

Relative to their financial footprint, customer-owned banks provide support beyond their size to local communities and make a significant contribution to the national economy, according to new research commissioned by the Customer Owned Banking Association (COBA).

The KPMG report Sector Impact Assessment of Customer Owned Banking in Australia found that the 61 customer-owned banks^[1] have five million customers and represent 70 per cent of Authorised Deposit-taking Institutions (ADIs) in the Australian market. And despite their relatively small share of market assets ($158.8 billion compared to $4,370 billion for the major banks), the contribution of customer-owned banks to people and communities is proportionately greater. 

The report found customer-owned banks punch above their weight because they:

• are considered the primary financial institution of more than 10 per cent of the adult population, and make up 5.6% of mortgage lending, well above their 3.5 per cent share of overall market assets,
• provide unparalleled demand for skilled employees in regional locations, and
• actively contribute in a disproportionate manner to sector-based and geographic communities through generous donations to charitable organisations and community sponsorships.

Minister for Regional Development, Local Government and Territories, and Member for Eden-Monaro, the Hon Kristy McBain MP, said the report recognises the strong investment of customer-owned banking institutions in regional Australia. “We’re seeing more branch closures in our regional communities, which has significant economic and wellbeing impacts on customers and restricts access to financial services,” Minister McBain said.

“But this report shows customer-owned banks are actively working with regional communities to enhance their services, and this investment is improving community cohesion and engagement, creating jobs and skills opportunities, boosting local economies, and ensuring that local businesses can access the services they need to operate.”

KPMG Australia Partner and Chief Economist, Dr Brendan Rynne, said customer owned banks occupy a unique position in Australian banking. “While collectively relatively small when measured by customer numbers, assets, total loans and revenue, Australia’s mutuals sector is large when measured by number of banks, branch footprint, and its presence in regional locations,” Dr Rynne said.

“Customer-owned ADIs are considered the primary financial institution by over 10 percent of the adult population and provide an unparalleled demand for skilled employees in regional Australia.”

COBA commissioned KPMG to measure the contribution of customer-owned banks to their local communities. Almost three-quarters of the customer-owned industry participated in the research, representing a broad spectrum of the industry. 

“Credit unions, building societies, and mutual banks are well known for putting customers first and giving back to communities, however we wanted to go beyond anecdotal evidence to truly quantify the impact our members are making,” said COBA Chief Executive Officer, Michael Lawrence.

“These findings provide strong empirical evidence of the extent to which our members put people before profits. Our sector has a large and growing footprint in Australia, as customers realise the benefits of banking with purpose.”

Strong branch network support jobs

Despite the shift to digital banking, customer-owned banks have maintained a strong branch network and continue to hire more Australians to support their members.

With 720 branches throughout Australia, the sector operates 18 per cent of total bank branches and more than one in five branches in regional areas, compared to the sector holding 3.5 per cent of total bank assets. This represents a significant investment in in‑person banking services

Employment in the sector grew by 4.4 per cent between FY2021 and FY2022, with 11,200 working at a customer-owned bank at the end of the most recent financial year and earning a combined $1.24 billion in wages, the report found.

By comparison, as the major banks have been under pressure to reduce costs, they grew employment at a slower rate of 2.4 per cent.

Due to the sector’s Australia-wide footprint, it is an unrivalled provider of highly skilled jobs in financial services in regional locations, with 52 per cent of staff working and living outside metropolitan cities.

Donations and volunteering

The analysis shows that customer-owned banks also contribute strongly to the communities in which they operate through generous donations and volunteering.

KPMG found the sector distributes around $6 per member per year to charitable organisations and community sponsorships. With a membership of around five million, this is equivalent to about $30 million injected directly into the community. This compares favourably for instance to the four major banks. Analysis suggests that their financial community contributions are circa $2 per customer on average.

At the same time, customer-owned banking staff are heavily engaged with local communities through paid volunteering, which is estimated to add up to around $13,000 per institution.

Model boosts service and pricing, supports everyday Australians in home ownership

The report found that customer ownership translates into better service and pricing for customers, including an implicit significant lending rate subsidy to members. KPMG estimates this subsidy to equates to a 0.3 per cent discount to the market interest rate – or more than $1,500 in interest annually on a $500,000 mortgage.

