Times have changed. Does mutual banking need to change too?
Australia is one of the few developed markets to still have a large population of mutual banks, with more than 60 in operation. They serve more than 4 million Australians (19% of the country’s bankable population) and hold above $150 billion assets (approximately 3% of total assets across authorised deposit-taking institutions, ADIs).
About 150 years ago, groups of likeminded workers and communities started to come together to create credit unions, mutual banks and building societies. Their goal was to provide access for hard-working members to the loans that investor-owned banks were not willing to grant them. By connecting members with savings to members in need of financing, mutual banks pride themselves for keeping their members’ interests at heart with competitive rates, great personal service and bespoke products without being pressured by profit maximizing shareholders.
Times have changed. Does mutual banking need to change too?
With financial inclusion close to 100% today in Australia, accessing and switching banking services and products for retail customers has never been easier. More than 60% of adult Australians have more than one banking relationship, and 18% have switched their main financial institution in the last three years[1]. As a result, member-owned financial institutions’ promise around providing better financial inclusion to its member base has long gone.
At the same time customers’ expectations about how they interact with their banks are rapidly transforming. People want anytime-anywhere services and seamless digital transactional capabilities. Without sufficient front-end technology investments in the last 10 years, the source of differentiation for most mutual banks’ customer service has severely faded.
The only promise that mutual banks were able to preserve from their past, and genuinely adhere to today is their competitive pricing. As member-owned organisations, without strict return on equity expectations, mutual banks today are often placed in the leader board when it comes to the best mortgage or deposit rates.
But is that a sustainable model?
Scale, Growth, Capital – the harsh reality
The most obvious challenge that mutual banks face today is the lack of scale. Commonwealth Bank of Australia (CBA) has 50 times bigger loan book than the largest mutual bank, and that ratio quickly goes above 200 times for the 11th largest mutual. As banking operation is a fixed cost business – increasingly so for players with convoluted legacy technology infrastructure, sizable branch network and manual operations – economies of scale are vital. From every $1 revenue earned, a mutual bank retains after operational costs on average only 20 cents vis-à-vis major banks’ 50 cents. On an asset base 50-200 smaller than the big banks’, your annual investment budget as a larger mutual does not exceed $10-30 million compared to major banks’ $1-2 billion.
What can $10-30 million do for a bank these days? Well, not much.
With the sheer volume of new regulatory measures being introduced and increasing challenges around cyber security, the cost burden that mutuals face are disproportionately high. CBA invested more than $800 million in 2021 on risk and compliance initiatives alone.
If a mutual wants to meet growing customer expectations around seamless, fast digital services, personalised engagements and innovative products, then establishing state-of-the-art onboarding, loan origination and customer relationship management (CRM) systems with a shiny mobile banking app are non-negotiable items on its investment roadmap. Each of these elements represents a $5-20 million project, even before facing the critical core banking system replacements that most mutuals face today.
The only way to resolve the scale challenge is by growth. Either by growing organically (i.e. attracting and retaining customers with an increasing share of wallet) or growing the asset base via merging with other mutuals. Both routes take time, and success is not guaranteed.
Even if a mutual bank can develop a genuine set of customer value propositions and magically solve its technology challenges, the pace at which it can organically grow its assets is capped by its capital position. A bigger balance sheet requires proportionately bigger capital. Sourcing capital from market (via mutual capital instruments) is extremely expensive. The pace at which a mutual can internally grow its capital via annual profits is moderate [the sector had 5.3% return on equity (ROE) in 2022, and retained profits need to fund investments too, not purely asset growth].
Similarly, mergers take a long time and incur huge transformation costs before scale benefits and business synergies can be realized. Merging any of the two larger mutuals today will still lead to a relatively under-scaled ADI. The 40 smaller mutuals sitting in the long tail will hardly become targets for M&A, given their small size relative to the complexity and costs of mergers.
Competing against time
Mutuals need to find to scale faster. The Australian Prudential Regulatory Authority (APRA) has been quite vocal about the need for smaller mutuals to be consolidated, given their limited ability to survive during times of sever financial stress. It would only take one large-scale cyber-attack, or a systematic financial crime control gap in the sector, and the regulator will lose its patience and force the sector to consolidate.
Modern mutuals have an important role to play in Australia’s future banking landscape. With a differentiated identity, and a sound sustainable business model, they can provide an alternative to big banks. Five of the best 10 Australian banks based on customer satisfaction in 2022[2] were mutuals, while none of the big four brands made it to the top 10.
The next few years will determine if the sector can credibly and sustainably reimagine the purpose and sources of differentiation of modern mutual banking, and find a faster route to economies of scale. Until then, the boards of mutual banks have huge responsibility to proactively guide their organisations in the right direction.
Adam Flesch PhD – Senior Client Partner, Head of Financial Services Strategy at Publicis Sapient
[1] RFI Global market research, 2022
[2] Forbes World’s Best Banks 2022