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Asia-PacificApril 6 2008

Small fry battle the big four

It is a given that larger banks have scale in their favour but Australia’s smaller banks are playing on customer service in a bid to win business, writes Virginia Marsh.
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Singing kittens, talking flowers, painted smiles and sashes on statues around the nation, a happy banking website – these all feature in Halifax Bank of Scotland’s (HBOS) ‘assault’ on the status quo down under. The marketing approach might be quirky but the intent is anything but light-hearted. HBOS’s plans represent both the UK group’s biggest ongoing international project and the largest banking network roll-out ever undertaken from scratch in Australia.

“HBOS is certainly the most aggressive new player we’ve seen in Australia in many years. Its plans for the east coast are very ambitious,” says Martin McGrath, financial services partner at KPMG in Sydney. “If you are a major Australian bank, you have to sit up and take notice.”

The local banking sector has long been dominated by the big four – Commonwealth Bank of Australia (CBA), National Bank of Australia (NAB), ANZ and Westpac. While the big four have prospered during Australia’s sustained economic boom, the good times, as well as innovative strategies, have spurred the rise of challenger banks, mainly with regional footprints. Prime among them are BankWest (HBOS’s local subsidiary), former Sydney-based building society St George, Bank of Queensland (BoQ – which has pioneered a franchise model), Queensland-based bancassurer Suncorp and community operator Bendigo Bank.

International players

Equally, while purely foreign operations remain relatively small locally, by global standards, international groups such as ING, Rabobank, Citi and HSBC are developing successful niche operations in Australia.

A key advantage for the challengers has been the poor standing of the big banks with many Australians. The big four, in particular, are widely seen to have overdone branch closures in the late 1990s, ahead of many of their international peers – and more aggressively. The public’s cynicism was only increased by the subsequent so-called cash-for-comment scandal in which the banks were found to have paid seemingly independent radio hosts for favourable commentary.

“The level of dissatisfaction with banks in Australia is very high, which indicated to us a propensity for people to move if the product or service offering they were given was of a sufficient quality, and we have certainly found that,” David Willis, chief executive of HBOS Australia, says of the decision to make a significant push in the local market.

Big four under fire

Although Australia has a stable legal and regulatory system, the big banks – often referred to locally as an oligopoly – are regular rapped by politicians. Wayne Swan, treasurer (finance minister) in the new Labor government, was scathing of the big four’s move in January to lift mortgage rates independently of a hike in official rates, even though the increases did not cover their higher borrowing costs following the global credit crunch. Mr Swan has also ordered a Treasury review on how to improve competition in the sector, saying that he wants to make it easier for Australians to switch banks (see Reg Rage).

“In a period of great turmoil and uncertainty in global banking, when you have events such as the Northern Rock crash going on and major global banks reporting mega losses, you would think encouraging people to take money out of banks is the last thing the government would be doing,” says a commentator.

More fundamentally, perhaps, Labor – which took power in November after 11 years in opposition – is not expected to change the so-called four pillars, the long-standing cross-party policy of not allowing mergers between the big four. Although not explicit, in effect the policy almost certainly precludes a foreign predator taking over one of the big four.

Aside from HBOS, which aims to build BankWest from a regional into a national operator, foreign banks have opted to develop relatively modest niche businesses in Australia. This reflects the relatively small size of a market with a population of 20 million, the country’s geographical isolation and the mixed local history of foreign banks.

“In the 1980s [when deregulation occurred], a whole host of banks came in but a lot went home with their tails between their legs,” says KPMG’s Mr McGrath. “The local banks refined their operations to take them on. It’s a really competitive market and the reality is that it’s not that big a market either.”

Strong brands

Among those that stayed are global giants Citi and HSBC. In February, Citi moved a step closer to fulfilling its ambition to be the leading credit card operator in the country, agreeing to take over management of Suncorp’s portfolio in a deal that allows the bancassurer to retain its brand on the cards themselves. HSBC, while ruling out developing a substantial branch network like rival HBOS, hopes to double its local customer base to one million by 2012, mainly concentrating on individuals and corporates that do increasing amounts of business and travel abroad.

Capitalising on Australia’s position as one of the world’s biggest exporters of commodities, Rabobank, the Dutch group, has developed a strong niche in its traditional specialism in food and agri-business. It has nearly 50 branches in Australia, mainly in rural areas that have been especially hard hit by the big four’s branch closures in the past decade. From this base, it is now pushing out into other areas, with its Raboplus initiative which, among other things, offers high interest savings accounts and low-cost, internet-based transaction accounts.

Analysts also single out ING Australia for its successful use of an internet banking model locally. It, too, has been offering high-interest savings accounts, as well as operating a significant fund-management operation.

