By Richard Meade*
With soaring mortgage rates expected to strain household budgets, there are calls – including from the Reserve Bank of New Zealand – for the Commerce Commission to investigate bank profits.
But rising profits and the widening margin between lending and borrowing rates mean the Reserve Bank is doing its job as much as it’s a sign of anti-competitive conduct.
The Reserve Bank’s overarching goals are to fight inflation and ensure financial stability. To achieve these, it does two things that the commission would normally frown upon.
First, the Reserve Bank runs the country’s largest legal price-fixing operation.
It does this by setting the official cash rate and by influencing banks’ expectations about its future changes. The official cash rate sets the interest rates on the deposits and loans registered banks have with the Reserve Bank, in turn affecting banks’ own lending and deposit rates.
Raising the official cash rate, and therefore the cost of borrowing, is one of the RBNZ’s principal tools for reducing inflation. However, higher interest rates can increase bank profits, not least because a low official cash rate shrinks profit margins by making it harder for banks to reduce the interest rates paid on deposits.
If ordinary competitors manipulated prices like this, the commission would investigate them for price fixing.
Price fixing to avert a meltdown
Until the 2008 Global Financial Crisis (GFC), deposit rates were closely in step with the official cash rate. When the Reserve Bank responded to the crisis by slashing the rate, mortgage and deposit rates followed suit.
But during the same period, deposit interest rates continued to track higher than the official cash rate and margins between lending and deposit rates fell significantly.
When COVID-19 stuck in early 2020, the official cash rate fell to historic lows. But deposit rates fell harder than lending rates, with banks’ lending margins jumping dramatically.
Soaring house prices bolstered demand for loans. Meanwhile, the banks’ need to offer competitive deposit rates was dampened due to the Reserve Bank’s support of cheap wholesale funding.
Hence the Reserve Bank’s price fixing averted financial meltdowns by, in part, preserving bank profitability.
The government is giving its strongest indications yet of a Commerce Commission study into bank profits after preventing a shorter select committee inquiry.https://t.co/tgknp34z0H
— RNZ (@radionz) March 14, 2023
Clamping down on competition
The second thing the Reserve Bank does that the commission normally dislikes is that it restricts the entry of another competitor, by setting and enforcing the rules on which entities are able to operate as banks.
The Reserve Bank also imposes conditions on how banks operate, such as requiring them to maintain minimum levels of capital.
That way the Reserve Bank limits risk in the financial sector by stopping unsafe operators from becoming banks and ensuring existing operators operate prudently.
As in other sectors, limiting competitive entry can make existing banks more profitable. The required minimum reserves of capital can also increase profits. Indeed, limiting bank sector competition has long been, until recently at least, considered important for financial stability. It reduces banks’ incentive to boost profits by taking risky bets using depositors’ money.
As for price fixing, the commission would normally take enforcement action if an organisation deliberately restricted competitive entry. But, as discussed above, the RBNZ has solid policy rationales for its approach.
Providing a ‘reference price’
In this regard, the Reserve Bank is not alone. Governments fix medicine prices to ensure accessibility and set minimum wages to support low-wage workers. The competitive impact of pricing focal points – such as those created by minimum wages or the official cash rate – can also be seen in other sectors.
In 2017, I co-authored a study into fuel pricing that recommended a reference fuel price published on one firm’s website be removed, which promptly happened. The commission subsequently undertook its own fuel sector study, providing evidence that removing this reference price resulted in reduced fuel margins.
The official cash rate is similarly a reference price for banks to use to set their own interest rates rather than openly compete for customers. So its use by the Reserve Bank can be expected to affect banks’ profit margins.
NZ banks' annual profit topping $7 billion in @KPMGNZ's FIPS likely to add fuel to the fire amid calls for a probe into bank profits and competition https://t.co/bpAVKUHICC
— Gareth Vaughan (@GarethHVaughan) March 13, 2023
Finding a balance
Clearly a balance is required between effectively fighting inflation and maintaining financial stability on the one hand, and promoting greater competition on the other. Strengthening bank sector competition should lead to sharper interest rates. But it will also affect how official cash rate changes feed through to wider interest rates and could lead banks to take greater risks.
So, before the commission is charged with scrutinising bank competition, consider the following questions. First, are growing bank profits due to banks acting anti-competitively, the Reserve Bank fighting inflation and preserving financial stability, or both?
Second, if bank profits are indeed excessive and due to anti-competitive behaviour, are there measures the commission could recommend and practically implement that would improve outcomes?
Finally, if bank profits are excessive, and at least partly due to the Reserve Bank doing its job, would interventions by the commission to improve competition worsen financial stability or frustrate the fight against inflation?
Answering these questions will need both the commission and the Reserve Bank to have serious conversations about how competition policy and banking regulation can be made to work together to achieve better outcomes for both bank customers and the wider economy. Little would be gained by improving bank competition if that reduces financial stability or worsens inflation.
*Richard Meade, Senior Research Fellow, Auckland University of Technology. This article is republished from The Conversation under a Creative Commons license. Read the original article.
31 Comments
Back on topic..
Who investigates corrupt or inept govèrnnent agencies..
Who investagates the DOL or the RB. AFTER RECENT ISSUES CAN THEY BE TRUSTED?
Te Whosdathief aka the dept of Labour or com com.
ITS A CONFLICT OF INTEREST FOR THE RB to be talking with Con Com.
The Government have made a bank account defacto compulsory as a sole means of paycing and claiming tax/benefits.
They therefore have a responsibility to protect depositors. A guaranteed central retail bank combined with the removal of fractional reserve lending (i.e. cash manufacturing). Then the retail banks can go to hell.