The sector’s focus on helping members own the home they live in results in a mortgage lending market share of over 5.5 per cent, above-system growth, and a higher proportion of lending to owner-occupiers (77 per cent compared to 67 per cent for all ADIs) and first home buyers (20 per cent compared to 16.5 per cent for all ADIs).

Strong contribution to Australia’s economic growth

In addition, the report found the economic footprint of the sector is much greater than its direct economic contribution. KPMG estimates an unplanned closure of the sector would result in an economic impact that is three times the size of the direct loss in wages, profits, and taxes.

Collectively, the sector contributes $2 billion to the country’s GDP, the report found, when considering wages, profits, and taxes – more than that of aquaculture, fishing, forestry, gas supply services, shipping or petroleum and coal product manufacturing. 

However, when taking into account other factors such as non-wage expenditure and planned investments, KPMG estimates the economic impact is equal to $5.7 billion

Read the report.

———

[1] The research was conducted prior to the mergers of Newcastle Permanent with Greater Bank, and Heritage Bank with People’s Choice Credit Union.

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Following on from two disruptive years in 2020 and 2021, the 2022 financial year again saw significant events and challenges. Not only did all Mutuals face deteriorating economic conditions and rising interest rates, many also were exposed to significant climate-related weather events, especially floods.

Darren Ball, KPMG National Sector Leader, Mutuals, commented: “There are several factors affecting Mutuals’ performance. Continued economic growth, in combination with a range of supply-side constraints, has resulted in a spike in inflation. The series of interest rate increases by the Reserve Bank of Australia (RBA) is affecting the Mutuals and their members in several ways. The second half of the financial year in particular has seen an arrest in the long-running slide in net interest margins, as lending rates have increased more than deposit rates. There is also a nationwide decrease in house prices and a more restricted willingness and ability by customers to borrow to own or invest in homes.

“The floods in many parts of Australia at the same time have provided a stark reminder of the exposure of many Mutuals to local weather events, especially for smaller lenders with a geographically concentrated membership. It reinforces the need to understand and manage future climate risks within their loan books.”

Key financial results for the mutual sector for the year are:

• Total assets increased by 7.5 percent to $158.8b (2021: $147.7b)
• Operating profit before tax decreased by 11.1 percent to $604m (2021: $680.5m)
• Lending increased by 8.1 percent to $120.9b (2021: $111.9b)
• Deposits grew by 7.0 percent to $124.9b (2021: $116.7b)
• Non-interest income increased by 2.4 percent to $430.7m (2021: $420.6m)
• Net interest margin decreased by 6bps to 1.93 percent (2021: 1.99%)
• Cost-to-income ratio increased by 48bps to 80.3 percent (2021: 79.9%)
• Average capital adequacy ratio decreased by 6bps to 16.29 percent (2021: 16.35%)
• Writeback of credit provisions of $19.5m (2021: $34.9m)
• 2 mergers completed (2021: 2)

Key challenges facing Mutuals in 2023

In the current turbulent environment, there are several strategic and financial key issues for Mutuals coming out of 2022 and going into 2023:

1. Strategic: The end of a long period of low interest rates in the final quarter of the 2022 financial year is having various major impacts on the residential lending market that the Mutuals focus on – the balance of these impacts pointing to a slowdown in mortgage lending performance.
2. Investment: The requirements for the Mutuals to invest continues to increase, putting pressure on both their capital base and the need to generate profits. Investment is needed in regulatory compliance, cyber defences, digital transformation and innovation, and ESG initiatives. This investment impacts the Mutuals disproportionally due to their relatively small size. 
3. Talent scarcity: An issue for many Australian employers. It is of particular focus for Mutuals due to access and affordability, with over half of all Mutuals’ staff living and working outside of the metropolitan areas.
4. Consolidation: Many Mutuals are looking to grow through mergers as the limitations of operating medium- and small-scale banks (especially cost inefficiencies and the ability to invest) remain firmly in place.

Outlook

Despite these headwinds, the sector outlook remains positive in the face of ongoing market and economic uncertainty, with 75 percent of respondents to the KPMG Mutual Industry Review survey revealing they feel confident in their three-year growth prospects (compared to 77 percent in 2021).

Darren Ball said: “The Mutuals punch well above their weight, but if the Mutuals want to continue this outsized impact for members and communities they need be progressive on several fronts. These include identifying and attracting talent, accessing innovation and scale through as-a-service models, partnering with RegTechs to respond to regulatory requirements and managing the substantial climate risks in their lending books proactively, as extreme weather events become the “new normal” in Australia.”

