Banking Agenda: Rising pressure

Banking Agenda: Rising pressure Australian major banks half year results 2016 May 2016

Overview ex t ern al p res s u res c o n t i n u e t o s h ap e t h e b an k i n g s ec t o r U n d erl y i n g c as h earn i n gs Average ret u rn o n eq u i t y T o t al $14.8b D ec reas e o f 2.5% ( t o t al o f al l f o u r b an k s ) 13.8% decrease o f 244 b as i s p o i n t s Net i n t eres t m argi n 2.02% decrease o f 1 b as i s p o i n t Bad d eb t ex p en s e I n c reas e o f 52% E s c al at i n g c o n c ern s ab o u t gl o b al an d regi o n al ec o n o m i c gro w t h rai s e q u es t i o n s ab o u t t h e s ec t o r s o u t l o o k. T h e b an k s w i l l c o n t i n u e t o rat i o n al i s e p o rt f o l i o s, s i m p l i f y o p erat i n g m o d el s, s t ren gt h en b al an c e s h eet s an d f o c u s o n b u i l d i n g c o re d o m es t i c b u s i n es s es. Bu t t h e q u es t i o n rem ai n s : Wh at w i l l d ri ve f u t u re gro w t h? T h e p as t s i x m o n t h s h ave b een c h arac t eri s ed b y s t o c k m ark et vo l at i l i t y, c o n c ern s o ver f al l i n g o i l p ri c es, an d i n d i c at i o n s o f s l o w i n g ec o n o m i c gro w t h i n Ch i n a an d o t h er em ergi n g m ark et s. Agai n s t t h i s b ac k d ro p, t h e b an k s 1 s h are p ri c es h ave c o n t i n u ed t o f al l f ro m t h ei r 2015 p eak s. External pressures are squeezing the banks performance. Profit growth continues to slow, under the influence of higher capital req u i rem en t s an d ri s i n g b ad d eb t c h arges. E vo l vi n g regu l at i o n i s l i k el y t o f u rt h er i n c reas e c ap i t al an d f u n d i n g c o s t s. Ad d i n g t o t h e ex t ern al p res s u res f o r t h i s h al f y ear, i n t ern al c o n d u c t an d c u l t u re i s s u es h ave b een ex p o s ed b y a s eri es o f high-profile allegations affecting all the banks. O n 3 rd M ay, t h e R es erve Ban k red u c ed t h e c as h rat e t o an h i s t o ri c l o w o f 1. 7 5%. T h i s f o l l o w s l o w er t h an ex p ec t ed inflationary pressures, amid Australia s continued transition to a b ro ad er b as ed ec o n o m y. T h e b an k s h ave m o ved q u i c k l y t o p as s o n t h i s red u c t i o n t o c u s t o m ers, b u t m ay f ac e f u t u re m argi n p res s u re f ro m t h e l o w er rat e. Figures throughout this report are calculated on the prior corresponding period unless otherwise stated. ANZ, NAB and Westpac s half year reporting periods ended on 31 March 2016. CBA s half year reporting period ended on 31 December 2015. Ban k s s h are p ri c e h i s t o ry ( p erc en t age c h an ge, average o f t h e f o u r m aj o r b an k s ) 0% - 5% - 10% - 15% - 20% - 25% - 3 0% - 3 5% M ar- 2015 M ay - 2015 J u l - 2015 S ep - 2015 No v- 2015 J an - 2016 M ar- 2016 S o u rc e: T h o m 5,500 4,500 3,500 2,500 1,500 S & P / AS X 200 s o n R eu t ers E I K O N, E Y an al y s i s Cas h earn i n gs ( p o s t t ax $ m ) Ban k s average 1 EY Banking Agenda: Half year results 2016 1. Unless otherwise specified, references to the banks in this publication refer to the big four Australian banks: ANZ, CBA, NAB and Westpac.