The large international banks have had the benefit of a slightly lower cost of capital than that of their Australian peers. But these have been offset, when analysing their Australia balance sheets, by the local banks’ larger proportion of retail deposits, analysts say.

Local challengers have put great store on customer service, using efficient and friendly service to win business well beyond their traditional regions and in the big four’s heartland. As a result, Bendigo and BoQ are nationally ranked number one and two, respectively, in terms of customer satisfaction.

Bendigo Bank, which takes its name from a well-known historical gold mining, farming and wool town in the state of Victoria, has positioned itself as a community-based organisation. It now has branches as far afield as Clovelly (an upmarket beachside area in Sydney’s chic eastern suburbs), Alice Springs in Australia’s red centre, Fremantle (a port community south of Perth that is known for its restaurants and artists), and all over Queensland.

Effective campaigning

Similarly, one of BoQ’s most successful campaigns involved just two simple questions, placed above its logo: “Do you know your bank manager’s name” and “Do you know his number?”

“I think we are still just about the only bank with the phone numbers of every branch in the phone book,” says David Liddy, chief executive of BoQ. “Of course, with owner-managers they are basically there forever. So, that is a big point of differentiation.”

Traditionally, the regional banks have been strong in mortgage lending – some, notably St George, based in south Sydney, are former building societies. While this remains their mainstay, they have also been building up their business operations, although usually from a low base. BoQ, for example, has set up an equipment-leasing arm. And in its expansion onto the east-coast, BankWest’s first move was to hire 300 frontline business banking staff.

In the business segment, the key focus has been small and medium sized enterprises (SMEs). “By their nature, SMEs are the most open to challenger banks,” says Paul Bartholemew, a senior analyst at East & Partners, a Sydney-based banking consultancy. “They are after something different and have been a bit fed up with the big four’s negligence of the sector.”

That is changing, however. “The big four are becoming more focused on SMEs again,” says Mr Bartholemew. That is part of a broader fightback in the past year or so, he adds. As mortgage lending has become more subdued, the big banks have reinvigorated their business offerings, the area with the strongest credit growth.

“They are sick of leaking market share to smaller or international banks. They want their natural customers back,” says Mr Bartholemew. This will also prove difficult for the regional banks from a structural point of view, given their weighting towards home and consumer lending.

“Where regionals have done very well is in mortgages,” says KPMG’s Mr McGrath. “While the housing market was booming along, they were riding that wave. But looking forward, the biggest growth is in business lending. The majors absolutely dominate business lending so that’s going to make it a lot harder for the regionals to compete in terms of growth.

“The big banks have got scale. This is an advantage. There is pressure for scale, pressure to get costs down and for the regionals to come together,” he says.

Market pressures

Reflecting such pressures, last year there was a drawn-out consolidation battle for Bendigo Bank. Bendigo rejected a A$2.7bn-approach ($2.5bn) from BoQ, instead opting to merge with Adelaide Bank.

Although Australian banks have the advantage over their peers in the US, UK and continental Europe of holding negligible direct exposure to US subprime borrowers, they have become increasingly dependent in recent years on offshore wholesale markets to finance unusually strong local credit growth.

“[Australian banks] may not have direct subprime exposure but they borrow in those same markets,” says Brian Johnson, banking analyst at JPMorgan in Sydney. “They have not had enough pricing power to pass on the increases [in their borrowing costs to customers].”

They have also benefited from unusually low levels of bad debts, something that analysts query looking ahead. “Rising household bad debts (predominantly unsecured) are a primary concern, with Australian (and New Zealand) households now more leveraged than peers in the UK, US and Canada,” says Ross Brown, banking analyst at Deutsche Bank in Sydney.

Nevertheless, analysts say that banks, including the regionals, will benefit from the difficulties of some of the non-bank mortgage lenders which, lacking retail deposits, have been even harder hit by rising wholesale finance costs. The regionals believe that they will continue to reap the benefits of big investments and differentiating strategies, even if their growth might slow.

Opportunity to grow

“The key is that we’ve got a parent that is very willing and supportive and which will invest significantly, so we have the opportunity to grow,” says HBOS Australia’s Mr Willis. Even if the big four have improved their service, the smaller operators believe they still have the upper hand in this area.

“The small players will continue to grow. People will always refinance or change banks,” says BoQ’s Mr Liddy. “Our growth is not economically linked. It’s very much us getting customers from the big four. Most of our growth comes from them. All banks are pretty similar in terms of branches and products and the prices they offer. The key difference is service and I think we deliver that better than anyone else.”

