Bigger, Better, Stronger... but 40+ will disappear

Australia's Customer-owned banking sector is undergoing significant consolidation. Australian Deposit Institutions (ADIs) representing this Sector are relatively smaller and have decreased from 400 in FY 1975 to 200 in FY 2000, marking a 50% contraction over 25 years. This trend continued, with a projected 52 ADIs by FY 2025, indicating a further 74% contraction. Despite this, the Sector's assets have grown from approximately $50b to over $178b in the last 25 years, and it now serves over 5.4 million Australians.

The ongoing consolidation, characterised by mergers and acquisitions among smaller mutuals and credit unions, presents both challenges and opportunities. This trend reflects the Sector's growing complexity and resiliency as institutions must navigate regulatory changes, competition from traditional and fintech players, and evolving customer expectations.

Forces Fueling Consolidation

Several key factors have driven the consolidation of the customer-owned banking sector:

1. Regulatory Pressures: Increased regulatory expectations, particularly around capital adequacy, liquidity, governance, and compliance, have placed significant financial and operational pressure on smaller ADIs. The wave of regulatory changes over the next 12-24 months across APRA, ASIC, RBA, Treasury, AUSTRAC and ACCC is daunting. Meeting these regulatory expectations often requires significant resource impact and technology changes, prompting smaller ADIs to seek mergers to pool resources and share technology and compliance costs. Customer Owned Banking Association (COBA) support is paramount going forward, as it will engage with governments and regulators to advocate and lobby legislative changes and ensure their application is "fit for purpose" for the Sector, balancing risk, reward, and cost of compliance.

2. Scale Efficiencies: One of the primary motivations behind consolidation is achieving economies of scale. Larger entities benefit from cost synergies in areas like technology, operations, and risk management, allowing them to compete more effectively. Consolidation can enable these smaller ADIs to enhance their service offerings, invest in digital banking solutions, and expand their geographic presence while maintaining a member-first approach.

3. Competitive Pressures: The rise of digital banking and competition from neo-banks and fintech startups has significantly altered the financial services landscape. Many customer-owned institutions, with limited resources compared to larger banks, have needed help keeping pace with technological advancements. Consolidation enables smaller ADIs to combine resources and expertise, enhancing their ability to innovate and stay relevant in a rapidly evolving market.

4. Changing Customer Expectations: Today's customers expect seamless, personalised, and digital-first banking experiences. Smaller ADIs often need more resources to invest in the advanced technology platforms necessary to meet these expectations. Consolidation allows customer-owned banks to provide better digital offerings while maintaining the customer-centric values that differentiate them from other traditional banks.

5. Maintaining Key Performance Measures

The key performance measures for the Sector include Capital Adequacy, Return on Assets, cost-to-income ratio, Loan Growth, liquidity, and Credit. While the Sector overall grew 9.1%, with capital and liquidity managed reasonably effectively, in line with APRA requirements, several smaller ADIs struggled and delivered flat or declining loan growth with deteriorating Credit. Generating a return on assets while maintaining an optimum Cost-to-income Ratio continued to create pressure for most ADIs across the Sector. As per S&P, "Mutuals' return on assets has fallen to 0.4% in 2024 from 0.8% 20 years earlier. This compares with the return on assets of the Australian major banks, which has only moved to 0.7% from 1.0% across the same period." S&P further states, “The cost-to-income ratio of Australian mutuals has remained high, averaging 75.8 per cent. This compares with an average of 47.8 per cent for the major banks over the past 20 years.” Margin pressure, S&P said, “is likely to remain for Australian mutual lenders. This will be more evident for those mutuals that chose to increase lending via brokers. The use of brokers can reduce the return on a mortgage by as much as 40 basis points."

Opportunities from Consolidation

Despite the challenges, the consolidation of the customer-owned banking sector presents numerous opportunities:

1. Enhanced Financial Stability: Larger, consolidated entities have more substantial balance sheets, allowing them to withstand economic shocks and volatility better. This enhanced financial stability helps customer-owned institutions provide continued, long-term support to their members, especially during financial uncertainty.

2. Investment in Technology: Consolidation allows smaller ADIs to pool resources for technology investment, helping them modernise their digital platforms, improve operational efficiency, and offer cutting-edge services like open banking, AI-driven financial products, and real-time payments. This investment is crucial to competing with digital-first rivals while delivering personalised service.

3. Greater Member Benefits: As per S&P "Many mutuals in recent years have loosened historical common bonds to facilitate mergers or generate lending growth. This is because boards have become more pragmatic about the compelling rationale for mergers." Consolidation can enhance the range of products and services available to a wider set of members. Whether expanding loan options, offering new financial planning tools, or improving customer base and service through digital channels, larger institutions can leverage economies of scale to provide more comprehensive and competitive offerings while still maintaining the ethos of member ownership.

4. Increased Capacity for Growth: With a more extensive scale, customer-owned institutions are better positioned to pursue growth strategies such as further expanding into regional Australia and offering specialised financial services required in those areas. These growth strategies could lead to broader market penetration with higher member engagement, further strengthening the Sector's prospects.

The Future of Customer-Owned Banking Sector

Customer-Owned Banking Sector collectively represents Australia's fifth largest household bank, with over $110b in household deposits and over $130b in household lending as of 30 June 2024. While this represents less than a 3% share of assets (or less than a 5% share of Household lending), in terms of physical presence, it's more than a 20% share of branches across Australia, predominantly in regional areas, where our members need us the most, demonstrating a deep commitment to our members.

As consolidation continues, potentially expected at an accelerated rate over the next 3-5 years, the customer-owned banking sector in Australia will likely see the emergence of fewer but more robust and resilient institutions—around less than 12, with half at an SFI Level (SFI = Significant Financial Institution with over $20b in assets). "The magic number for Australian mutual lenders could be less than 10,” S&P Global projected in an analysis of the sector outlook. APRA will more closely supervise these institutions, and the Sector will benefit significantly from improved financial stability and risk management practices. They will be better equipped to meet regulatory demands, fend off competition, and adapt to their members' changing needs, demonstrating the Sector's adaptability and resilience.

#CustomerOwnedBanking #COBA #BankingConsolidation #FinancialServices #BankingInnovation #DigitalBanking #FintechCompetition #FinancialStability #RegulatoryChallenges #BankingTransformation #BankingFuture