M M Ho m e O vervi ew R even u e Cap i t al an d l i q u i d i t y R O E Co s t t o i n c o m e As s et q u al i t y Weal t h an d i n s u ran c e Co n t ac t s Overview c o n t i n u ed I n t h i s i n c reas i n gl y c h al l en gi n g o p erat i n g en vi ro n m en t, c o s t discipline and finding ways to bring sustainable cost efficiencies t h ro u gh t ec h n o l o gy h ave b ec o m e t o p s t rat egi c p ri o ri t i es. Al s o at t h e t o p o f t h e b an k i n g agen d a i s h arn es s i n g t ec h n o l o gy i n n o vat i o n t o w i n m ark et s h are, p art i c u l arl y i n t h e ret ai l s p ac e. As the banks focus on creating simpler, more efficient customerc en t ri c o rgan i s at i o n s, F i n T ec h i n ves t m en t i s c o n t i n u i n g i n vari o u s f o rm s. FinTech b an k s m u s t l o o k f o r a c l ear p o i n t o f d i f f eren t i at i o n t o s u p p o rt gro w t h The rapid growth of the FinTech industry has become one of the biggest challenges for banks globally. Banks must respond logically to the resulting opportunities and threats, which include a new breed of nimble and efficient non-bank competitors with lean overheads and compelling offers. Ac c o rd i n g t o t h e EY FinTech Adoption Index, b an k s are i n ves t i n g i n c u s t o m er- f ac i n g t ec h n o l o gy t o w i n m ark et s h are an d s h are o f w al l et. I n a c o s t - c o n s t rai n ed en vi ro n m en t, c o l l ab o rat i o n w i t h t h e ri gh t F i n T ec h p art n ers c an b e a c o s t ef f ec t i ve p at h t o ac h i eve t h i s. Ho w ever, F i n T ec h i n ves t m en t req u i res a l o gi c al f o c u s t o d el i ver a c l ear p o i n t o f d i f f eren t i at i o n. Cu rren t l y, m u c h o f t h e i n ves t m en t aro u n d i n c u b at o rs an d ac c el erat o rs ap p ears t o b e ei t h er ad d i n g t o t h e ever- ex p an d i n g p o o l o f F i n T ec h s o r b ei n g c h an n el l ed t o w ard f u n d i n g s i m i l ar p ro j ec t s, p art i c u l arl y ap p s. Ban k s n eed t o t ak e a f res h l o o k at t h ei r i n n o vat i o n s t rat egy, as k i n g: Wh y are w e i n n o vat i n g? Wh at are w e i n n o vat i n g? Ho w s h o u l d w e b e i n n o vat i n g? Wh y d o c u s t o m ers u s e F i n T ec h? E as y t o s et u p an ac c o u n t o re at t rac t i ve rat es / f ees Bet t er q u al i t y o f s ervi c e Ac c es s t o d i f f eren t p ro d u c t s an d s ervi c es Bet t er o n l i n e ex p eri en c e an d f u n c t i o n al i t y o re i n n o vat i ve p ro d u c t s t h an t rad i t i o n al b an k 0% 10% 20% 3 0% 40% 50% S o u rc e: E Y F i n T ec h Ad o p t i o n I n d ex ( s u rvey res u l t s f o r Au s t ral i a) T h e s i m p l i c i t y i n vo l ved i n u s i n g F i n T ec h p ro d u c t s an d s ervi c es i s d ri vi n g ad o p t i o n 2 EY Banking Agenda: Half year results 2016

Revenue c o n t i n u i n g m o m en t u m Af t er en d u ri n g p eri o d s o f c o n t rac t i o n, n et i n t eres t m argi n s h ave s t ab i l i s ed o n an average b as i s, n o t w i t h s t an d i n g vari at i o n s b et w een t h e b an k s. T h i s h as b een ac h i eved b y re- p ri c i n g o f l o an s i n t h e b ac k b o o k an d t h e p as s i n g o n o f s l i gh t i n c reas es i n f u n d i n g c o s t s. T h i s c o u p l ed w i t h s o l i d c red i t gro w t h i s d ri vi n g t h e b an k s continued revenue growth. Mortgage repricing in the first quarter has started to flow through to net interest income. P res s u re p o i n t s rem ai n h o w ever, i n c l u d i n g i n c reas es i n f u n d i n g costs, low rates and fierce competition for business lending as h o m e l