“The success of the Mutuals in seizing the opportunities and dealing with the challenges will determine how they continue to make an impact through the delivery of member value and community contributions. A proactive and responsive Mutuals sector will be able to build on its positioning as purpose-driven organisations, to continue to find new ways of serving their members and their communities,” he added.

About KPMG’s Mutual Industry Review 2022

The survey examines the performance and trends of mutuals in Australia’s financial services industry for the 2022 financial year. The mutual sector covers Australia’s mutual banks, building societies and credit unions. The survey also considers the responses to a qualitative questionnaire covering the risks, challenges and opportunities facing the industry, and includes a number of articles by KPMG authors.

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Maria Trinci

KPMG’s Major Australian Banks Full Year Analysis Report 2022 finds that the Majors reported a combined cash profit after tax from continuing operations of $28.5 billion, up 7.2% on FY21.

The Australian economy has continued its strong post-COVID recovery, with the impacts of the RBA’s seven successive interest rate rises since May 2022 yet to drive any material slowdown in business and consumer activity. As a result, the Majors have benefited from continued credit growth in their FY22 results.

Also behind the improved profit performance, we are starting to see the impact of rising interest rates, driving an increase in average net interest margin (NIM) of 3 basis points compared to 1H22. This is still however 9.5 basis points lower than in FY21, demonstrating that the benefit of rising interest rates is only just starting to flow through to bank profitability. This comes after over a decade of extremely low interest rates which have created prolonged pressure on the Majors’ margins, which are now beginning to rise from a low base.

However, there is a more challenging outlook for the Majors with inflation putting pressure on their cost bases and new provisions being taken for potential economic stress ahead.

The Majors have worked hard throughout the year to address their cost bases, however overall costs have increased only marginally, with the average across the Majors’ being 1.3%. All of the major banks have signalled that their cost targets will be either adjusted or abandoned as these inflationary pressures continue.

The average cost-to-income ratio decreased from 2021 by 30 basis points to 49.2%. A number of factors including continued regulatory compliance requirements, ongoing customer remediation (albeit declining) and increased labour and FTE costs are putting pressure on the overall cost to income ratios.

KPMG Banking Partner Maria Trinci added: “What will prove interesting is how the costs will 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.”

Having recently weathered the pandemic from a credit perspective and written back a combined $925 million in provisions in FY22, the Majors have now returned to more normalised provisioning. While credit quality remains strong at this point with delinquencies at their lowest level since 2018, with interest rates anticipated to continue rising into 2023, the Majors are signalling a likely economic slowdown, increasing unemployment and falling house prices. These factors are expected to lead to raised provisions in the years ahead.

Of particular focus for the Majors and their mortgage books is the rolling over of a large volume of low fixed rate loans that were written during the COVID pandemic when residential valuations were at their peak. 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, which is expected to begin to materialise into mid-FY23 where $237 billion of loans are scheduled for roll-over across the Majors.

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.

Steve Jackson, KPMG Australia’s Head of Banking commented: “After over a decade of ultra low rates weighing on bank profitability, the recent rapid rises in interest rates are starting to provide some initial margin relief for the Majors.

However, the monetary policy tightening cycle is also introducing inflationary pressure which is working against the Majors’ efforts to reduce their cost bases and, depending on the pace and strength of rate rises, contributes to the potential for economic slowdown and a rise in bad debts.

Banks are signalling challenging times ahead for the economy and the big question is whether a ‘soft landing’ will be achieved that avoids the harsher potential outcomes.”

Key highlights of the results are as follows:

• The Majors reported a combined cash profit after tax from continuing operations of $28.5 billion for the year, an increase of 6.5 per cent on FY21 and an increase of 65 per cent 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 3 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 decreased modestly from an average of 52.0 per cent in FY21 to 50.2 per cent. Excluding notable items, operating costs increased by 1.3 per cent to $39.2 billion, 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 per cent. 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 bps to 11.65 per cent. The strong capital position saw each Major announce share-buy backs totaling $14.0 billion during the year, in a move to deliver stronger returns to shareholders.

• Dividend pay-out ratios remained steady at 71.0 per cent, 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 per cent, 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.

