INSIGHT

The role of banking in the infrastructure-led recovery

By Michael Ryan, David Donnelly, Tom Bleby
Banking Infrastructure

Key challenges and opportunities for banking 7 min read

On 4 March 2021, Allens hosted a webinar with Anna Bligh, CEO of the Australian Banking Association, to discuss the role of banking in Australia's infrastructure-led recovery. In this Insight, we unpack some of the key challenges and opportunities that were brought to light in the discussions.

Key takeaways

  • Banks and the infrastructure industry are optimistic about the future of infrastructure delivery in 2021 and beyond. Perhaps no surprise, but 2021 is set to be 'significantly brighter' than 2020.
  • 2021 presents an opportunity for banks to continue to drive forward Australia's infrastructure investment, and they will be called on to play a significant role. Currently, the very low cost of funds allows banks to both take higher risk and price risk in at a rate the market can tolerate.
  • An energy transition from fossil fuels to renewable sources is well underway in Australia and banks are assisting with that transition.
  • While home ownership and housing investment are likely to remain the most significant part of commercial banks' portfolios, banks also have a demonstrated appetite to be the funding partner for public infrastructure projects such as social housing.
  • The future of infrastructure investment is inescapably linked to environmental, social and governance (ESG) factors. For banks this lies in green finance, sustainability and social infrastructure, driven not only by increased shareholder and community interest in ESG factors, but an acknowledgement that those factors will contribute to the lifetime return from long-term assets.

Optimism and opportunities for infrastructure as the economy grows

Infrastructure will perform a central role in Australia's economic recovery from the COVID-19 pandemic. Banks have played, and will continue to play, a key role in not only supporting Australian individuals and businesses managing the effects of the pandemic, but also as a key capital provider in the investment of new infrastructure for a post-pandemic world.

2021 has given banks and key stakeholders in the infrastructure industry cause for significantly more optimism than was expected 12 months ago. For banks, rising house prices, access to well-priced debt, significant decreases in loan deferrals and Australia's surprising economic growth all contribute to a positive sentiment in the sector.

2021 has also brought with it an opportunity to pause and consider what direction infrastructure investment should take in Australia. Re-prioritising infrastructure projects and improving collaboration amongst government, financiers, communities and industry are the key challenges facing infrastructure delivery in Australia. We have previously written on the importance of careful scrutiny of how, where and on what type of projects public funds should be spent. A coordinated approach to the investment in, and delivery of, the right projects will deliver a range of benefits not only to Australia's recovery from the pandemic, but to the environment, communities and the Australian economy.

Australia's infrastructure pipeline – where are we heading?

The outlook for Australia's infrastructure pipeline is strong. Infrastructure Australia's recently published priority list includes 44 new projects worth an additional $59 billion.

A key priority for banks now, and a central focus for infrastructure investment in the banking sector, will be diversification of investment in energy. There is no doubt that Australian banks recognise the transition and transformation happening in the energy mix nationally, so investment in a broad spectrum of energy sources presents a key commercial opportunity.

The Australian Prudential Regulation Authority (APRA) and its counterparts in other OECD countries have all identified climate risk and exposure to fossil fuels as a potential risk. The expectation from APRA is that banks assess their vulnerability to climate change and develop and implement mitigation strategies. Part of this is diversifying banks' exposure across the energy mix to ensure they have no disproportionate exposure to any one technology, especially to fossil fuels.

COVID-19 has also presented an opportunity for infrastructure investment. Trends such as regionalisation resulting from the pandemic will impact Australia's infrastructure priorities. Slowing population growth allows an opportunity for government investment to catch up in areas where infrastructure has fallen behind, eg by easing congestion and building Australia's export chain capability. This then positions Australia to capitalise on a return to migration and increased population growth.

Banks as enablers of COVID-19 recovery

Banks play a role of facilitating the flow of capital to fuel the economy back into productivity and growth. They will not only play an important role in future infrastructure delivery in Australia, but have already contributed to, and will continue to contribute to, Australia's economic weathering of the pandemic.