en d i n g gro w t h s l o w s. Havi n g rep ri c ed res i d en t i al m o rt gages, t h e b an k s h ave m o ved o n t o b u s i n es s l en d i n g p o rt f o l i o s. Bu t t h ere are l i m i t s t o h o w m u c h f u rt h er t h e b an k s c an go w i t h rep ri c i n g, es p ec i al l y i n l i gh t o f t h e c u t t o t h e c as h rat e. Bu s i n es s l en d i n g w i l l al s o s ee c o m p et i t i o n f ro m As i an b an k s, p art i c u l arl y f ro m J ap an an d Ch i n a, l o o k i n g t o b u i l d m ark et s h are an d F i n T ec h s, p art i c u l arl y at t h e s m al l er en d o f t h e l en d i n g m ark et. Al t h o u gh h o u s i n g c red i t h as s l o w ed, as regu l at o ry l i m i t s o n l en d i n g t o p ro p ert y i n ves t o rs t ak e ef f ec t an d s o m e m ark et s s t art t o c o o l, R es erve Ban k s t at i s t i c s i n d i c at e t h e s t ro n ges t gro w t h i n b u s i n es s c red i t s i n c e t h e G F C. Ho w ever, t h i s gro w t h o p p o rt u n i t y w i l l s ee c o m p et i t i o n f ro m F i n T ec h p l ay ers an d w i l l d ep en d o n business confidence and the health of the domestic economy. In this operating environment, banks will find it increasingly difficult to balance margin versus market share improvement. Net i n t eres t i n c o m e ( c as h b as i s $ m ) Net i n t eres t m argi n ( c as h b as i s ) 9 7 9 %,000 2. 2% 8,000 2. 1%,000 2. 0% 6,000 1. 5,000 1. 8% Cred i t gro w t h ( s y s t em c red i t gro w t h y o y, s eas o n al l y ad j u s t ed ) M S - M S - M S - M 12% 10% 8% 6% 4% 2% 0% ar- 2013 ep 2013 ar- 2014 ep 2014 ar- 2015 ep 2015 ar- 2016 Ho u s i n g c red i t o w n er o c c u p i er Ho u s i n g c red i t i n ves t o r Ho u s i n g c red i t Bu s i n es s c red i t S o u rc e: R es erve Ban k o f Au s t ral i a, E Y an al y s i s 3 EY Banking Agenda: Half year results 2016

Capital and liquidity w h at i s u n q u es t i o n ab l y s t ro n g? After major equity raisings in FY15, in the first half of 2016 the b an k s h ave rel i ed l argel y o n o rgan i c c ap i t al gen erat i o n ef f o rt s. T h ey are al s o w el l u n d erw ay i n s i m p l i f y i n g t h ei r b u s i n es s t o improve capital efficiency, through divisional restructuring, d i s c o n t i n u i n g l o w ret u rn b u s i n es s an d d i ves t i n g l o w ret u rn as s et s. T i er 1 c ap i t al rat i o s c o n t i n u ed t o i n c reas e o ver t h e h al f, n o w averagi n g 11. 9 %. A number of regulatory capital and liquidity issues were clarified i n 2015, b u t s everal rem ai n o n t h e agen d a. K ey am o n g t h es e f o r the Australian market is: What constitutes unquestionably s t ro n g? O t h er o u t s t an d i n g i s s u es i n c l u d e t h e s u i t e o f regu l at o ry proposals dubbed Basel 4, including the fundamental review of t h e t rad i n g b o o k ( F R T B) t o ad d res s l o c al m ark et ri s k req u i rem en t s, t h e n et s t ab l e f u n d i n g rat i o ( NS F R ), an d t o t al l o s s ab s o rb i n g c ap i t al ( T L AC). T h es e evo l vi n g regu l at i o n s are ex p ec t ed t o req u i re o n go i n g res o u rc es t o s u p p o rt i m p l em en t at i o n. O n t h e c ap i t al f ro n t, f u rt h er i n c reas es are l i k el y, w i t h n ew ru l es ex p ec t ed t o b e an n o u n c ed b y t h e en d o f t h e y ear. AP R A h as signalled somewhat higher 2 c ap i t al req u i rem en t s, b u t i m p l em en t ed o ver a t i m e f ram e t h at t h e regu l at o r b el i eves i s w el l w i t h i n t h e s ec t o r s c ap ac i t y t o ab s o rb. M o re w el c o m e h as b een t h e Bas el Co m m i t t ee s s t at em en t t h at i