2022 saw growth across both housing (up 5.7 per cent on 2021) and non-housing lending (up 13.2 per cent on 2021). Much of this growth has been the result of strong increases in house prices in the first half of FY22 and the continued post-COVID economic recovery. The Majors are signalling they expect this growth to soften as we move into 2023.

“Now more than ever is the moment for the Majors to accelerate their digital transformation efforts, to reduce their reliance on (increasingly expensive) FTE and bring efficient, technology-enabled solutions to their core middle and back office processes, where 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”, said Jackson.

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Steve Jackson

KPMG analysis has found that the Australian major banks (‘the Majors’) have reported improved profits and returns for the first half of the financial year 2022, despite ongoing pressure on their interest margins.

KPMG’s Major Australian Banks First Half Year Analysis Report 2022 finds that the Majors reported a combined cash profit after tax from continuing operations of $14.4 billion, up 5.1 per cent on 1H21.

After the disruptions of recent years, profits have almost returned to pre-COVID levels with cash profits after tax still slightly down 0.4 per cent on the 1H19 results from three years ago, signalling a relatively flat medium-term growth path. The increase in total operating income (on a cash basis), up 0.8 per cent on 1H21 and rising from $39.6 billion to $39.9 billion, has been a cause of the growth in cash profits. Off the back of this earnings growth, the Majors’ return on equity (ROE) has risen to 10.6 per cent from 10.4 per cent in FY21.

The underlying drivers of the Majors’ operating income growth have been the continued strong volumes in both mortgage and business lending. As Australia powered ahead in the first half of FY22, both areas saw continued high demand. The value of mortgage loans was up 2.5 per cent on 2H22, growing to $1,812 billion. At the same time, business lending grew 4.8 per cent in the last half year, to a figure of $1,077 billion.

Steve Jackson, KPMG Australia’s newly appointed Head of Banking and Capital Markets commented: “The major banks have successfully used the recovery of the Australian economy and the strong housing market performance to deliver improved financial results. With returns on equity in the sector now again restored to double digits but with uncertainty ahead, it will be interesting to see how they maintain their current momentum.”

As expected given the continued low interest rates (the RBA only just increased interest rates for the first time since November 2010), net interest margins (NIM) have continued to decrease and have acted as a drag on financial performance. For the majors, the average NIM dropped to 175 basis points, down 13 basis points from FY21. The industry-wide depressed NIMs have been the primary brake on the Majors’ profit growth.

Hessel Verbeek, KPMG’s Banking Strategy Lead, commented: “The market dynamic has been dominated by the NIM decrease resulting from low lending rates in a very competitive market and strong demand for low margin fixed rate mortgages. This downward pressure has only partially been offset by lower funding costs from near-zero deposit rates. The impacts of an extended period of low interest rates are deeply baked into net interest margins.”

In the context of both Australia’s COVID recovery and a higher inflation future (driven in part by the war in Ukraine), the story on loan loss provisions has changed from recent times. On a net basis, provisions of $218 million have been released during the period to bring overall provisioning closer to pre-COVID levels due to the strong performance of the economy.

Another interesting development has been the decrease in balance sheet strength, with the average CET1 ratio declining by 90 basis points to a still very strong 11.8 per cent. While in recent years the Majors have been shoring up their capital position through divestments and lower dividend pay-out ratios, this trend appears to have ended.

KPMG Banking Partner Maria Trinci added: “We may have reached an inflection point on balance sheet strength. This signals that the Majors have left the recent disruptions behind them, and are now charting a new course. They are starting to ‘draw down’ on the balance sheet ‘deposits’ they have been making since 2020.”

With strong operating income growth and lower margins, the third major profit lever is cost performance. As has been the case in recent years, the Majors have again struggled to structurally reduce costs. Total operating expenses across the Majors decreased by 1.0 per cent to $4.9 billion. As a result, the average cost-to-income ratio decreased from 2021 by 73 basis points to 49.6 per cent.

Hessel Verbeek added: “While the overall outcome has been an almost flat cost trajectory for the Majors, there are three things happening which are netting each other out. Inflation has driven up ‘run-the-bank’ costs, further growth and transformation costs have been added and meanwhile some cost reductions from efficiency programs have been realised. Unfortunately this means that the Majors are not on a path of significant sustainable cost improvements.”

