The smaller financial institutions in Australia seem to be under assault on all sides – except, perhaps, one. The regulators (APRA and, to an extent, ASIC) seem to give them a hard run, at times. The Basel II accord, although not explicitly helping the larger banks, gives an advantage to them in that they have enough data to model economic capital properly. Over the last 30 or so years very few (if any) new smaller institutions have opened their doors and many have merged into larger entities, or demutualised and listed.
Is this process a terminal decline in this sector of the industry?
To me, there are good arguments both ways. Certainly, the number of smaller institutions is dropping. Their cost to income ratio is much higher than the larger banks. They seem to be de-mutualising and merging with alacrity. To say that the sector will survive, or even prosper, only by becoming big seems to be an, ummm, interesting argument. Saying that the small institutions will survive by becoming big sort of defeats the purpose.
As a proportion of the industry, though, they are holding their own. They are also more profitable, on several measures, than the banks. They seem to be able to make more from their customers despite (or perhaps because of) their reliance on the “old fashioned” interest margin, rather than fees.
Because of their higher equity ratios, I do not think that Basel II would have much of an effect anyway. The mutuals cannot unload equity back to their members, except by making losses on their core business and this would alarm APRA, and probably their members, too. The smaller listed institutions can’t really unload much without alarming the regulators, either.
The Bankwatch blog has an interesting discussion on the profitability of smaller branch networks that would be interesting to see replicated in Australia. The paper they link to indicates that the mid-size banks (the regionals would be the equivalent here) do relatively poorly from their branch networks, while the smaller and the larger ones do better. I would not be surprised if the same were the case here.
All in all, I remain agnostic. I will look to see what happens when the larger banks get serious about using their Basel II systems to drive pricing, as risk-based pricing in the retail sector is not common (yet) here. This could hurt the smaller institutions proportionately more.
On the other hand, they seem to be adept at driving more profit out of their members than the banks are. Profits are always the key to surviving and prospering. We will