t will focus on not significantly increasing overall capital req u i rem en t s 3 in Basel 4 proposals. This apparent re-think on c ap i t al l evel s m ay res u l t i n t h e ab o ve c h an ges b ei n g c al i b rat ed t o avo i d a s u b s t an t i al c ap i t al i n c reas e. Al t h o u gh T L AC i s ai m ed at G - S I Bs, AP R A i n t en d s t o i m p l em en t i t s o m e f o rm f o r t h e m aj o r b an k s, as rec o m m en d ed b y t h e F S I. Ho w ever, E Y ex p ec t s a c au t i o u s ap p ro ac h gi ven t h e l o c al i m p l em en t at i o n c h al l en ges p res en t ed b y Au s t ral i an b an k s o f f s h o re f u n d i n g m o d el s. O n t h e f u n d i n g f ro n t, t h e NS F R w i l l b e an o t h er i m p o rt an t f ac t o r in determining the unquestionably strong issue. In line with Bas el 3, AP R A h as c al l ed f o r a f u n d i n g rat i o o f at l eas t 100%, w i t h t h e p o t en t i al f o r an ad d i t i o n al b u f f er. I n t h e l o n ger- t erm, m o re s t ab l e f u n d i n g req u i red u n d er t h e NS F R m ean s m o re ex p en s i ve f u n d i n g f o r t h e b an k s. I t m ay req u i re t h em t o at t rac t even m o re d ep o s i t s t h an u n d er t h e c u rren t L CR regi m e n o eas y t as k i n a l o w i n t eres t rat e en vi ro n m en t. T h b k s c o n c t h F R i l l t c o n s t n t o n i n c u m b p s o n t o c u s t o m h i i n t t o n l d i n e an are ern ed e NS w ac as a rai earnings and profitability. They warn that the extra costs rred ay e as ed ers as gh er eres rat es en g. T i er 1 Cap i t al 13. 00% 12. 00% 11. 00% 10. 00% 9. 00% 2. Wayne Byres, Chairman, APRA, Remarks for The Regulators panel, A50 The Australian Economic Forum, 29 January 2016 3. Basel Committee on Banking Supervision, Press release: Revised market risk framework and work programme for Basel Committee is endorsed by its governing body, 11 January 2016 4 EY Banking Agenda: Half year results 2016

ROE i n ves t o rs f ac e l o w er ret u rn s Maintaining stronger capital and funding profiles means i n ves t o rs w i l l l i k el y h ave t o ac c ep t a l o w er s et t i n g f o r R O E. R O E i s d ec l i n i n g an d al t h o u gh t h e b an k s average R O E o f aro u n d 14% i s at t h e h i gh er en d o f t h e s c al e am o n g gl o b al p eers, i t rem ai n s w el l b el o w t h e p re- G F C h i gh t een s i n ves t o rs w ere u s ed t o. I t i s u n l i k el y t o i m p ro ve d ram at i c al l y. D es p i t e b an k s s eek i n g t o o f f s et t h e i m p ac t o f h i gh er c ap i t al req u i rem en t s b y rep ri c i n g l o an p o rt f o l i o s, s t ri c t er c ap i t al ru l es, n arro w er m argi n s an d h i gh er b ad d eb t c h arges w i l l c o n t i n u e t o p u t p res s u re o n ret u rn s. P ay o u t rat i o s are al s o b ei n g s q u eez ed b y i n c reas ed c ap i t al n eed s, t h e c h al l en ge t o gen erat e R O E i n a l o w m argi n / h i gh c o m p et i t i o n en vi ro n m en t an d t h e i m p ac t o f i n ves t m en t i n t ec h n o l o gy o n t h e b an k s ab i l i t y t o red u c e o p erat i n g c o s t s. T h i s h as l ed t o h ei gh t en ed s p ec u l at i o n o ver p o t en t i al f u t u re d i vi d en d c u t s. R et u rn o n eq u i t y ( c as h b as i s ) 20. 0% 17. 5% 15. 0% 12. 5% 10. 0% 7. 5% 5 EY Banking Agenda: Half year results 2016

