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Report on falling profit growth of banks; terms of reference of the Daughter of Campbell inquiry, in particular, regulation and mergers; sale of the Commonwealth Bank and KPMG recommendation on the buy-back proposal to shareholders

KARON SNOWDON: Well, banks have started reporting their half-year profit results, and it's a bit of a mixed bag. Leading the pack have been Westpac, which notched up an almost 18 per cent rise in net profit, and St George, which saw an 11 per cent gain. Although the biggest, National Australian Bank, managed less than 5 per cent, the figures are still looking healthy, on the whole, although some unkind financial press today have been critical of the NAB, which is unlikely perhaps to make the $2 billion for the whole year.

John Buttle, from KPMG, annually surveys the performance of the whole finance sector. He says the growth in bank profits has contracted from the exciting levels of the past few years.

JOHN BUTTLE: I guess the big increases in profitability over the last couple of years is slowing. From '93 to '94 there was an 81 per cent increase in profitability, and '94 to '95 only a 23 per cent increase. But I'm predicting that the latest round of results will show a slowing in that growth, and that's because there's a significant pressure on interest spreads, particularly due to the fierce competition in the residential lending market. And many of the participants in the finance area are highly dependent upon residential lending as a major source of income.

The other thing is that the banks have benefited from the fact that they've had a lot of non-accural debt in the past at fairly high levels, and that's come off very rapidly; so, the non-accrual debt has been turned into productive debt and that's going straight to the bottom line, and even bad debts, the level of bad debts, is a lot lower than it has been in the past.

KARON SNOWDON: The banking sector has a big year ahead of it, not just dealing with falling profit growth, but as well a blurring of the lines between banks and other finance providers, and it faces yet another inquiry.

The Federal Government is yet to announce the terms of reference for the Daughter of Campbell Inquiry, but the big banks at least have made it clear the top of their wish-list is simpler regulation and the go-ahead on mergers.

Another industry watcher is Coopers & Lybrand tax partner, Jeremy Pooley.

JEREMY POOLEY: In contrast to the PSA Inquiry of last year, its probably going to be as significant as the original Campbell Inquiry was in respect of deregulation of the financial system. It will be significant in terms of assisting the Government to shape the future of the financial sector, both in terms of regulation and in terms of their competitive framework.

KARON SNOWDON: Is it likely that we could end up with a single, overarching sort of consumer regulator?

JEREMY POOLEY: Yes, I think that's possible.

KARON SNOWDON: Like the Competition Commission?

JEREMY POOLEY: Yes, that's possible and I think there's a case to be made to aggregate all those consumer issues into one separate organisation, which then will apply some uniformity to all standards of regulations within the financial services sector.

KARON SNOWDON: Now on the merger question, the major banks' arguments for allowing more mergers - they're wanting more mergers - is that there are many more players in the financial sector now, offering services. So that competition is less likely to be reduced by allowing several institutions to consolidate, and that it would indeed allow more efficiency throughout the industry. Will that argument carry at the Inquiry, do you think, or indeed with the Consumer and Competition Council?

JEREMY POOLEY: I think at this stage it's a fairly open question. The issue is to whether branch closures can be achieved without bank mergers, and the industry is saying, 'Possibly not' and there's a school of thought which says 'Yes, you can get efficiencies simply by having enough diversity in the number of players in the market.' And that's a very important thing. From a consumers' point of view, they like diversity.

KARON SNOWDON: And the most likely scenario is the subsuming of several regional banks by some of the majors perhaps.

JEREMY POOLEY: Oh, I think that's probably maybe the first cab off the rank. The harder issue of course is whether you permit a large institution like NAB to take over another large institution like the ANZ or Westpac.

KARON SNOWDON: And the other area we haven't discussed of course is superannuation. And the banks will be arguing very hard for a clarification on the retirement savings accounts that they've been promised.

JEREMY POOLEY: That's right. Now, the Government has said they'll stick by that promise, but there may be some additional details which probably do need to be clarified, and this is the time to actually clarify them.

KARON SNOWDON: We last spoke, Jeremy, with you at the time of last year's Prices Surveillance Authority Inquiry into Bank Fees and Charges. Now the only real effect to come out of that whole exercise was that the banks were required to offer low cost accounts, and to provide that. How would you rank the compliance on that score?

JEREMY POOLEY: I think banks have done overall a pretty fair job in doing that. They've opened a few new accounts, they've made a move to user pricing, which admittedly can't be done overnight, but they've actually made the commitment to go that far.

KARON SNOWDON: So that you pay for the frequency of your use of services.

JEREMY POOLEY: Absolutely. And if you go into a branch, it's going to cost you more. If you are prepared to transact with your bank by electronic means, which is ATM or EFTPOS, then it's simply the number of transactions which you do per month. And the fewer transactions, then the less cost.

