AUSTRALIA'S FINANCIAL SERVICES INDUSTRY hits its stride

Following the resilience of Australia's financial services industry during the GFC, three of its top executives - Michael Ullmer SF Fin Deputy CEO NAB, Brad Cooper CEO BT Financial Group, and Phil Chronican SF Fin CEO ANZ Australia - examine the issues ahead and the outlook for growth as part of the changing economic dynamics within the region.






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Publication: InFinance
Author: Fahrer, Marion
Date published: October 1, 2010

FINSIA What will be the main effects in global financial markets of the huge shift underway in geopolitical and economic power towards emerging countries? How will Australia's financial markets be affected by the emerging economic strength of China, India and the rest of Asia?

PC: A quite profound shift occurred last year with emerging economies in Asia growing, for the first time, without growth taking place in the United States or Europe. Despite earlier scepticism about this, China managed to decouple its growth from the West and it has become very clear that these emerging countries - particularly China and India - now have the ability to determine their own economic destiny.

The implications of this for Australia are huge because of our strong economic linkages with Asia. For example, although the United States remains in our top 10 export markets, it is the only non-Asian country in that list. There is an obvious symmetry between the needs of Australia and Asia, with Australia as a capital importing but resourcesrich country sitting alongside Asia, which needs those resources and can supply Australia with capital.

While ANZ is positioning itself to take advantage directly of the growth opportunities within the Asian region, our super regional strategy is also very focused on orienting the business appropriately in our home markets (Australia and New Zealand) as these markets are being driven by trends in Asia. This also provides strong benefits for our domestic customers that are looking to position themselves for the growth in these markets.

Australia has an opportunity to play a much more significant role as a regional financial services centre. We already have a large funds management market that could be leveraged into a regional capacity. And, we also have strong legal and regulatory frameworks, and although there are some tax impediments to taking a greater regional role in financial services, the report from the Johnson Committee highlighted the several things that can be done to minimise them.

MU: A significant shift is occurring in the balance of world economic power driven by the growth in the emerging economies in the East, and financial markets will follow those trends. We're already seeing the dramatic rise in the Chinese banks, and this will continue. One of the big challenges for the banking system in the Western world is the shortage of deposits available to fund lending activities whereas, in the Asian region, there is a surplus of deposits and cash. That is going to drive the capacity of the Asian banks and they will become far more influential in global financial markets.

Australia is in a fascinating position; we are a fundamental player in the development of the Asian economies. The huge social change that's underway in China and India, moving from a rural subsistence economy to an urban consumer economy has massive ramifications in terms of the demand for resources. And, as the populations of those economies develop in terms of their personal wealth, that is likely to have significant effects on their diet. These factors will be reflected in the demand for our commodities and agriculture industries and provide new opportunities for Australian financial services.

There will be some opportunities around mobilising deposits both at the retail level and the corporate level within Asia but, in practice, it is very difficult to establish successful footholds in these markets. More importantly, we need to look at the profound changes that have begun in terms of the orientation of our economy and the extent to which it will become far more integrated into Asia, over time. These factors will also affect the demand for our education services, and our trade flows and population growth.

BC: The increased demand for consumer, capital and primary products from within the Asian region, associated with its current rapid economic growth, will clearly have implications for Australia's resources sector. It also presents real opportunities for our financial services industry as the substantial growth in the region's middle class increases wealth management demands. To capitalise on these opportunities we need to make sure that our taxation system doesn't inhibit the free flow of capital and it also provides a high degree of certainty in terms of the tax obligations, both domestically and offshore.

Australia is already wedded to the Asian growth story but regional agreements in terms of financial services are required to build on that. There has been industry discussion about the concept of a 'financial services passport' whereby we would have regional agreements between identified countries with laws around how money can be invested and repatriated in all of these locations. This would facilitate a freer flow of capital within the region and provide wider opportunities to access its rapid growth in savings. In this environment, Australia would more clearly emerge as a gateway for financial services within the region, or a proxy for it.

With a well-regulated and transparent financial system, and a highly skilled and innovative workforce (particularly in the funds management arena), Australia provides potential opportunities for global investors to take advantage of the Asian growth story without some of the risks associated with direct investment into Asia. But we really need to maintain an open, competitive financial system with minimal restrictions and barriers around ownership.

FINSIA What are the longer term effects for the industry of the global financial crisis (GFC)? How will the governance and regulatory structure of the global financial system evolve?

MU: The GFC has produced a discontinuity in the development of the financial system, not only because of the stress it went through, but also because of the subsequent drive to re-regulate in the developed world. In the United States, the Dodd- Frank Financial Services Reform Bill ran to over 2,000 pages without the regulations; and there's been a similar approach in Europe and the United Kingdom, with politicians reflecting the public angst around the perceived or real behaviours of the industry as being the catalyst for a period of incredible stress.

There has also been a discontinuity in the public perceptions of financial institutions. A lot of it comes down to customer service and value for money but, in other countries, there has been a more intense perception that senior bankers have been insensitive, and a greater focus now on compensation issues.

