Question

The ROE for Australia’s four largest banks for the year 2019 is respectively 13.80% (CBA), 10.40% (Westpac), 11.70% (NAB) and 11.90% (ANZ)?

Required:

1. There is little variation in the magnitude of the ROE’s between the banks. Provide an economic explanation for why (2 Marks)?
2. The magnitude of the ROE’s for the banks is approximately what should be expected (the long-run share returns is 10 to 12%). Why may there be less accounting bias in reporting on the ROE of banks than for firms in other industries (3 marks)?

Answer 1

ROE is the return on equity wherein the Net income is divided by the Shareholders equity.

A. There is little variation between the magnitude of the ROE between the banks because banks often set targets for ROE to be maintained at a particular level. Plus as per the central banks directions, they often have to maintain their revenue as banks are an integral part of the economy because they hold savings of the citizens, if their targets or not met, they may have to liquidate their assets, or seek more debt in order to maintain the respective level of ROE. Plus banks often can't lend beyond a certain extent of their assets which is why there is little variation between banks ROE.

B. Banks have a central authority which overlooks each and every aspect of the overall banking system, if there is an accounting bias it may lead to cancellation of licenses as banks invest people's savings. Australian central bank is Reserve Bank of Australia which overlooks such cases, if there is a discrepancy found than the licenses are often cancelled, firms in other industries invest with their own savings or shareholders capital and often report accounting bias because they don't have any central authority who can cancel their license. Plus other firms have different working cycles wherein their revenue might decline because of cyclicity, which acts as a base to account for any discrepancy.