M Ho m e O vervi ew R even u e Cap i t al an d l i q u i d i t y R O E Co s t t o i n c o m e As s et q u al i t y Weal t h an d i n s u ran c e Co n t ac t s Cost to income i n n o vat i o n an d gro w t h p ro gram s c o n s t rai n c o s t i m p ro vem en t s Cybersecurity m o re t h an j u s t an I T i s s u e Co s t d i s c i p l i n e h as b ec o m e a t o p s t rat egi c p ri o ri t y, w i t h t h e b an k s p u l l i n g h ard o n a ran ge o f c o s t l evers. Ho w ever, el evat ed regu l at o ry an d c o m p l i an c e c o s t s an d t h e n eed t o i n ves t i n i n n o vat i o n an d gro w t h p ro gram s are red u c i n g t h e impact of efficiency initiatives. As a result, banking jaws for the h al f y ear h ave b een n egat i ve an d c o s t t o i n c o m e rat i o s h ave been close to flat or have risen. I n ves t i n g i n great er p ro c es s au t o m at i o n i s h i gh o n t h e agen d a. T h i s w i l l n o t o n l y red u c e c o s t s b u t al s o i n c reas e c o n t ro l, m eet regu l at o ry req u i rem en t s an d d el i ver en h an c ed c u s t o m er ex p eri en c e t o at l eas t m ai n t ai n m ark et s h are. T rad i t i o n al l y, t h e R O I o n au t o m at i o n i n i t i at i ves h as b een h i gh. T o d ay, i n a l o w er gro w t h en vi ro n m en t, b an k s w i l l n eed t o c aref u l l y c o n s i d er a m o re h o l i s t i c ap p ro ac h t o au t o m at i o n t o m ax i m i s e R O I. O n i n c i n t o m i o n t h n o l o s u c h b o t i c s c h l n t h t i t i o n b u s i n s c f o d i t i s i n b k i n o p i o n s d d i s p t i n o f f s h o n o o u t s o u i n t h n o l o m s b k s n t o f o c u s o n d i n t i n t h o f o o f t h f u t u T h i s i l l u i b k s t o m o f u l l i t h t h o f o o n h i n c i n l s o f t o m i o n m m f o t h p i c u l t h o s u n d i n l i n l n m u p c s i n go g ad van es au at ec gi es as ro are al en gi g e rad al es as e r gi g an g erat an ru g ri g r rc g models. The relatively high speed to benefit of many of these ec gi es ean an eed, an ves, e w rk rc e e re. w req re an en gage re y w ei r w rk rc e w at reas g evel au at ay ean r em, art arl y e ert ak g ro es vo vi g an al ro es g. Co s t t o i n c o m e ( s t at u t o ry ) 55% 50% 45% 40% T o u c h i n g o n al l areas o f b an k i n g, c y b ers ec u ri t y i s t ak i n g u p an i n c reas i n g p erc en t age o f b an k s I T b u d get s. Ban k s n eed a c o m p reh en s i ve c y b ers ec u ri t y s t rat egy t h at i n t egrat es w i t h al l t h ei r d i gi t al s t rat egi es. R at h er t h an ad d i n g o n c y b ers ec u ri t y at t h e en d o f t h e d i gi t al t ran s f o rm at i o n p ro c es s, d i gi t al as s et s s h o u l d b e b u i l t o n t h e t o p o f a h o l i s t i c c y b ers ec u ri t y p l at f o rm. T h i s en ab l es d i gi t al as s et s t o b e s ec u red agai n s t c y b ers ec u ri t y ri s k f ro m t h e o u t s et an d rem ai n p ro t ec t ed i n a c o n t i n u al l y evo l vi n g c y b er en vi ro n m en t. an agi n g c y b ers ec u ri t y ap p ro p ri at el y i s n o t o n l y c ri t i c al f o r p ro t ec t i n g s h areh o l d ers i n t eres t s, i t i s al s o an i m p o rt an t p art o f t h e c u s t o m er ex p eri en c e. Cu s t o m ers are h i gh l y c o n c ern ed ab o u t t h e s ec u ri t y o f t h ei r p ers o n al i n f o rm at i o n and financial assets held by their banks. Strong c y b ers ec u ri t y c red en t i al s en h an c e t ru s t an d i m p ro ve a b an k s val u e p ro p o s i t i o n. I t i s eq u al l y i m p o rt an t i n b u i l d i n g t ru s t w i t h regu l at o rs, b u s i n es s p art n ers an d s u p p l i ers, w h o are al s o i n c reas i n gl y f o c u s ed o n t h e c y b er res i l i en c e o f t h e financial services providers they engage with. 6 EY Banking Agenda: Half year results 2016

