Discover how the shift from Low for Long to higher interest rates can create new financial opportunities for banking, private credit, super funds, and the net-zero transition in Australia.

Watch more from the New Monetary Order Video Series and discover how financial institutions are adapting to the evolving monetary landscape.

Kate Coffey

Hi, I'm Kate Coffey and I'm a senior consultant at Oliver Wyman based in our Sydney office, and I'm joined today by Ross Eaton, who's a partner in our financial services practice and co-author of the New Monetary Order report. Thanks so much for being here today, Ross.

Ross Eaton

Thanks for having me, Kate.

Kate

Ross, you've been leading Oliver Wyman's analysis of the New Monetary Order. Would you mind sharing a bit about what it is and why it's important?

Ross

The New Monetary Order refers to the sudden increase in interest rates we've had since 2022 from where they went near zero to more normal levels that they're at today. Now, the context for this is if we go back to the global financial crisis, we saw the Reserve Bank of Australia and other central banks around the world cut interest rates in response to the crisis.

In Australia we saw rates then gradually decreasing for the next 15 years until they hit effectively zero right after COVID. Now, Australia's not alone in this phenomenon. In other markets like the US, Canada, Europe and the UK, we saw rates cut to near zero levels and essentially stay at zero or close to zero for that entire time.

We call this period the Low for Long, and so our New Monetary Order report investigates the distortions that have happened with the monetary and credit system as a result of this Low for Long period and how economies and the credit system might fare now that we're suddenly reverting to more normal rates.

Kate

What do you see are the key opportunities and risks that are emerging as a result of the changes to monetary policy and regulation in Australia?

Ross

I'll start with the risk side. The most obvious thing that's been widely reported is the impact of higher interest repayments on households and businesses. There's a lot of strained balance sheets right now, and in particular if we look at the household sector here in Australia, it's heavily indebted. We've got large mortgage balances combined with a sudden increase in mortgage repayments and therefore households are doing it tough. Now, we're seeing credit losses edge up slowly. We haven't seen anything catastrophic yet, but it remains to be seen.

If we look at the opportunity side, there's three things I'd like to call out. Firstly, on the banking side, what we've seen with the sudden increase in interest rates most recently is initially we saw NIM expansion, so banks having higher net interest margins, that's quickly been eroded away due to competition on both the lending side and the deposit side. But what we've seen is a slowdown in mortgage growth and an increase in business lending. After spending a long period of time concentrating their balance sheets excessively, some would argue in mortgages, we're now seeing banks able to revert to a more diversified balance sheet. Because business lending is more profitable on a return on equity basis, that should help to bolster bank profitability.

The second area we call out in the report is private credit. Private credit is lending to companies by non-banks, and this is a very active space. We estimate there are a hundred participants in the market in Australia in terms of both private credit funds and those investing in the space. And there's a lot of hype around this at the moment as banks run into challenges where there are areas where their appetite doesn't allow them to lend or there are other niche specialties where they're not serving customers, that provides an opportunity for private credit funds. We've seen that space growing and we predict it will continue to grow.

The third major space is super funds. We look at the super fund industry, we've seen that grow very rapidly throughout our lifetimes and in particular in the last 10 or 15 years, and it may surpass the total size of the banking market here in Australia within the next few years. Now, super funds, as well as being large, have also signaled a desire to allocate more of their money to alternative investments, including private credit. If we see an increase in demand for private credit, we will also see super funds be able to allocate more of their funds there.

Kate

Yeah, the growth of super funds in Australia over the last decade or so has been fascinating and I'm interested to see how that plays out. I'm also interested to understand how you see the net zero transition is likely to interplay with the new monetary order.

Ross

The net zero transition will require a staggering amount of money. Estimates are in the order of a few trillion dollars for the Australian economy between now and 2050. That's a massive amount of investment that's going to be required. Now, traditional bank lending will not be able to meet the needs of that because a lot of these investments are early-stage technologies, speculative investments that have a high risk, high reward profile, and that's outside of the appetite of traditional bank lending.

We are going to need to see venture debt providers, private credit players, and also equity providers making investments to support all that. The other area we've seen in the most recent Labor Budget is a desire from the government to play a more active role in steering capital into the economy for this purpose and achieve the nation's net zero goals, so we may see more of that in future as well.

Kate

Yeah, absolutely. Given the Opposition's recent announcements around nuclear energy and their plans, it could be interesting as well to see how that goes. Do you have any advice for financial institutions in Australia going forward in this new environment?

Ross

There are a number of scenarios that we call out in the paper, and depending on the scenario, there'd be various plays that could be advantageous or disadvantageous, but three things to call out that we think will be advantageous regardless of scenario.

The first is investing in customer experience and digital processes. Customers more and more are expecting seamless digital interactions with their financial services providers and there's a lot of investment going into that and that needs to continue. Secondly, investing in digital processes can not only help improve the customer experience, but can also help to reduce cost. In an environment where banks increasingly have returns that are closer to utilities than where they once were, a key lever for improving profitability is building scale and reducing cost, and you need the digital processes to support that.

The second one is being more flexible with balance sheets. Capital and liquidity are finite, and in a world where there's going to be increased demand for credit, banks are going to have to get a bit more creative. Originate to distribute models and partnerships that will enable banks to serve and retain their customers without using quite as much balance sheet and liquidity is a key solution there.

The third thing, going back to the earlier part of our conversation on the climate transition, is that is a huge area of opportunity, and it does come with significant risks, but also potentially significant upside for those prepared to back themselves as well as helping to fulfill their sustainability and net zero goals.

Kate

Thanks so much for your insights today, Ross. Appreciate you taking the time.

Ross

Thank you, Kate.

Kate

Thank you for watching.

