Despite being pummelled by rising bad debts, first-half earnings reports show Australia’s biggest financial institutions are strong enough to withstand the COVID-19 crisis.

The average common equity tier 1 (CET1) capital ratio, the ultimate measure of bank strength, is sitting at 10.9 per cent, 0.12 percentage points higher over the half. Total equity of $258 billion was up 5 per cent.
Amid economic uncertainty, the bank results showed their capital and liquidity strength.  Simon Bosch
During management presentations, analysts probed about how much capital could be eroded if the economy struggles out of the virus by more than banks anticipate. But buffers appear large enough to cover even the banks’ most bearish downside economic scenarios.
“The banks are in a strong position. Liquidity is not, and wont become, an issue and capital is strong,” said Deloitte banking and capital markets partner Steven Cunico.
“With their base case scenarios, banks are already saying the economy will drop, unemployment will rise and house prices will fall sharply. But if that happens, provisions may well now be sufficient so that they will take it in their stride and be OK.
“The focus has been on what if it gets much worse? But even if it does, banks should be fine. They have sufficient capital to absorb the hit and can deal with that through capital management, including reducing dividends.”
This earnings season will be remembered for a dramatic divergence in dividend policies. In February, before the impact of COVID-19 was properly understood, CBA paid out $3.5 billion in dividends at $2 per share. But a week ago, National Australia Bank cut its dividend by two-thirds, and ANZ last Thursday and Westpac on Monday deferred decisions on their interim payouts altogether.
The banks are battening down the hatches for a hard slog out of the crisis and boards have had to delicately balance the interests of retiree shareholders reliant on dividend income with banking regulator’s demand that they maintain capital strength.
Ratings agencies have backed the banks’ focus on stability and strength. After the Westpac result, S&P Global Ratings said a strong capital base, its decision to defer its interim dividend and the strength of its domestic banking franchise provide a good buffer for the Australian major bank to absorb higher loan loss provisions”.
Westpac chief executive Peter King said on Monday that all the banks “go in to this downturn with good levels of capital to buffer the economic downturn and a downturn can be exacerbated if banks go in in a weak position and cant continue to lend. That is one of the things that gives me confidence: our system is in good shape and we will continue to lend.
The results showed lending growth up 5.3 per cent over the half, according to EY, as many large corporates borrowed more to get them through the crisis.
EY’s banking and capital markets leader, Tim Dring, said the banks’ role of supporting the economy by acting as a conduit for credit and liquidity flows to SMEs and deferring loan repayments for mortgagees and small businesses “provides an opportunity for the sector to redress at least some of the reputational damage of recent years but it also brings risk.”
These will include managing reputation as difficult choices on which business to support and which to let fold during a process of managing credit losses are made in coming months. Such decisions will be made against a backdrop of declining profitability.
Across the sector, return on equity has continued to fall, by a whopping 5.57 percentage points to an average of 6.4 per cent, according to analysis by KPMG.
“Downward pressure on ROEs will remain for the foreseeable future, given the ongoing impact of a deteriorating global and local economy,” said KPMG head of banking Ian Pollari.
This will increase focus on costs. Average cost-to-income ratios increased from 46.1 per cent to 54.8 per cent, reflecting large and ongoing customer remediation and regulatory compliance costs. Meanwhile, competition and low official interest rates will continue to pressure margins.
The average net interest margin of 1.93 per cent was down 3 basis points compared to the first half of 2019, said KPMG, due to competitive pricing pressures.
During the crisis, Mr Heath said the banks are being viewed in a different light and their approach to tough decisions to made over the next six to 12 months could determine whether they can repair the damage inflicted by the Hayne royal commission.
“The strength of capital and liquidity is an important base, but the reserves arent endless,” he said. “Tough decisions will have to be made about how businesses are going to fail, and the way banks do that is going to set them up for the next decade.