How banks have enabled support and recovery during the crisis

The support that retail commercial banks have provided to households during the pandemic is well-known and documented. In addition, the Reserve Bank of Australia (RBA) through its Term Funding Facility to Support Lending to Australian Businesses, enabled banks to draw on additional funds at very low interest rates. Without the implementation of the RBA's facility, banks may have had to access funding at higher rates and from international sources.

An increase in deposits from retail customers has also placed banks in a strong position to fund infrastructure development. Typically, banks have been able to fund approximately 60% of their investments from their deposit base. At current levels, banks are able to fund approximately 75% from deposits. The option for banks to draw more from their own base and access the RBA's term facility are important factors in allowing banks to participate in funding new project opportunities.

Commercial banks have provided support to businesses and made significant headway in repairing some of the reputational damage suffered in recent years as a result of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry.

The role of banks in public infrastructure delivery

While participation and facilitation of the energy transition will be a key infrastructure priority for banks, a number of other project areas will equally require significant investment in the coming years. Social infrastructure, and housing in particular, is a key growth area and existing shortfall issues are being compounded by increasing house prices.

Social housing is an area with a lot of potential, but with its own complexities. The projects require a number of parties to come together, including local, state and federal governments. Those with planning decision approvals and powers can develop levers to incentivise commercial parties to think differently about what and how they build, and how they price the asset. Banks have a demonstrated appetite to be the funding partner on social housing projects, eg ANZ stated in October 2018 an intention to spend $1 billion on affordable and sustainable homes by 2023 (a target which has already been exceeded).

In a similar space, there is interest in increasing investment in build-to-rent schemes, but the banks 'don’t hold all the levers' and such schemes still need a government framework around them before companies will be willing to make significant investments, and banks are confidently able to underwrite that finance.

While the biggest part of the banks' investments is, and is likely to remain, in home ownership and housing investment, every bank has its own risk appetite and portfolio mix. Banks will continue to assess projects on a case-by-case basis but there is a live conversation in the sector between banks, regulators and governments to find the right regulatory settings to allow an appropriate amount of risk.

The importance of ESG factors in decision-making

In the past decade, the understanding around ESG issues has moved from being a 'fringe issue' to becoming integrated into everyday business and commercial decisions. In banking, there is a well-informed understanding that reputational damage is shareholder damage, with a quantifiable cost.

Every bank reports on ESG. These reports are increasingly of more interest to the investor community, and that interest does not show any signs of diminishing. The issues are diverse, ranging from the environment, climate change and the energy mix, social inclusion and diversity to modern slavery requirements. One issue is that the consistency of reporting hasn’t been the case on other ESG initiatives and is not always comparable.

ESG is a significant factor in the future of infrastructure investment, and banks will place greater emphasis on these issues in their longer-term investment and credit decisions. Where banks lend to major infrastructure projects, they must be cognisant of the life of the asset and the return over a period of decades and ensure that they are not left with a 'stranded asset' and any unwanted social and environmental issues that may follow. The alignment with ESG objectives is now central to credit assessment and that brings many positives for the development of infrastructure that is aligned to the needs of the nation.

What's next?

Uncertainty remains a key concern in some sectors, and while Australia's economic outlook today is undoubtedly positive, until the public health challenges presented by the COVID-19 pandemic are resolved through vaccination and other means and there is a permanent reopening of international borders, that uncertainty will remain unresolved.

There is a continued role for banks to play in infrastructure investment, and while there is cause for optimism, the future is not without its challenges. Potential skills shortages in both infrastructure delivery and banking present challenges while Australia's borders remain closed. Banks, regulators and governments at all levels in Australia will need to continue to work together to find the right settings to facilitate growth and the development of infrastructure in Australia that is 'fit for purpose' in a post-pandemic world.

Stay informed

Subscribe to our insights and updates