Asset quality t h e c red i t c y c l e h as t u rn ed I n t c o l l t i p s i o n d t b k s l b t h b i c i t n m t h h p k i m p t c h t h b o t t o m o f t h c c l t t h d o f t h m i n i n b o o m t h d o n t u i n c o m m o d i t p c d l s o f t o n o m i c n m t n o c h l n s q u i t. rec en y ears, ec ve ro vi rel eas es an w ri e- ac, en ab ed y e en gn red en vi ro en, ave el ed eep ai rm en arges at e e y e. Bu e en e g, e w rn y ri es an a gen eral y er ec en vi ro en are w al en gi g as et al y No n - p erf o rm i n g l o an s h ave s h o w n a great er u p t i c k t h i s h al f y ear, suggesting the credit cycle has finally turned. This has been m ark ed b y h o m e an d p ers o n al l o an s l o s s es i n t h e res o u rc es s t at es o f Wes t ern Au s t ral i a an d Q u een s l an d an d b y a n u m b er o f i n d i vi d u al c o rp o rat e ex p o s u res. O t h er p o t en t i al areas o f c o n c ern are: Dairy exposures in New Zealand as falling dairy prices start to i m p ac t as s et q u al i t y ; Commercial property in selected markets experiencing flat ren t s an d i n c reas i n g vac an c y rat es ; an d S o f t en i n g d em an d f o r ap art m en t s i n areas t h at h ave s een significant growth in supply. I n c reas ed c o m p et i t i o n an d t h e q u es t f o r gro w t h, p art i c u l arl y i n t h e b u s i n es s an d i n s t i t u t i o n al b an k i n g arm s, m ay h ave res u l t ed i n l o o s er c o ven an t s f o r s o m e f ac i l i t i es. Af t er m an y y ears o f o p erat i n g i n a l argel y b en i gn c red i t en vi ro n m en t, c red i t ri s k i s l i k el y t o gai n great er p ro m i n en c e aro u n d t h e b o ard ro o m t ab l e an d t h i s c o u l d t es t t h e b an k s c red i t f u n c t i o n s i n t h e f u t u re. Ho w ever, t h e i n c reas e i n n o n - p erf o rm i n g l o an s i s o f f a very l o w b as e, w i t h l i t t l e evi d en c e o f s y s t em i c ri s k gi ven s u b d u ed c red i t gro w t h an d c o n s ervat i vel y l everaged c o rp o rat e b al an c e s h eet s. Bad d eb t c h arges ( s t at u t o ry ) ( $ m ) 1,000 7 50 500 250 R at h er, n o n - p erf o rm i n g l o an rat es are n o rm al i s i n g af t er a p eri o d o f u n u s u al l y l o w l evel s an d t h ey are i n p o c k et s rat h er t h an ac ro s s t h e b o ard. Wh i l e Au s t ral i a s h i gh h o u s eh o l d d eb t l evel s m ay m ak e h o u s eh o l d s vu l n erab l e t o i n c reas es i n i n t eres t an d u n em p l o y m en t rat es, t h e b an k s h ave i m p ro ved c ap ac i t y t o ab s o rb b ad l o an s t h ro u gh t h ei r s t ro n ger c ap i t al p o s i t i o n s. Specific provisions ($m) 2,000 1,600 1,200 800 400 Co l l ec t i ve p ro vi s i o n s ( $ m ) 3,250 3,000 2,7 50 2,500 7 EY Banking Agenda: Half year results 2016

Wealth and insurance s o l i d res u l t s D es p i t e t h e i m p ac t o f vo l at i l e i n ves t m en t m ark et s, t h e b an k s w eal t h an d i n s u ran c e o p erat i o n s rep o rt ed gen eral l y s o l i d res u l t s. Co n t ri b u t i n g f ac t o rs i n c l u d ed l i f e i n s u ran c e rep ri c i n g, i m p ro ved l ap s e rat es, l o w er gen eral i n s u ran c e c l ai m s an d gro w t h i n p ri vat e w eal t h f o r s o m e o f t h e b an k s. As an t i c i p at ed, t h e b an k s are d i ves t i n g an d res t ru c t u ri n g c ap i t al i n t en s i ve w eal t h o p erat i o n s as t h ey l o o k f o r w ay s t o f ree u p c ap i t al an d i m p ro ve ret u rn s. F u rt h er d i ves t m en t s m ay f o l l o w, w i t h As i an b u y ers rep o rt ed l y ex p res s i n g i n t eres t i n Au s t ral i an w eal t h an d i n s u ran c e b u s i n es s es. As p art o f revi s i n g t h ei r w eal t h o p erat i o n s, t h e b an