Australian banks speed up Asian retreat as competition and oversight mounts

Amidst tighter regulatory pressures, analysts weigh in on whether Asia is still a market worth conquering.

Australian banks appear to be feeling the heat of growing competition as aggressiveness from domestic banks are increasingly putting foreign players out of the running for Asia’s profitable banking pie.

This comes as Sydney-based Australia and New Zealand Banking Group (ANZ) sold its massive retail and wealth business in Singapore, Hong Kong, China, Taiwan and Indonesia to Singapore’s DBS in a move that significantly scaled down the Australian lender’s presence in Asia. The deal was completed last February for an undisclosed sum as ANZ moves to focus on its core business in Australia and New Zealand amidst lack of further growth opportunities in the region.

“In retail and wealth, although we have grown a profitable business in Asia, without greater scale ANZ’s competitive position is not as compelling,” ANZ CEO Shayne Elliott said in a statement following the divestment.

The sale follows a flurry of exits by Australian banking players from the region to focus on markets closer to home as Commonwealth Bank (CBA) has similarly moved to engage its advisors in the possible sale of its insurance business PT Commonwealth Life in Indonesia. Not far long behind, CBA announced the sale of its life insurance business in Australia and New Zealand to major insurance player AIA Group for $3.8b.

"Providing customers with access to high quality products and services for all their financial needs is core to the vision of the Commonwealth Bank. Whilst distributing life insurance is a fundamental part of our strategy, we are open to different models for doing so. CBA remains committed to serving its Indonesian customers through PT Bank Commonwealth and its digital strategy," CBA said when reached for comment.

Overseas obstacles
Whilst offshore expansion always poses a challenge for any business seeking further growth opportunities beyond its borders, it is particularly hard for banks to expand as they must deal with multiple levels of regulations, both at the product disclosure and prudential levels, said Tim Dring, EY Oceania Banking and Capital Markets leader.

"The global regulatory platform is not harmonised and we are seeing local regulators move in different directions in response to local market conditions," he noted. "As a consequence, it is often difficult for Australian banks to leverage home market experience and processes."

Home to over 4.4 billion people, Asia represents a huge market that once conquered, can generate exponential rate of returns as many offshore successes have proven in the past. A study by accounting firm KPMG estimates that less than a third (27%) of Southeast Asian population are in possession of a bank account—which presents a wealth of opportunities for retail banks looking to tap into the region.

“Australian financial institutions have seen Asia as not just our neighbours but the location of a large and growing middle class with a perceived appetite for wealth management services,” Grant Thornton Partner & National Head, Financial Services, Madeleine Mattera said, as the region is increasingly attracting the world's ultra wealthy with a report from Asian Private Banker estimating AUM by Asian private banks at a whopping US$2.01t in 2017.

However, Australian companies eager to cash in on the opportunities provided by region’s multi-billion financial services industry would have to compete against the dominance of banks born and bred in the territory. This is especially true for Chinese and Japanese banks whose assets have expanded twenty and fifteen fold respectively in the thirty-year period between 1980 to 2010.

“Domestic banks in Asia have also become much more aggressive eating up market share to foreign competitors, amongst which are Australian,” said Natixis chief economist Alicia Garcia Herrero. “In addition, competition is Asia is much stiffer due to Chinese and Japanese banks huge liquidity and increasing ability to lend overseas.”

Tapping on markets far from home would also necessitate more time to adapt and learn, which might not be an attractive option for banks looking for quick returns on overseas risk.

“From the perspective of an Australian-based financial services commentator, I see that Sydney and Melbourne based brands are yet to build the same cachet that iconic local brands enjoy on Orchard Road in Singapore,” added Mattera. “Trust takes a long time to build and Australian capital and Australian shareholders may not have the patience—particularly as there is no guarantee that the returns are there for an overseas entrant.”

Regulatory roadblocks
Tighter regulatory pressures back home may also be speeding up the retreat of Australian banks from the region as the country’s primary regulator, Australian Prudential Regulation Authority, unveiled stricter capital requirements on banks last July, noted Garcia Herrero.

To be classified as “unquestionably strong”, major banks would need to raise the common equity tier-1 ratio to 10.5% by January 1, 2020. To meet the new capital adequacy, APRA estimates that major banks would need to raise capital by 100 bps from the level in December 2016, which can also be achieved by selling assets with high risks and/or low returns, Garcia Herrero explained.

The Basel III capital treatment of minority stakes is also making it significantly less attractive for banks to invest in Asian banks, Dring added.

“Australian banks are facing rising regulatory pressures at home to boost their capital positions, and the scaling back of some operations can help them improve their buffers,” said BMI Research head of Asia Country Risk Chua Han Teng.

The country’s unique tax system also makes it doubly hard for companies to expand offshore. Australia operates on an imputation system which determines the proportion of franking credits attached to dividends paid out.

Under the imputation system, a massive share of offshore earnings reduce the ability of banks to pay fully franked dividends which means that banks are likely to face higher capital costs for overseas activities than domestic ones.

“However, one of the important reasons why Australian companies are discouraged from expanding offshore is the huge overall tax cost associated with making foreign profits,” said BDO director of national tax Lance Cunningham in a 2017 media release.

The system does not give any franking credit for the tax paid by companies on foreign profits and does not stop double taxation of foreign profits which can result in as much as 70% tax rate on foreign profits, he added.

“It is little wonder that many Australian companies are opting for Australian takeovers rather than expanding offshore when they are faced with the alternatives of investing offshore at an overall tax rate of 70%, or investing onshore with an overall tax rate of between 0 and 49% (depending on the tax profile of the shareholders receiving the Australian profits as franked dividends),” Cunningham explained.

For example, an Australian corporate group sets up a wholly-owned subsidiary in USA. The tax is $400,000 if the USA subsidiary makes AU$1m in profit under a 40% USA Federal and State tax rate. The subsidiary then pays after tax profits of $600,000 to its parent company which pays no Australian tax on the dividend.

However, tax disincentives arise when the Australian company wants to pay the $600,000 USA dividend to its Australian shareholders as unfranked dividend given the fact that there is no Australian tax paid by the company on foreign profits.

“Therefore the Australian shareholders will pay tax on the unfranked dividend at their marginal tax rate. If the shareholders are individuals on the highest marginal tax rate of 49%, the Australian shareholders will pay tax of $294,000 on the $600,000 unfranked dividend. This means that the total USA and Australian tax paid on the $1,000,000 USA profit is $694,000 i.e. a tax rate of almost 70%.”

When faced against such pressures on margins and growth hampering their ability to scale, Dring believes that Australian banks have no other choice but to re-assess their business trajectory, simplify their portfolios and pull out from markets offering no opportunities to scale which includes stakes in their Asian counterparts.

This gives banking players more time to focus on their strengths like trade finance and the movement of capital in territories they know by heart but it may come at the cost of losing Asia’s billion dollar banking potential.