No Let-up Yet For Mcfarlane

John McFarlane from ANZ demonstrated clearly yesterday that market share was not the only driver of bank profits, with a result for the year that featured a 17.2 per cent return on shareholders' equity and an 18pc improvement in net earnings.

Perhaps the most impressive part of this result is not the fact that the company has reduced its risk profile which, since McFarlane joined has been his stated objective but that the bank has made serious inroads into the home loans market.

Over the past year, ANZ has captured 23pc of all new mortgages in home lending and has picked up more than its market share of credit cards.

At the same time it has taken its cost-to-income ratio down from 60.9pc to 55pc and is on track to lower this to 53pc.

While National Australia Bank will report its earnings today, it is probably fair to say that on the home-loan front NAB and St George have been the more sluggish competitors.

While all the major banks have been working on staff reductions and branch closures as a means to reduce costs, the next major leg in this strategy is technology.

The Commonwealth is considered the leader in technology and Internet usage and the NAB is said to be at the bottom of the pack it only last week announced its Concert alliance with AT&T and BT.

The use of the Internet has two major components: the first is to home in on customers and provide the banks with a very detailed profile of each one and tailor products to their needs.

The second is simply to enable the cost-cutting exercise to operate at a new level. It could be a few years away yet but the general idea is that unified systems will allow the elimination of layers of transactions.

If one can make a fairly crude analogy, it would be the equivalent of a bar code on a product being scanned and the manufacturer being instantaneously aware that the shelves needed to be restocked. It's about cutting out the administration in the middle and with it the costs.

All the banks are on the same bandwagon in this regard. This has been embraced faster by some but the difference between the first and the last is maybe two years and, in the medium to longer term, this will not matter greatly.

Similarly, there has been a strong emphasis in the financial community on the banks entering online stockbroking. This is merely another product, albeit one that lends itself to the Internet more readily.

So what is it that differentiates ANZ from its pack? Where some banks look at volume of customers to run through its infrastructure, the ANZ cannot.

In part this is because for the ANZ to align its customer base with that of its major competitors would be a very costly exercise.

The thrust of some others has been to leverage off the customer base and try to sell as many products as possible.

Again this does not quite accord with the ANZ.

Each of the ANZ's customers is looked at in terms of the economic value-added model. In other words, each one has to return more than the ANZ's cost of capital (15pc) to cut the grade. If they don't their product will be repriced.

Every bank wants the multi-product high-value-added customer but the ANZ needs them and probably drives harder to get them.

The challenge for McFarlane, however, is growth. Technology will get costs down and milking the worthwhile customer base will improve income but there is a limit.

And it must be remembered that against this backdrop there is a long way to go in the margin squeeze for domestic loans. While the interest margin reported yesterday was slightly better than in the previous corresponding period, the Australian and New Zealand interest rate margins were down and will no doubt continue to go down, as they will for all banks.

So the issue for McFarlane is how to drive medium-term earnings given absolute volume growth is not the short-term answer. The first and most obvious possibility is to achieve cost cuts through sharing of back office costs like processing or front office functions like branches.

Westpac, which has huge mortgage processing abilities through its SA processing centre, has already tried to do this with limited success.

Indeed the ANZ was one of its first targets. However, the ANZ decided it could undertake this function more cheaply on its own.

The other option, of course, is via a merger with, say, the NAB.