The Banks Are Ripping Us Off!

(Part Ⅱ)



Last month, I wrote about some common misconceptions about the profitability of the banks operating in New Zealand, and noted that the Big Four Aussie banks, while quite profitable compared with banks elsewhere in the world, are not wildly profitable in comparison to many other listed companies in New Zealand. I noted that other banks in New Zealand are not nearly as profitable, and that there are definite benefits to New Zealand in having a strong and financially robust banking system.

But that column left several questions unanswered. The other questions I get asked about the banking system are three.

First, shouldn’t the banks, “which make so much money in New Zealand”, be prevented from closing branch operations in rural and small provincial towns? When the only bank in town is closed by its (usually foreign) owner, lots of people are left without any practical means of accessing banking services. That is especially true of older New Zealanders, who are typically less familiar with online banking services.

Yes, it is undoubtedly a headache for some people when the only physical bank for miles closes its doors, but of course the same is true when the local doctor retires and isn’t replaced; or when the local petrol station closes for lack of business; or when the local post office closes. No privately-owned business, as banks are, should be expected to act against its own commercial interests. If Government feels it is important for, say, Stoke, to have a local bank and no private bank sees a case for keeping a bank there open, then it is surely up to Government either to direct the bank which it owns itself (Kiwibank) to open a branch there or, better, to call for tenders from all the banks asking what subsidy would be required from taxpayers for one of them to maintain a branch there.

Second, do the banks have a “culture problem”? A recent report on the “conduct and culture” of the banks, undertaken by the Reserve Bank and the Financial Markets Authority (at very considerable cost to taxpayers), found that by and large the banks in New Zealand operate responsibly. But all the banks have had a letter from the Reserve Bank warning them that the Reserve Bank is watching for any sign of irresponsible behaviour, or inappropriate “culture”.

I have to admit, at the risk of incurring the wrath of the Reserve Bank, which of course is the regulator of the bank of which I am chairman, that this preoccupation by the Reserve Bank about bank culture seems quite unwarranted. The banking sector in New Zealand is intensely competitive: if customers don’t like the conduct or culture of the bank they deal with, they have the option in most towns and cities of dealing with at least four or five other banks – and in Auckland with perhaps another 10 or 15 other banks, at least four of them locally owned and one of those owned by the government.

Apparently, there is some concern that bank staff may be incentivized to make loans to people who really shouldn’t be borrowing, and a suggestion that such incentives should be scrapped. But to my knowledge there are no plans to restrict the incentives paid to the staff of car dealerships for selling cars to people who really can’t afford them; nor to restrict the commission paid to real estate agents who sell homes to those who really can’t afford them. There is of course already a very real disincentive for banks to make loans to those who really can’t afford to service the loans: banks strongly desire to make loans only to those who can afford to service those loans. No bank makes money lending to people who can’t afford to service the loan.

Third, the Reserve Bank has recently proposed to roughly double the amount of equity capital which banks must hold in relation to their risk-weighted assets.

All bank assets – loans, investments in bonds, cash at other banks, and so on – carry a “risk weight”, and banks must hold some equity capital against those assets. Assets which are judged to be essentially riskless, such as balances held in cash at the Reserve Bank or short-term government bonds, have a so-called zero risk weight, which means that banks do not need to hold any equity capital against such assets. Loans to a corporate borrower, on the other hand, are assigned a 100% risk weight. Mortgages on residential property carry an intermediate risk weight.

Currently, for every $100 of risk-weighted assets which banks hold, they must finance at least $8.50 by means of shareholders’ funds (equity), funding the balance through deposits and other forms of borrowing. The Reserve Bank is proposing that over the next few years the Big Four Australian-owned banks must increase the ratio of equity to riskweighted assets from at least 8.5% to at least 16%, while other banks must increase the ratio of equity to risk-weighted assets from 8.5% to 15%.

As a former Reserve Bank Governor myself, I absolutely understand the reason for wanting to ensure that the banks, and particularly the “systemically important” Australian-owned banks, have a strong relationship between their equity capital and risk-weighted assets.

But the Reserve Bank’s proposal would make New Zealand banks more strongly capitalised than almost any other banking system in the entire world, which is the more surprising given that all the stress tests which the Reserve Bank has required banks to do in recent years – usually involving quite extreme levels of economic stress in terms of falls in property prices and levels of unemployment – have shown that New Zealand banks are already very well capitalised.

Requiring the banks to double the amount of equity they hold against their risk-weighted assets will clearly have potentially farreaching consequences. Banks might raise more capital from their offshore parents (where overseas owned), but could also decide to scale back their lending and/ or increase the interest rates they charge on loans. Given the high likelihood of a recession in the next five years and the limited scope which the Reserve Bank has to reduce the Official Cash Rate further in response to such a recession, it seems more than slightly reckless to risk materially dampening the potential supply of credit over the next few years.


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