k s are f u n d am en t al l y c h an gi n g t h ei r o p erat i n g m o d el s t o h ard w i re c u s t o m er c en t ri c i t y i n t o t h e w ay t h ey w o rk. T h e b an k s vert i c al l y i n t egrat ed m o d el s are b ei n g c h al l en ged b y c o n t i n u ed rem ed i at i o n o f ad vi c e m o d el s, l o w c o s t o p erat o rs an d t ec h n o l o gy. T h e i n c reas ed f o c u s o n c o n d u c t an d c u l t u re h as reignited debate over how to manage conflicts of interest and ac t i n t h e b es t i n t eres t s o f t h e c u s t o m er. R ec en t t u rb u l en c e i n t h e ad vi c e i n d u s t ry, c o u p l ed w i t h an i n c reas i n gl y en gaged an d d i gi t al l y - aw are p u b l i c, h as c reat ed t h e p erf ec t en vi ro n m en t f o r d i gi t al d i s ru p t i o n. T ec h n o l o gy, i n t h e f o rm o f ro b o ad vi c e, h as a k ey ro l e t o p l ay. F ro m AS I C s standpoint, adviser-led roboadvice tools could significantly i m p ro ve t h e q u al i t y o f ad vi c e. I f c u s t o m ers c o n t i n u e t o rat e q u al i t y h i gh l y an d AS I C s t art s s eei n g m eas u rab l e i m p ro vem en t s, the wealth management industry and financial advice profession will benefit in the long run. Weal t h o p erat i n g earn i n gs ( $ m ) 1,800 1,400 1,000 600 200 8 EY Banking Agenda: Half year results 2016

Market conduct and risk culture re- b u i l d i n g t ru s t T h e c o n t i n u ed c o n d u c t an d c u l t u re s c ru t i n y o n b an k s h as s t ep p ed u p an o t h er n o t c h. T h e b an k s h ave b een h i t w i t h a s eri es o f high-profile conduct matters. These have included alleged bank bill swap rate manipulation, industry-wide reviews into life insurance claims practices and ongoing financial advice service delivery and charging, and fines and remediation for responsible lending and credit card limit increase practices. The compensation of customers for poor financial advice in wealth management b u s i n es s es c o n t i n u es. AP R A an d AS I C w i l l c o n t i n u e t o p u s h b an k s t o d evel o p c u s t o m er- an d ri s k - c en t ri c c u l t u res t o c reat e a l o n g- t erm s o l u t i o n t o c o n d u c t i s s u es i n t h e s ec t o r. T o t h i s en d, AP R A i s ex p ec t ed t o rel eas e an i n f o rm at i o n p ap er i n t h e c o m i n g m o n t h s f o l l o w i n g i n i t i al i n d u s t ry en gagem en t. I n Ap ri l, t h e F ed eral G o vern m en t rel eas ed a $ 127 m ref o rm p ac k age d es i gn ed t o s t ren gt h en AS I C an d an n o u n c ed t h e introduction of an industry funding user pays model from 2017. This announcement substantially bolsters ASIC s authority, res o u rc es, an d s u rvei l l an c e an d en f o rc em en t c ap ab i l i t i es. AS I C w i l l al s o h ave an ad d i t i o n al Co m m i s s i o n er w i t h ex p eri en c e i n t h e prosecution of financial crimes. The package will further focus the industry on its commitment to rebuild trust and confidence i n b an k s. I f el ec t ed t h i s y ear, t h e F ed eral O p p o s i t i o n h as p ro m i s ed a R o y al Co m m i s s i o n. T h e p ro p o s al h as d raw n a m i x ed res p o n s e, w i t h concerns it may undermine Australia s global reputation as a strong and well-regulated financial system, duplicate the work of t h e F i n an c i al S y s t em I n q u i ry, an d d el ay o r n o t res u l t i n c u s t o m er c o m p en s at i o n. T h e Au s t ral i an Ban k ers As s o c i at i o n rel eas ed i t s s i x p o i n t p l an t o s t ren gt h en c o m m u n i t y t ru s t, i n c l u d i n g an i n d ep en d en t revi ew o f p ro d u c t s al es c o m m i s s i o n s an d p ro d u c t b as ed p ay m en t s. O t h er ac t i o n s go t o i m p ro vi n g c u s t o m er c o m p l ai n t s h an d l i n g an d b et t er s u p p o rt i n g w h i s t l e- b l o w ers. T h e s p o t l i gh t o n c o n d u c t an d q u es t i o n s o f t ru s t h i gh l i gh t t h e n eed f o r t h e b an k s t o f o c u s o n d evel o p i n g a t ru l y c u s t o m c en t red c u l t u re. er 9 EY Banking Agenda: Half year results 2016

