Friday, October 29, 2010

Bank ROE – back to 20%?

Stephen Bartholomeusz in today’s Business Spectator:

Like NAB, ANZ has lifted its overall return on equity, to 13.9 per cent versus NAB’s 13.2 per cent, although ANZ achieved an ROE of 15.5 per cent in the second half. To put that in perspective, before the financial crisis ANZ was generating ROEs slightly above 20 per cent.

The big difference between ANZ’s metrics in 2007 and its metrics today, however, is that big discrepancy in the returns on equity they yield. That’s because pre-crisis ANZ’s tier one capital ratio was 6.7 per cent and today it is 10.1 per cent.

It is the pressure to return to ROEs in the high teens that does pose some threat of oligopolistic behaviour. While there isn’t any strong evidence of that in the three full-year banks results tabled so far, the level of concentration in the system means it remains a risk.

That’s why the focus of any debate about the intensity of competition in the system ought to be forward-looking and structural – it needs to focus on how to make the remaining regional banks more competitive and how to bring the non-banks back into the market – rather than populist bashing of the banks for highlighting the reality of the margin pressures they are experiencing today.

Once again I pose the question – why should banks be targeting ROEs in the high teens?  This has never made sense to me, and makes even less sense now, when the banks are more highly capitalised than they used to be, more stringently regulated, and have just demonstrated their “too big to fail” tag by getting the benefit of a government guarantee the moment they started to look a bit wobbly.

How can this massive margin to the risk free investment be justified?

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