Australian regulators are to be congratulated for the way they were positioned to help us manage through the GFC, and also their very proactive stance in ensuring that we resist importing solutions to problems that we've never had.

Going forward there will be a lot of factors at play including increased public expectations about the social and fair value objectives of banks. This is a perfectly normal process, and it will be important for financial services professionals to respond meaningfully to these trends.

BC: Although the majority of the de-risking in financial markets has already occurred in Australia, financial institutions in many other countries still have some way to go to strengthen their balance sheets and improve supervision. Australia was shielded from the worst of the GFC because we were relatively strong in both of those areas. Going forward, it will be important not only to ensure better capital coverage but also greater transparency and consistency in terms of the types of assets included as risk-weighted assets.

It is still unclear what the shakeout in markets will be from all of the regulatory and structural changes underway but with increased regulation, banks around the world will need to have more capital invested to achieve stronger balance sheets, and this will inevitably produce a lower return on equity. However, with reduced volatility and a more predictable return, Price-Earnings (P/E) ratios might be strengthened.

We are currently in a transition phase to a new and different equilibrium, which markets and investors, alike, are finding uncomfortable. As we head towards this new equilibrium, credit is more expensive, risk is being reduced, and challenges are arising in terms of how much capital is required and how financial institutions globally can raise this capital all at the same time. In fact, they simply can't do it quickly. This is all creating further risk aversion and, in response to that, many investors are moving out of equities and into the traditionally safer havens of cash and term deposits. As the economy and company profits start to improve and people invest more, then debt markets will start to open up more, financing will become cheaper and momentum will return to the markets. It's currently difficult for investors to see what the catalyst for this will be.

PC: Not surprisingly, the GFC brought home the negative effects of having too much leverage, particularly with some private equity (PE) firms and banks becoming involved in deals where there was a layering of leverage and of risks. In response to this once-in-a-lifetime lesson, we are now likely to see an extended period of risk aversion and conservatism.

Demand for business credit has been quite soft for a couple of years and housing lending is also dropping off. I think we are likely to see demand for credit remaining subdued both because the cost is going up and also because people's risk appetite will be lower. We are unlikely to see, for many years, the double-digit growth in home lending that occurred prior to the GFC and, with a higher cost of capital, returns on equity for banks are also likely to be lower.

In the years ahead, there will be stronger regulatory frameworks and regulators will require banks to be more conservative and have greater capital coverage. This is all going to be just a fact of life for banks.

FINSIA What is your vision for the future of Australian banking? How many banks will Australia have in the world's top 20 banks by 2025? Will they have smaller balance sheets? Will scale matter?

MU: While we still have a couple of Australian banks in the top 20 in the world, as Cameron Clyne is fond of saying, that is essentially battlefield promotions. In normal circumstances it is hard to imagine that this situation will continue, simply because of the size of our economy.

Banks will have a much greater focus on stability and security going forward and the importance of the domestic franchise of a financial institution will continue to reassert itself. People have realised that it's the domestic franchise, whether that's a commercial or retail franchise, that gives banks their stability.

As the GFC clearly demonstrated, there are times when wholesale funding and particularly offshore wholesale funding is simply not valuable. And that is the nightmare scenario for any banker. The liability side of the balance sheet will now have much greater prominence and financial institutions will return to seeking ways to liquefy their balance sheets and to tap into the surplus liabilities in the developing world; whether that's through the corporate bond market or securitisation.

But investors are going to be a lot more cautious. They will value simplicity and transparency, and they'll also look very hard at the reputation and behaviours of the originating financial institution securitising a portfolio of assets.

Financial institutions are also likely to seek to have smaller balance sheets; and for those balance sheets to be funded in a far more robust and long-term way to bring much better more stability and security to their balance sheet. However, this is a bit of a challenge for Australia, because our economy has always been an importer of foreign capital, and the four major banks are the key mechanism for doing that.

The solution probably rests in: finding ways to mobilise the huge pool of superannuation monies here in Australia; establishing techniques to appropriately tap into funding from overseas; and encouraging a greater savings culture.

An important paradox of the current moves to re-regulate is that although politicians are looking for more competition, by imposing significant regulatory burdens on smaller players that are not well-equipped to handle that, many of them are being driven out of the market and there are also higher barriers for new entrants.

PC: At some point during the GFC, Australia had four banks that were in the top 20 in the world - not due to our size but because we were prudently managed. My vision for the future of Australian banking is that we are an outward-looking, prudently managed, sound industry that embraces good technologies in order to become very efficient in a world sense.

There are a lot of opportunities to embrace new generations of electronic payments technology and we are only just starting to come to terms with that. While the Australian and New Zealand banking industry was quick to embrace new technology a decade or two ago, more recently, we have fallen a bit behind other industries.

It is very important that banks take an outward-looking view of the world economy. Both the Australian and New Zealand economies are very integrated with Asia and our banks need to position themselves to facilitate trade, foreign exchange, international payments, investments and migration, because these things will help to drive our economic activity.

Bank balance sheet management is certainly changing. No-one wants to be dependent on shortterm wholesale markets. The focus is increasingly on having secure sources of long-term funding and the dark days of the GFC showed that it is critical to have a sustainable medium-term model for funding the balance sheet.

