Returns to Scale in Mutual Banking

Is scale the pathway to success?

Takeaways

• The mutual banking sector is struggling in a highly competitive Australian Banking market
• Mutuals can be successful – and international comparators (e.g. the UK) show this
• High compliance and change demands disproportionally impact smaller players who have a restricted capital base and poor operating performance
• Mergers will continue, but scale benefits must be realised – noting also that these mergers can often be seen as unpalatable
• Embracing points of difference provides a critical pathway to relevance – with the only alternative being the demise of the organisation

Mergers will continue, yet the returns from scale due to merger are unclear

Customer-owned banking has a long history of providing accessible services for those often excluded from mainstream banking. The persistence of a model focused on member service demonstrates a clear need and value in the mutual-bank concept.

But many mutuals in Australia suffer from a bi-modal customer base – an older “rusted on” cohort, which is loyal but often unprofitable, as well as transient younger adults & students who often switch quickly to providers that offer a better digital experience at a lower price, particularly when it comes to core lending needs.

Compound this core customer issue with materially higher investment demands to meet increasing compliance, cyber, digitisation and regulatory capital & liquidity requirements, and it is no surprise that smaller mutuals with a restricted capital base and relatively poor operating performance are struggling to survive.

Mutuals have responded by merging in order to access scale and a larger capital base that can defray these costs. In the 1970s Australia had more than 600 registered credit unions and building societies. As of 2024, there were ~60 mutual banks holding ~5% of the market.

• Despite significant merger activity in the sector in order to build scale over the last 50 years, market share captured by mutuals has remained largely unchanged at ~5%.
• In contrast mutual banks in the UK hold ~30% share of mortgages and ~35% of all retail savings.

Can mutual banks in Australia stay relevant?

Greater market share is not yet mapping to higher returns

‘Bigger is usually better’ is a classic business axiom. In most industries, there is a strong correlation between a high relative market share (RMS)¹1 and profitability. Figure 1 clearly shows this relationship for banking participants in Australia against the consolidated position for mutual banks using return on equity (RoE) as the measure of profitability.

The mutual banking sector is a clear laggard with an aggregate RoE of 4.7% vs a market average of 10.9%.

Figure 1: RoE vs relative market share within the Australian Banking sector (2023).

Scale for the sake of it?

Recent significant “mergers of equals” including Newcastle Permanent Building Society & Greater Bank and Heritage Bank & People’s Choice Credit Union in 2022 have created new market-leading entities. 

Higher returns might be expected of these entities.  This is not what was observed in 2023. Figure 2 below suggests a negative correlation between size and return across the sector.  It is important to note that it is early days for some of these merged entities – and yet, the figures suggest there is more work to be done.

Figure 2: RoE vs relative market share Mutual Banks in Australia (2023).

Results don’t appear to be playing into profits – yet.

A comparison of the pre- and post-merger performance of these recent large mergers suggests that the process of merging has negatively impacted profitability². Again, it is important to note there is more work to do with some of these mergers in terms of post merger integration – but initial analysis is worthy of further investigation.

Figure 3: RoE of selected merger participants vs sector averages (2020, 2023).

The principles of mutuality mean that many member-owned banks do not share profit as their primary motivation (despite the clear need for surplus for re-investment).  However, APRA’s increasing focus on capital adequacy makes efficient capital management an increasingly challenging goal.  In addition, higher profitability enables greater re-investment to meet evolving regulatory requirements & customer needs.

Despite this lack of clarity of return, scale and change are inevitable

Next steps

Consider a half-day facilitated workshop to explore strategic options

1. Relative market share (RMS) for the market leader is calculated in relation to the #2 player; the RMS for all other players is calculated in relation to the market leader. ↩︎
2. We recognise that the relative under-performance of recently merged entities may be due to operational complexity post-merger, with synergy benefits yet to be realised. ↩︎