Key highlights of the results are as follows:

• The Majors reported a combined cash profit after tax from continuing operations of $14.4 billion, up 5.1 per cent from the prior comparative period (PCP). This result reflects strong growth in lending and reductions in large one-off notables including remediation/regulatory and impairment expenses.
• The average net interest margin (cash basis) saw continued compression, decreasing 13 basis points from the first half of 2021 to 175 basis points. Declining margins were driven by low lending rates, a shift in the housing lending mix towards lower margin fixed rate lending and higher holdings of low-yielding treasury assets and.
• Cost-to-income ratios decreased modestly from an average of 50.3 per cent in HY21 to 49.6 per cent. The Majors reported a decrease in operating costs of 1 per cent to $19.7 billion, reflecting reductions in notable items, offset by higher staffing expenses in response to increased lending volumes, wage inflation, and increased investment in growth and productivity.
• Write-backs to aggregate loan impairment expenses of $218 million were driven by continued improvements in the economic outlook and strengthened asset quality. These releases were offset in part by targeted provisioning to capture potential downside in the evolving macro-environment and monetary policy changes.
• On average the Majors’ Common Equity Tier 1 (CET1) ratio decreased by 90 basis points to 11.8 per cent as all four of the Majors completed share buy-backs over the half and lending growth has driven higher Credit Risk-Weighted Asset (CRWA) usage. The Majors’ CET1 ratio still remains comfortably above APRA ‘unquestionably strong’ benchmark of 10.5 per cent.
• Dividend pay-out ratios increased to 66.0 per cent from 63.2 per cent in the prior comparative period.
• Higher earnings have seen Returns on equity (ROE) increase by 21 basis points from the PCP to 10.6 per cent, returning to the double-digit standards from before the pandemic.

Going forward, the RBA rate rise from 3 May signalled the end of a prolonged period of ultra-low interest rates. There is a general expectation that this will support a recovery of NIMs. The impact of interest rate increases will likely be tempered by continued strong competition for lending volumes, the recent peak volumes of fixed rate loans and the upcoming unwinding of the COVID-related cheap Term Funding Facility funding from the RBA. In addition, a combination of higher interest rates and high household debt levels will over time result in increased mortgage impairments.

“We expect to see the dual impacts of both net interest margin relief and higher levels of mortgage book stress, as RBA interest rates are expected to increase several times. However, these impacts will take their time to pull through as both margins and book quality have built up their momentum over a long period of low rates,” said Verbeek.

Read the full report.

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James Mabbott

The world will be a different place as it emerges from the COVID-19 crisis, with Australians’ work, life and travel permanently changed by the pandemic, according to a new report by KPMG, Our New Reality: Predictions after COVID-19.

Remote working and digital commerce will rise across all industries, as the 9-5 workday is challenged and corporate real estate needs are impacted. Work will be measured by outcome rather than input, with a more flexible approach as leaders understand and work with the personal circumstances of their employees. Current organisational hierarchies will no longer fit this new reality, with a shift to flatter and more fluid, task-based work processes instead.

Emerging technology will be another driver of this change, with the 5G rollout boosting speed and reliability across Australia, making remote work much easier and more viable. The mass adoption of video conferencing and collaboration apps will also grow the need for Virtual Reality and Augmented Reality technologies, expanding their current niche use cases.

“We expect to see a previously unimaginable boost to the simultaneous transformation of industries and society. The onset of COVID-19 has exposed existing weak links across industries, government and in our economy. The urgency and importance of addressing these weak links has radically shifted and many decisions and discussions have been brought forward,” says James Mabbott, Partner-in-Charge, KPMG Futures.

“At the same time it raises many questions. With more people working from home, demand for large infrastructure projects won’t uniformly return to pre-COVID levels. How will cities adapt to this new world? Will the shifts towards remote working be a catalyst to reduce emissions – balanced with increased energy demand in residential sittings?” he asks.

Four-stage recovery path:

The report predicts a four stage path through recovery

1. professional and personal lives are disrupted as the primary focus is on limiting damage to lives and livelihoods. 
2. Recovery: hiring, investment and consumer sentiment cautiously improve.
3. New Reality: enduring shifts remain as new behaviours born out of the crisis become the “new normal”.

