The profitability of the major Australian banks may be marginally higher than that required to provide bank shareholders with a fair return on their investment in bank shares, analysis by the Australian Centre for Financial Studies suggests.
Kevin Davis, research director at the ACFS, yesterday published a
paper that centres on the market-to-book ratios of the major banks (that is, the stock market value of equity relative to the book value in each bank's balance sheet).
For the four major banks this ratio ranges from 1.3 for National Australia Bank to 2.1 for Commonwealth Bank, with an average of 1.5 times for all the four banks.
A ratio of this order is "indicative of some inadequacies in competition", Davis wrote in the discussion paper.
Davis speculates in the paper that the sustained price-to-book ratios of the major banks are the decisive factor in the quest by the boards and management of those banks to realise returns on equity of at least 15 per cent and preferably greater.
He argues that bank managers are seeking to ensure that investors in bank shares are seeking "a ball park rate of return (including franking credits) of around 11 to 12 per cent."
A 15 per cent accounting return on equity for the major banks is "quite possibly" consistent with the rate of return required by shareholders, Davis wrote.
Davis also reviews arguments over whether banks' share prices reflect barriers to entry in banking or are justified by the "franchise value" in large banks' operations, including their lower cost of funds.
Davis concludes that bank returns "may be somewhat higher than is consistent with fierce competition", but he goes on to say that "the important message is that by focusing on accounting returns the debate may be looking in the wrong place.
"Instead, more attention should be paid to why market to book ratios for the major banks are (and have been for some time) at levels well in excess of unity."