KARON SNOWDON: But haven't we generally seen banks respond to the increasing competition from their competitors, not just by cutting costs - there's been so many job losses in the industry - but by, indeed, increasing fees and charges generally?

JEREMY POOLEY: Yes, well, I think that's an increasing worldwide trend, moving away from interest income to non-interest income, and we will continue to see that trend. Perhaps the PSA Inquiry was the first recognition at various levels, including consumers and government, that that's indeed the way things are going to go, and it's a question of how it's managed for the next five or six years until people become comfortable with that notion.

KARON SNOWDON: But we'll be paying more for basic bank services.

JEREMY POOLEY: We'll be paying more. You can pay less, but it's really up to you how you modify your banking behaviour, and that's the critical point. The banks were arguing during the Inquiry that this is a service which has traditionally been provided free, and people have to some extent overused it. So, now it's a question of how many times you go to the bank and what you go to the bank for and, more importantly, whether you use a very expensive distribution channel - like going into a branch, which is costly for the bank - or whether you're prepared to use an ATM or an EFTPOS to get your money.

KARON SNOWDON: Now, we've concentrated on the consumer side of banking here. What about the business side of banking? Are there any implications for the business sector's dealings with banks and financial institutions that are likely to come out of this Federal Government Inquiry?

JEREMY POOLEY: I think there probably are, but the focus has never been on business because it's been perceived that business has been quite well served by a range of providers; indeed, large businesses now go to the market themselves rather than go through a bank. I think the real issue is probably at the small business end, and there may well be some issue there which probably should be canvassed at this Inquiry.

KARON SNOWDON: Like what?

JEREMY POOLEY: The cost to small business of obtaining a bank loan. But there's really a distinction here to be made between what you'd call venture capital which is a very small business, and what you'd call more established businesses. And the banks and the risk portfolio have traditionally gone for more established businesses. As the market matures and non-bank players continue to come into the market, I expect that hole to be filled.

KARON SNOWDON: Jeremy Pooley is a tax partner with accounting firm, Coopers & Lybrand. The issue of making it easier for bank mergers to take place, is perhaps the most contentious one confronting the forthcoming Inquiry.

John Buttle, from KPMG, believes competition will be enhanced if more takeovers are allowed.

JOHN BUTTLE: It would probably enhance competition, I suspect, and the rationalisation would ultimately bring down the cost basis of the financial institution, and that would allow then to pass on benefit to consumers.

KARON SNOWDON: Wouldn't it reduce competition, if you had fewer players in the market?

JOHN BUTTLE: Not really. What you're doing is you're bringing together players of a different background and bringing them under the same sort of regime and having common rules as a base from which they can compete. And no particular part of the finance industry will have any particular advantages over another. I think that because we are over-banked, we need to get that level of infrastructure down.

KARON SNOWDON: The next major event on this year's banking calendar, of course, is the sale of the Commonwealth Bank, of the Government's remaining 50 per cent share of the Commonwealth Bank. And the Bank itself, its decision to buy back and cancel 10 per cent of its own shares was approved at the shareholder meeting just this week.

Now KPMG did the independent experts' report, which has your signature recommending the buy-back to shareholders; that recommendation was sold to ordinary shareholders largely on the basis of an improved earnings per share equation. But one of the complaints at the shareholders' meeting - and I attended that - was that there was no quantified comparison with any other option, such as, for example, say, a return of capital to shareholders. Would you accept that as fair criticism?

JOHN BUTTLE: Well, I wouldn't be in a position to actually state whether that was fair criticism or not. From my point of view, our obligation was only to report on the proposal, not on any other alternative. I really couldn't proffer an opinion on that.

KARON SNOWDON: So there was no consideration of other options, and the relative merits of those for shareholders?

JOHN BUTTLE: I'm not saying that at all, no. I'm just saying that from KPMG's point of view, our role was to consider that particular option.

KARON SNOWDON: Well, I would have thought the only way to recommend a particular track for shareholders to vote on would be to weigh up the pros and cons of several options.

JOHN BUTTLE: No, no. Our role was really to give an opinion as to whether the proposition was fair and reasonable for the shareholders, which it was. But our role was not to say whether this was the best course. So, we have no opinion on that.

KARON SNOWDON: But the bank itself presented that as the best course to shareholders, based on your report.

JOHN BUTTLE: Well, the bank of course considered many options, and took that course of action, which was presumably in their minds, the best course.

KARON SNOWDON: John Buttle is the Chair of KPMG's Banking and Finance Group.

And at the General Meeting, the Commonwealth Banks' Chairman, Tim Bessley, said he didn't have any information on other options for shareholders to consider. It made the bank's buy-back of 100 million shares, at a cost of about a billion dollars, even if it is the best option and gives shareholders the best result, it was - as everyone expected - a fait accompli; and isn't that becoming the usual situation at general meetings?

Well, The Business Report returns next week of course, on Friday and we'll be bringing you the second part of our look at Shanghai.