Australia's four biggest banks continue to get bigger, increasing their market dominance and making it harder for smaller banks to compete in the already consolidated industry.

This pressure on smaller banks is only set to increase once Australia and New Zealand Banking Group Ltd.'s A$4.9 billion purchase of Suncorp Group Ltd.'s banking arm goes through. The acquisition, announced in July, will be the country's biggest banking deal in more than a decade.

The combined assets of Australia's biggest banks — Australia and New Zealand Banking Group, or ANZ; Commonwealth Bank of Australia, or CBA; Westpac Banking Corp.; and National Australia Bank Ltd., or NAB — ballooned to A$4.291 trillion as of June 22 from A$3.928 trillion in the prior-year period, according to data from the Australian Prudential Regulation Authority. This makes up more than 72% of the A$5.951 trillion assets of the country's banking sector. Assets of all the other local banks added up to A$796.71 billion, putting them at a competitive disadvantage.

"The ability to leverage operating costs and access cheaper funding is key in a bank being able to generate attractive returns," Nathan Zaia, equity analyst at Morningstar told S&P Global Market Intelligence. "Scale is important."

The bigger banks can generate returns on equity above their cost of capital, "but for smaller banks it's tough given they have a funding and operating cost disadvantage," Zaia said.

Big getting bigger

Although the big four still compete among themselves, the high market concentration has been a concern for the Australian banking system. In recommending changes to the industry, the Royal Commission, which investigated misconduct in the nation's financial services industry between 2017 and 2019, stopped short of top-to-bottom reform, though it found irregularities and illegal practices by banks.

After the commission submitted its final report in 2019, the then chair of the Australian Competition and Consumer Commission, Rod Sims, said "a cosy banking oligopoly is surely at the heart of recent problems, so we must and will find ways to get more effective competition in banking." The competition watchdog declined to comment when contacted by S&P Global Market Intelligence.

ANZ's announced deal is expected to push it into third place among the country's banks in terms of mortgages and retail deposits, The Australian Financial Review reported July 18.

Shayne Elliott, ANZ's chief executive, said at the time that the deal will "improve competition" in Australia's Queensland state, a claim rebuffed by the chief of a smaller lender that operates in Queensland and New South Wales.

Elliott told the Australian Financial Review that the deal would help it better compete with the big players in the market, adding that "just as Suncorp probably feels dwarfed by ANZ, we feel dwarfed by CBA." ANZ's market share in the home loans market stood at 13.9% at the end of fiscal 2021, according to the bank's results. In comparison, CBA's market share in home lending stood at 25.1% as of June 2022, according to its full-year results. ANZ had been working on building up its market share in the important mortgage market after it missed the housing boom.

Nothing for competition

The deal, however, "will do nothing to promote competition and will further entrench the Sydney/Melbourne myopia in the banking sector," Heritage Bank CEO Peter Lock said in a July 18 statement. "The takeover of Suncorp by ANZ will simply increase the power of the major banks in Australia. It's even worse that we're losing a Queensland-based bank, and the different perspective that brings."

Heritage Bank referred to prior comments by their chief when asked for comment, while CBA, Westpac and NAB did not comment.

"The concentrated banking system in Australia affords material business and funding stability advantages to the four major banks, including in relation to their pricing flexibility, franchise, distribution, and diversity," said Sharad Jain, an analyst at S&P Global Ratings. "We reflect these advantages in our assessment that each of the major banks' business positions and funding profiles are better than those of the regional and other smaller lending institutions."

Lacking heft

Smaller regional banks lack the heft to compete with the big four, mostly because they can only access more expensive funding and have smaller marketing budgets.

For example, smaller banks lack the scale to access securitization funding, said Martin North, principal at Digital Finance Analytics. These banks do not have the "critical mass for securitization deals to fly," North said, adding that these lenders are also limited by ordinary bond offerings as they need to offer higher coupons to offset risks.

Efforts by the regulators to foster new entrants to the banking industry have met with mixed results. The Australian Prudential Regulation Authority announced rules in 2018 to allow online-only neobanks to start. Volt Bank was the first fully digital bank to be granted a restricted license in May 2018, and was followed by Xinja Bank, 86 400 and Judo Bank.

The neobanks were supposed to use technology and compete with the four majors, but only Judo from among the four survives. Xinja exited in 2020 after failing to control its spending, while 86 400 was bought by NAB in early 2021. Volt returned its banking license and shut down in June after it failed to raise sufficient funds.

Australian Prudential Regulation Authority Chair Wayne Byres said during a speech in May at the Financial Review Banking Summit that competition in the financial sector brings innovation and enhanced outcomes for customers. Byres noted that the "longer-term growth in the share of banking assets held by non-major banks — which was severely set back by acquisitions related to the global financial crisis the associated flight to quality — has recommenced in recent years as smaller players again attract a larger share of new business."

The prudential regulator did not offer a fresh comment when contacted by Market Intelligence.

"Smaller players and new entrants may continue to pursue specialties in niche areas or focus on offering new products as a means to differentiate themselves from heightened industry competition," said Darcy Gannon, analyst at IBISWorld, an industry and market research database firm. "Alternatively, smaller players may consider mergers with one another as a means of expanding in the industry without losing larger amounts of autonomy."