BC: The pivotal factor determining the future success of banks will be how they can meet more (or all) of their customers' needs. This then relates to how truly customer centric their strategy is and how it translates to everything they do. This is why there is so much interest currently in the wealth management area.

For the major banks in Australia, the key challenge will be around becoming a provider of the full set of financial services to all of our customers. We have active relationships with around 5.2 million Australians through the Westpac Group, but less than 20 per cent of those customers have their wealth products with us. So we have a huge opportunity to help more Australians accumulate, manage and protect their personal wealth - for instance through market-leading superannuation and insurance solutions - which is a growth opportunity on which we are very focused.

FINSIA Will there be further blurring in the distinction between wealth management, insurance and banking? How significant globally will Australia's superannuation industry be by 2025 and how will it change, and what major changes are likely to occur in the financial advice segment by then?

BC: One of the key opportunities ahead will be in executing an integrated, customer-centric strategy to provide full financial services to the existing customer base.

One of the best examples of this sort of convergence is our BT Super for Life product, which is integrated with online banking so customers can see their super as their longterm savings vehicle, and become much more engaged with it as they regularly track it online along with their savings account, mortgage, credit card etc.

Many see this convergence between banking and wealth as primarily around products and technology but I think it's much bigger than that - and perhaps much harder to achieve - because at its core is cultural alignment between banks and their wealth management businesses. It's about having a teller at a bank branch talking to a customer about their superannuation needs and being able to provide a simple and accessible solution. Most people in our industry know this is a long way from where banking and superannuation used to be.

PC: Customers don't tend to segment their financial services needs into insurance and wealth management and banking. They take a much more integrated approach towards their own personal balance sheets. There is a lifecycle to their financial needs (including the need to borrow early in their lives and accumulate assets later on for their retirement). Unless we are providing the whole of that solution for our customers, we are likely to lose them at some point.

We run the risk with a very regulatory intensive regime around financial advice that it will be simply too expensive for many smaller investors to access, when they could benefit significantly from this sort of advice. I think that we need to find a model that will allow for fairly generic advice to be given (possibly even online) without having to meet all of the regulatory requirements that are being introduced in this area.

MU: All of the indicators are currently pointing to further convergence between banking, wealth management and insurance, the recent reviews of the superannuation industry have clearly identified the need to deliver reductions in the cost of providing superannuation services. The broader community seems to be looking for greater stability and lower-cost services; this also points to the need for scale. There will be niche players at the other end of the spectrum, say, in a financial advisory capacity, that have no need for a balance sheet and a capital structure. But the middle ground is going to be increasingly difficult for financial institutions to inhabit.

There will be a major shift back to basics in terms of orienting services around what the customer needs, and everything within the organisation will need to be aligned to delivering that. The exemplars of consistently high customer service around the world also have superior shareholder returns and everyone within those organisations is empowered to do whatever is the right thing for the customer.

FINSIA How will innovation change the way financial services are provided?

PC: One of the key areas where significant innovation will continue to occur is in terms of the back office, with straight-through processing etc. There is still a lot of paper in this area and there are many other industries, such as logistics, where much more thought has gone into how people can use technology. A good example is the courier firms - everything is now bar-coded and can be easily tracked electronically. We have been doing a lot of work focusing on our mortgage document processing but there is still considerable scope for increasing the usage of technology in this area.

Interestingly, although internet banking has now been in use for basic transactions for about 10 years, there has been little growth in the number of transactions in the past seven or eight years. Obviously, the growth now is occurring in terms of hand-held devices.

There are a lot of exciting things ahead in terms of payments. We are now in a new generation of technology with things like Paywave (where for a small payment you can just wave a card to access services). By the end of this decade, I think there will be an electronic replacement for cheques.

There will continue to be a role for bank branches, but they will be a place where people go to have conversations about their transactions, and the transactions themselves are likely to take place online.

BC: We believe innovation is at the heart of developing new, more relevant and more accessible financial services products and services. We try to use innovation to make things simpler for our customers who we know find many aspects of financial services - like superannuation - confusing and intimidating.

Making complex products simple, accessible and relevant to our customers is a key challenge for us all and is critical if we're going to address Australia's retirement savings challenges.

With intergenerational reports showing that by 2050 there'll be only 2.7 people working for every person over 65, (it's currently five for every one), innovation is a very real issue. As a country we need to innovate to ensure we are ready for that. As an industry (and for the Government), we need to innovate to drive more engagement with superannuation so people will become better prepared for retirement and able to sustain the lifestyle they want.

MU: A decade ago, there was genuine concern among traditional banking players, that a wave of innovation in mobile telephony and the internet would make the traditional banking model redundant. But so far it's been very, very hard for those models to operate on a standalone basis, because although customers want to use the internet for initial exploration of what they want to do, they want to talk to a real person when they're making major financial decisions.

Most importantly, customers are looking for an integrated and seamless array of channels that allow them to access their financial institution in the way that suits them, when it suits them. Banks are natural vehicles to house innovation and, if they don't innovate in these ways, they will lose relevance.

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