8 key themes predicted:

1. Ways of working will change permanently: this will be the “robot century” and the rise of the gig worker, as economic conditions spur greater focus on productivity, workforce automation and remote working, with a much more flexible approach.
2. Australia’s workforce will automate and relocate: people will increasingly work remotely, as corporate real estate is repurposed or reduced. This will see people choosing choose larger residential properties with space for work and home offices, rather than smaller inner-city dwellings.
3. Digital commerce will expand in more sectors: the crisis has accelerated the growth of remote delivery, from education to telehealth and fitness, with red tape that previously stifled progress and innovation now cut.
4. Supply chains will get much smarter: sustained home delivery demand will require significant investment in logistics and delivery infrastructure, with supply chains becoming local, agile and smart.
5. Building business continuity and resilience becomes a core competency: cash/liquidity has become critical for survival, as organisations struggle to balance what they can control with things they can’t.
6. Climate change will attract more capital investment: as we realise opportunities from new regulation and new technology.
7. Impacts of debt burden drive new regulation: with current financial security heavily tied to a fast-shrinking concept of permanent, lifelong employment, there is unprecedented government spending at federal and state levels, from stimulus packages to healthcare responses, welfare support, with Universal Basic Income (UBI) in the spotlight.
8. Revisiting globalisation as citizens and governments go local: governments will prioritise national needs over the global outlook as new barriers slow the free movement of goods, labour and capital, with travel permanently reduced and increasingly local.

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Ian Pollari

KPMG analysis finds that the Australian major banks (‘the majors’) have reported a continued decline in aggregate cash profits for the first half of 2019.

KPMG’s Major Australian Banks Half Year Analysis Report 2018-19 finds that the majors reported a combined cash profit after tax from continuing operations of $14.5 billion for the first half of 2019, down 4.0 percent (compared to first half of 2018).

The majors face challenging conditions from slowing lending growth and margin compression at the same time as delinquencies rise in a softer domestic economy. In addition, remediation costs are a major drag on performance, as the majors seek to rebuild trust with customers post the Royal Commission.

Ian Pollari, KPMG Australia’s Head of Banking commented: “Falling housing demand, tightening credit standards and greater competition, in particular from the non-bank sector, have combined to constrain the major’s revenue performance in retail banking.”

“As the headwinds show no signs of abating, the majors will need to carefully balance their revenue, capital management and cost objectives to preserve industry returns, at the same time as they execute on large, complex regulatory change programs to restore trust in the sector,” Mr Pollari added.

The majors have continued to allocate a greater proportion of their spending towards risk and compliance, rising substantially to comprise almost 40 percent of the majors’ total investment expenditure for the first half of 2019.  Faced with growing competition from non-bank lenders and new entrants, the majors will need to balance this investment profile with digitalisation and innovation to maintain market share and deliver an enhanced customer experience.

Hessel Verbeek, KPMG Partner, Banking Strategy, said: “As the majors deal with risk and compliance challenges, they will continue to focus their efforts on simplification as they seek to drive greater efficiency in their core franchises to manage their financial performance.”

Key highlights of the results are as follows:

·        The majors reported a cash profit after tax from continuing operations of $14.5 billion for the first half of 2019, down 4.0 percent (compared to first half of 2018). The deterioration in cash profits was driven by lower net interest and non-interest income in a challenging operating environment, margin pressure, and rising regulatory and customer-related remediation costs.

·        The major banks recorded an average net interest margin of 195 basis points (cash basis), down 11 basis point compared to the first half of 2018, largely driven by customers switching from higher margin interest-only home loans to principal and interest and increased short-term wholesale funding costs.

·        The majors recorded a decline in net interest income (cash basis) of 1.6 percent from the first half of 2018 to $31.6 billion and non-interest income (cash basis) decreased by 11.1 percent compared to first half to $9.6 billion, due to customer remediation (reversal of revenue) and lower fee income. Housing credit recorded an increase of 1.5 percent in the half, with non-housing credit growing a modest 1.3 percent.

·        The average cost-to-income ratio increased by 47 basis points across the majors from the first half of 2018 to 46.1 percent, attributed to higher customer remediation costs and lower revenue in the first half of 2019, partly offset by the non-recurrence of some one-off items in the prior comparative period.

·        The major banks’ aggregate charge for bad and doubtful debts decreased by $23 million to $1.8 billion (statutory basis) for the first half of 2019 (down 1.3 percent on first half of 2018), with lower collective provisions for some of the major banks, partly offset by higher individual credit impairment charges.