BANK OF QUEENSLAND TAKES THE FRANCHISE ROUTEWhen David Liddy arrived at Bank of Queensland (BoQ) in 2001 as managing director after 33 years at Westpac, BoQ had a cost-income ratio of 79%, the smallest footprint and smallest customer base of any bank in the state. “Yet, we were the ones called ‘Bank of Queensland’. I had to get reach and scale and not blow our expenses beyond 79%,” says Mr Liddy, now also chief executive. The solution was to develop a franchise system and to build up a business banking arm from scratch to balance BoQ’s traditional mainstay in mortgage lending. Seven years on, BoQ has more than trebled the size of its network, and more than a third of its branches are now located outside its home state, while its corporate book has grown to about 40% of its balance sheet. At its last annual results announcement, it recorded a 22% rise in normalised net profits to A$106m ($98.2m) after growth in loans under management of 27% and retail deposits of 33%. Mr Liddy drew his inspiration from BoQ’s agency system. When he took the helm, about a third of the bank’s 91 outlets were agencies run by third parties but they were underperforming. “They looked like corporate branches, you would not have known the difference,” he says. “We moved that model to be incentivised on balance- sheet growth – assets and liabilities – rather than the number of transactions over the counter every day.” All new branches opened since then have been paid for by franchisees and the bank has, in the past two years, begun to convert corporate branches into the new model.As of early February, BoQ had 192 owner-managed branches, 77 corporate branches and 13 transaction centres. “On average, we’ve seen an increase in funding [balance-sheet growth] of around 70% [from converted corporate branches]. Same business, same location, same customer base – different management. We probably won’t convert all our own branches but, if they are not performing above system, they are candidates for conversion,” he says.Franchisees pay for all the establishment costs of a new branch, which represents an up-front investment of about A$400,000 in New South Wales and Victoria, key regions targeted by the group. Typically, BoQ identifies an area where it would like a branch and then finds a local operator with which it chooses the precise location. BoQ takes out the lease on the property, which is fitted out in a standard BoQ kit and sub-let to the operator. Owner-managers, most of whom are former employees of other banks, are responsible for staff, power and all the other fixed running costs.Engine room for growth“Basically, the bank shares net margin with them. We give them a share on a loan or deposit, plus we pay them a transaction type fee,” says Mr Liddy. “[The franchise system] has really been the engine room behind the growth of the bank. We are growing at 2.5 to three times the banking system and it is directly attributable to the performance of our owner-managed stores. “It makes a lot of sense. I don’t have to motivate these people to give good customer service at all. If they don’t get customers, look after them, grow them and, importantly, retain them, they don’t get financially rewarded. It’s a typical small business proposition. Look after your customers and create value.”Risk management is controlled at headquarters in that most lending is central. “We are like a factory. We provide them with product, brand and the credit criteria that go around lending decisions. Consumer credit is scored. So garbage in, garbage out. But the policies are sufficient so they will pick up  fraud, etc. We don’t really need to control service,” he says. “We have minimum standards and are trying to be number one in customer satisfaction; we are currently number two. The staff are motivated because they ‘live or die’ by whether they give good customer service.”So far, so goodAnalysts say that BoQ’s move into franchising has paid off handsomely – so far. “The issue is whether, as your network gets bigger, you can effectively manage all your franchisees, so that the service and servicing you provide is still outstanding,” says one commentator. “Any bank that has a bad manager can end up with a bad branch and reputational damage. But that risk is exacerbated when you have to deal with a franchisee who has bought in, rather than an employee that you can sack or redeploy.”The bank believes its system is unique. In Australia, Colonial First State had also experimented with franchises prior to its takeover by Commonwealth Bank in 2000 but had not developed as complete a franchising system as BoQ.“We looked at every sort of franchise but a bank is quite unique in that one of things you sell in a bank is credit,” says Mr Liddy. “You must have rigourous processes in place – I’m not saying you don’t in other areas – but in banking it is very severe.”The biggest lesson has been getting central staff to perform to the expectations of franchisees. “Head office staff have had to understand these are small business owners that are customers and they won’t put up with second class service. They provide support to franchisees that are demanding a far higher expectation of service.”Mr Liddy declines to reveal his targets but says the roll-out in opening owner-manager branches has peaked and that he intends to pursue further acquisitions. The bank failed in its attempt to merge with Bendigo Bank last year but did manage to acquire two building societies, including Home, which brought it a small but valuable footprint in the state of Western Australia which, with its resources-base, is leading the country’s economic boom, together with Queensland. “There’s no other bank in Australia that’s opened almost 200 branches in four years. We won’t be doing that magnitude again,” says Mr Liddy.He is clear that BoQ aims to be a “big small bank”, not a “small big bank”. “It is not about matching the majors in terms of footprint. It is about differentiating the way we deliver service. We don’t use brokers, we don’t use third party, we use our own people. It is a very effective distribution model.”

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