Contacts Tim Dring Ban k i n g & Cap i t al M ark et s L ead er O c ean i a Tel: +61 3 9288 8054 t i m. d ri n g@ au. ey. c o m Rowan Macdonald M an agi n g P art n er, F i n an c i al S ervi c es O c ean i a Tel: +61 2 9248 4019 ro w an. m ac d o n al d @ au. ey. c o m Gerard Dalbosco P art n er, F i n an c i al S ervi c es Tel: +61 3 9288 8658 gerard. d al b o s c o @ au. ey. c o m Stephen Jack P art n er, F i n an c i al S ervi c es Tel: +61 2 8295 6636 s t ep h en. j ac k @ au. ey. c o m Andrew Price P art n er, F i n an c i al S ervi c es Tel: +61 2 9248 5946 an d rew. p ri c e@ au. ey. c o m James Roberts P art n er, F i n an c i al S ervi c es Tel: +61 2 9248 5424 j am es. ro b ert s @ au. ey. c o m E Y As s u ran c e T ax T ran s ac t i o n s Ad vi s o ry About EY E Y i s a gl o b al l ead er i n as s u ran c e, t ax, t ran s ac t i o n an d ad vi s o ry s ervi c es. T h e i n s i gh t s an d q u al i t y s ervi c es w e d el i ver h el p b u i l d t ru s t an d c o n f i d en c e i n t h e c ap i t al m ark et s an d i n ec o n o m i es t h e w o rl d o ver. We d evel o p o u t s t an d i n g l ead ers w h o t eam t o d el i ver o n o u r p ro m i s es t o al l o f o u r s t ak eh o l d ers. I n s o d o i n g, w e p l ay a c ri t i c al ro l e i n b u i l d i n g a b et t er w o rk i n g w o rl d f o r o u r p eo p l e, f o r o u r c l i en t s an d f o r o u r c o m m u n i t i es. E Y ref ers t o t h e gl o b al o rgan i s at i o n an d m ay ref er t o o n e o r m o re o f t h e m em b er f i rm s o f E rn s t & Y o u n g G l o b al L i m i t ed, eac h o f w h i c h i s a s ep arat e l egal en t i t y. E rn s t & Y o u n g G l o b al L i m i t ed, a U K c o m p an y l i m i t ed b y gu aran t ee, d o es n o t p ro vi d e s ervi c es t o c l i en t s. F o r m o re i n f o rm at i o n ab o u t o u r o rgan i s at i o n, p l eas e vi s i t ey. c o m. 2016 Ernst & Young, Australia. Al l R i gh t s R es erved. APAC No. AU00002625 E D No n e S1629288 T h i s c o m m u n i c i o n p d i n f o i o n h i c h i s c u t t h t i m o f p d u c t i o n. T h i n f o i o n c o n t n i n t h i s c o m m u n i c i o n d o n o t c o n s t i t u t c d s h o u l d n o t b i o n s u c h. P f s i o n c s h o u l d b s o u t p o t o t i o n b n t i n i c o n o f t h i n f o i o n. E s t & Y o u n d i s c l m s l p o n s i b i l i t d l i i l i t ( i n c l u d i n i t h o u t l i m i t i o n f o d i t o i n d i t o c o n s u t i c o s t s l o s s o d o l o s s o f p f i t s ) s i n f m t h i n d o n o o m i t t t o b d o n b p i n i c h h h o l l o p i l o n o f t h i n f o i o n. p t h i o n t h i n f o i o n d o s o i t s o n s k. L i i l i t l i m i t b s c h p u n d P f s i o n S t d s L s l i o n. at ro vi es gen eral rm at w rren at e e ro e rm at ai ed at es e ad vi e an e rel ed as ro es al ad vi e e gh ri r an y ac ei g ak en rel an e an y e rm at rn g ai al res y an ab y g, w at, r an y rec r rec r eq en al, r am age r ro ari g ro an y g e r ed e e y an y art y rel an e, w et er w y r art al y, an y e rm at An y art y at rel es e rm at es at w ri ab y ed y a em e ap ro ved er ro es al an ard egi at ey. c o m / au 10 EY Banking Agenda: Half year results 2016