By Jill Fraser for Lending Central 

Defying the dire predictions of many commentators and the domination of the Big Four banks, regional banks, credit unions and building societies have continued to deliver solid financial results (although significantly down on prior periods) and strengthened balance sheets in the 2009 financial year to 31 March.

KPMG has analysed the ‘second tier’ of the Australian banking sector and found that the sector continues to be a relevant and important provider of financial services.

“These sectors have continued to be profitable. However their ability to compete with the major banks is being sorely tested in these challenging markets” said Martin McGrath, partner at KPMG.

Profitability was significantly lower compared to the previous half-year due primarily to an increase in bad debts expense in business lending for the regional banks and, for credit unions and building societies, a decline in net interest and non-interest income.

(Credit unions and building societies appear to have avoided the immediate impact of the global financial crisis by recording bad debts expense similar to the previous half-year, which reflects their small exposure to business lending.)

In the first half of FY2009, regional banks reported a decrease in profit after tax of 68%; credit unions’ decrease was 30% and building societies’ decrease was 4%.

However, when contrasted to the carnage experienced by many larger overseas financial institutions, the regional bank, credit union and building society sectors remained profitable overall in the period reviewed.

McGrath said deposit growth was strong during the first nine months of the financial year (ranging from 10.5% for the credit unions to 4.2% for the regional banks) helped by the government guarantee.

“Deposit growth is fundamental to the growth plans of credit unions and building societies in particular. They have competed aggressively in this area and to some extent will have benefited from the “flight to cash” by customers who have steered away from equity and property investments.”

The growth in deposits has however fallen well short of the 15.5% growth recorded by the major banks, which continue to be aggressive competitors.

Average loan growth over the nine months was respectable, ranging from 4.3% for credit unions to 7.7% for building societies, with home loan growth the main contributor and business and consumer lending lagging. 

“This increase in exposure to mortgage loans, as opposed to business and consumer lending, appears prudent given the deteriorating economic conditions,” McGrath said.

These institutions are beneficiaries of the government guarantee of deposits, which is provided free for retail deposits of less than $1 million. For deposits in excess of $1 million, a fee of 1.50% is charged to institutions rated below “A”, compared to 1.00% for “A” rated and 0.70% to “AA” rated institutions such as the four major banks.

“However this is a two edged sword for the regionals, building societies and credit unions. The higher fee applies to two of the three regional banks and all of the building societies and credit unions making it more expensive for them to attract large cash deposits. This has impacted the regional banks’ profitability in particular,” McGrath noted.

The outlook for the next year will largely depend on the sector’s ability to access funding markets at competitive rates and the size of a likely increase in bad debt expense as the impact of job losses is felt.

“They are unlikely to be able to expand rapidly or aggressively take on the majors. Factors such as the differential pricing of the government guarantee place these institutions at an obvious disadvantage.

“However by continuing to focus on the strength of their balance sheets, serving their customers well and sticking to the markets they know well, there is no reason why the sector cannot continue to succeed,” McGrath said.