Discover how the shift from Low for Long to higher interest rates can create new financial opportunities for banking, private credit, super funds, and the net-zero transition in Australia.

Watch more from the New Monetary Order Video Series and discover how financial institutions are adapting to the evolving monetary landscape.

Kate Coffey

Hi, I'm Kate Coffey and I'm a senior consultant at Oliver Wyman based in our Sydney office, and I'm joined today by Ross Eaton, who's a partner in our financial services practice and co-author of the New Monetary Order report. Thanks so much for being here today, Ross.

Ross Eaton

Thanks for having me, Kate.

Kate

Ross, you've been leading Oliver Wyman's analysis of the New Monetary Order. Would you mind sharing a bit about what it is and why it's important?

Ross

The New Monetary Order refers to the sudden increase in interest rates we've had since 2022 from where they went near zero to more normal levels that they're at today. Now, the context for this is if we go back to the global financial crisis, we saw the Reserve Bank of Australia and other central banks around the world cut interest rates in response to the crisis.

In Australia we saw rates then gradually decreasing for the next 15 years until they hit effectively zero right after COVID. Now, Australia's not alone in this phenomenon. In other markets like the US, Canada, Europe and the UK, we saw rates cut to near zero levels and essentially stay at zero or close to zero for that entire time.

We call this period the Low for Long, and so our New Monetary Order report investigates the distortions that have happened with the monetary and credit system as a result of this Low for Long period and how economies and the credit system might fare now that we're suddenly reverting to more normal rates.

Kate

What do you see are the key opportunities and risks that are emerging as a result of the changes to monetary policy and regulation in Australia?

Ross

I'll start with the risk side. The most obvious thing that's been widely reported is the impact of higher interest repayments on households and businesses. There's a lot of strained balance sheets right now, and in particular if we look at the household sector here in Australia, it's heavily indebted. We've got large mortgage balances combined with a sudden increase in mortgage repayments and therefore households are doing it tough. Now, we're seeing credit losses edge up slowly. We haven't seen anything catastrophic yet, but it remains to be seen.

If we look at the opportunity side, there's three things I'd like to call out. Firstly, on the banking side, what we've seen with the sudden increase in interest rates most recently is initially we saw NIM expansion, so banks having higher net interest margins, that's quickly been eroded away due to competition on both the lending side and the deposit side. But what we've seen is a slowdown in mortgage growth and an increase in business lending. After spending a long period of time concentrating their balance sheets excessively, some would argue in mortgages, we're now seeing banks able to revert to a more diversified balance sheet. Because business lending is more profitable on a return on equity basis, that should help to bolster bank profitability.

The second area we call out in the report is private credit. Private credit is lending to companies by non-banks, and this is a very active space. We estimate there are a hundred participants in the market in Australia in terms of both private credit funds and those investing in the space. And there's a lot of hype around this at the moment as banks run into challenges where there are areas where their appetite doesn't allow them to lend or there are other niche specialties where they're not serving customers, that provides an opportunity for private credit funds. We've seen that space growing and we predict it will continue to grow.

The third major space is super funds. We look at the super fund industry, we've seen that grow very rapidly throughout our lifetimes and in particular in the last 10 or 15 years, and it may surpass the total size of the banking market here in Australia within the next few years. Now, super funds, as well as being large, have also signaled a desire to allocate more of their money to alternative investments, including private credit. If we see an increase in demand for private credit, we will also see super funds be able to allocate more of their funds there.

Kate

Yeah, the growth of super funds in Australia over the last decade or so has been fascinating and I'm interested to see how that plays out. I'm also interested to understand how you see the net zero transition is likely to interplay with the new monetary order.

Ross

The net zero transition will require a staggering amount of money. Estimates are in the order of a few trillion dollars for the Australian economy between now and 2050. That's a massive amount of investment that's going to be required. Now, traditional bank lending will not be able to meet the needs of that because a lot of these investments are early-stage technologies, speculative investments that have a high risk, high reward profile, and that's outside of the appetite of traditional bank lending.

We are going to need to see venture debt providers, private credit players, and also equity providers making investments to support all that. The other area we've seen in the most recent Labor Budget is a desire from the government to play a more active role in steering capital into the economy for this purpose and achieve the nation's net zero goals, so we may see more of that in future as well.

Kate

Yeah, absolutely. Given the Opposition's recent announcements around nuclear energy and their plans, it could be interesting as well to see how that goes. Do you have any advice for financial institutions in Australia going forward in this new environment?

Ross

There are a number of scenarios that we call out in the paper, and depending on the scenario, there'd be various plays that could be advantageous or disadvantageous, but three things to call out that we think will be advantageous regardless of scenario.

The first is investing in customer experience and digital processes. Customers more and more are expecting seamless digital interactions with their financial services providers and there's a lot of investment going into that and that needs to continue. Secondly, investing in digital processes can not only help improve the customer experience, but can also help to reduce cost. In an environment where banks increasingly have returns that are closer to utilities than where they once were, a key lever for improving profitability is building scale and reducing cost, and you need the digital processes to support that.

The second one is being more flexible with balance sheets. Capital and liquidity are finite, and in a world where there's going to be increased demand for credit, banks are going to have to get a bit more creative. Originate to distribute models and partnerships that will enable banks to serve and retain their customers without using quite as much balance sheet and liquidity is a key solution there.

The third thing, going back to the earlier part of our conversation on the climate transition, is that is a huge area of opportunity, and it does come with significant risks, but also potentially significant upside for those prepared to back themselves as well as helping to fulfill their sustainability and net zero goals.

Kate

Thanks so much for your insights today, Ross. Appreciate you taking the time.

Ross

Thank you, Kate.

Kate

Thank you for watching.