·        The majors’ continued to increase their capital position, with an increase of 25 basis points over the half year in their average Common Equity Tier 1 (CET1) capital ratio to an average of 10.8 percent of risk-weighted assets (RWAs), reflecting the continued focus in meeting increased regulatory capital requirements. At the same time, maintaining the level of dividends have proved challenging during the half.

·        With lower revenue, rising regulatory costs and ongoing customer remediation, the majors’ return on equity (ROE) has decreased 88 basis points from the first half of 2018 to an average ROE of 12.0 percent, with average dividend payout ratios increasing to 78.4%, up 79 basis points from 1H18.

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Amanda Price

Australian startups are missing out on the potential for boards to play a transformational role in their development and growth, with only half (55%) of founders saying that they would choose the same board again, if they had the choice.

A new report released yesterday, “The Startup Board Report” compiled by KPMG High Growth Ventures and Think & Grow, based upon in-depth interviews with 26 startup board directors in Australia, the US, the UK and NZ, and a survey of over 70 Australian startups, paints a comprehensive picture of how high growth ventures appoint and interact with their boards.

Key findings of the report include:

• Only one in four Australian startups have an independent director on their board
• 65% of startups don’t have a formal recruitment process for board members
• 92% of startups have board members who are external investors in that startup
• Close to one in four (24%) said they would not choose the same board again, with startups who have completed Series A, Series B and Series C+ funding rounds much more likely more likely to say that they’d change their board if they could go back, relative to seed stage funded start-ups (30% vs 15%)
• Only half (50%) of startups compensate their board members with cash or equity.

Amanda Price, head of KPMG High Growth Ventures said: “For startups, boards can play an important role beyond governance, by helping startups scale through providing key experience, perspective and access to individual board members’ personal networks. Founders who have the right support around them are far more likely to succeed than those who don’t – and boards, formed well, can have a transformational impact. This research has uncovered a massive opportunity to re-write the playbook for how Australian startups build, manage and refresh their boards.”

Anthony Sochan, partner, Think and Grow added: “We are at an interesting tipping point. With enough critical mass and traction, we are amongst a vibrant Australian tech ecosystem, flush with talent and cash. As we continue to scale and mature as a community, we want to ensure we are providing founders and their companies with the best advice possible. The feedback from our international interviewees was clear: we have an opportunity in Australia to do this far better, do not take this as an opportunity to be as good as overseas market, instead try to leapfrog us.”

Board make-up revealed 

The report found that on average, Australian startup boards have four members, while advisory boards tend to have three members. There is a independence gap on Australian startup boards, with only one in four Australian startups having an independent non-executive director. Even for startups that have raised a Series C funding round, 40% still did not have an independent director on their board.

This contrasts strongly with the prevalence of investors and venture capitalists sitting on startup boards, with 92% of startups saying they had investors on their board. Feedback from the experienced board directors interviewed in the report underlines the benefit of having more independent voices on Australian startup boards, particularly given the relatively small pool of venture capital firms in the market providing board members for the investees.

A strategic opportunity to build great boards 

A major opportunity identified by the report is to professionalise how founders recruit and refresh their boards. Most (65%) startups do not have a formal process to appoint board members. Board members were most commonly found via the founder’s networks, both professional (58%) and personal (27%). The next most common sources are Venture Capitalist referral (33%) and via referral from other board members (28%).

The consensus amongst the prominent directors interviewed for the report was that diversity of thought and background was essential for effective startup boards. They also believed that a professional approach to sourcing, managing and compensating board members was an imperative. Currently, only half of startups compensate their board members.

Amanda Price said: “Ultimately, it is clear that more support in sourcing the best global talent and experienced directors for startups is key to success, not only for the startup but the Australian startup industry. We need to foster an ecosystem that encourages executives, leaders and directors from all walks of life to engage with startups by reaching out, sitting on advisory boards and being an observer. We hope to kick-start this process through this report, which we intend to be a comprehensive guide to help founders build the boards to supercharge their startups future growth.”

Anthony Sochan added: “This report clearly demonstrates that a need exists to redefine our standards on what makes a great board for startups. Fortunately there are some very clear actions that Founders can take today to improve things including; appointing an independent board member, regularly reviewing the suitability of current board members and ensuring a suitable level of skill, expertise and experience exists on the board proportionate to the phase of business. We have a window of opportunity to not only get this right, but to set a new standard for startup boards globally. There is no reason why we in Australia cannot lead this conversation.”

Download the report.

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