NZ banks have roughly $650bn in liabilities (eg customer deposits) and $700bn in assets (mortgages etc). The banks are required by RBNZ to have about 10% in equity (around $60bn). Now, let's say banks target a 12.5% return to equity holders after tax (this is the current average). This basically means profits have to be about $10bn ($7.5bn after tax). It's just maths - the profits are a function of total deposits, the RBNZ rules on equity, and the return on equity that the banks target to satisfy their funders.
Now, what happens if you increase tax? Well, banks will still aim to provide the same return on equity after tax, so the net interest margin spreads - i.e. the extra tax burden just gets passed on to borrowers and savers.
So, what to do about this $7.5bn a year transfer from NZ businesses and mortgagors to rich equity holders? The answer is to either (a) tax the crap out of return on equity (difficult when equity holders are often overseas) or (b) reduce the equity requirement and guarantee some deposits (some risk), or (c) reduce that $650bn by offering an excellent value public banking alternative - long-term mortgages backed by the state, zero fee current accounts that earn a bit of interest etc.
Why do you assume Banks in New Zealand should be able to "decide" what return on equity they should earn? NZ banks are some of the most profitable in the OECD (4th highest i believe). Why is that level of ROE be take as a given?
Secondly you ignore the main reason banks make such huge profits per capita - because the over financialization of the housing market creating massive debt levels. If overall debt levels were reduced, banks wouldn't be making so much profit per capita, even with the same ROE.
Firstly, I agree that the ROE is shamefully high - noting that BNZ and ASB are in the 15 - 16 range! My challenge is on the wisdom of focusing on taxing profits when our banking sector is so uncompetitive - the banks will just protect their target ROE and pass any extra tax costs onto bank customers. So, what to do? Cap ROE? How would that work - 400 pts above OCR? What if a bank struggled to get equity and was at risk of breaching RBNZ rules because of the cap?
That's why (and to your second point) I would focus on reducing the inflated balance sheets of banks - created by our mortgage frenzy. That was the main driver for my proposal to offer banking, mortgages etc as a simple public service reducing our reliance on parastical commercial banks.
Totally the answer is (c).
Without mutuals (not-for-profits) the banks, while technically an oligopoly, actually operate as a monopoly.
I'd add further that the NZRB through it's price-setting using the OCR has become 'complicit in this corruption' in that it telegraphs changes so far in advance that banks all know what's going to happen months in advance and raise prices accordingly. And they're slow to bring them down. (Rocket-and-feather pricing.)
NZ politicians must stop the NZRB using the OCR as it does. It is a blunt weapon that targets a sub section of the population while the NZRB, politicians and pundits all say 'we' it is in fact 'they' that bear the burden. The NZRB MUST prove that the OCR does in fact target those creating inflation before it uses it. Have they ever proven this? No. They absolutely have NOT.
I wrote last year to David Clark suggesting that, as ComCom lacks capacity and spine, such a study could be contracted to an international financial institution (ADB, World Bank or ideally IMF). Got a dismal response, but I think this is by far the best way forward, as it requires serious competence and independence:
"Unfortunately, the Commerce Commission has a disappointing track record in tackling competitive failures, despite a newly strengthened competition framework and ample funding ─its NZD60 million budget compares favourably with the AUD260 million budget of the better-performing Australian Competition & Consumer Commission.
To that end, and in the interests of identifying impactful and implementable recommendations to improve sectoral competition, I suggest that you consider contracting external advice from one of the international financial institutions of which we are a shareholder, i.e., ADB, the World Bank or the IMF.
The World Bank and ADB’s technical assistance windows support grant-financed sectoral competition reviews for developing member countries. However, a developed member country, such as New Zealand, may also request and pay for such a review. Nevertheless, a better option would be to request for IMF technical assistance advice from either IMF’s headquarters or the Suva-based Pacific Technical Assistance Center (PFTAC). Such advice would not only draw upon the best available international knowledge and experience, but it would also be subjected to unparalleled quality assurance and stand-up robustly to the inevitable industry challenges.
The study (or studies) outline terms of reference should include consultations with affected parties, preparation of legislative drafting instructions, recommendations to address our weak transfer-pricing regime, and preparation of an implementation plan. The Commerce Commission could instigate and fund the studies. NZD3 million should be adequate for each study and can be accommodated within the Commerce Commission’s budget."
1) It takes 6 or 7 players with equal market share to have perfect competition. We are a long way from that with 4 main players cornering 85% of the market.
2) Government needs to legislate to make ComCom give competition more weight. ANZ would have never been allowed to buy The National Bank had these requirements been in place.
3) We need open banking. People need to be able to sit at their desks and shift their fixed mortgages and term deposits at no cost.
4) We need the deposit protection scheme in place. Then and only then might RBNZ be required to consider the ability to change the regulatory framework.
5) We need more productivity in NZ. This means shifting the risk weightings between housing and business lending. Removing recourse mortgages is one way to achieve this.
1. Not in consumer goods where the manufacturer ( apple, Sony, Samsung,....) Control world wide pricing.
1.v2. not in NZ,electricity where 24 retailers are controlled by 3 , 4 generators controlled by a dumb government!
Of the 15 banking organisations The top 4 banks offer the best deals and have the higher rating. Nothing stopping the other suppliers( bank's) from stepping up.
Cornered... Wrong! We have choice
The RB needs to assist 2 tier maybe?
As an investor, I wouldn’t risk my precious capital unless I have reasonable odds of a 15% return. Sure, sure, the profits have soared on the back of easy money, but let's be real, this train's gonna come to a screeching halt any day now and so would the bank profits. And don't even get me started on the government's feeble attempts at competition – if they had even a smidge of backbone, they'd pump some equity into Kiwibank and give it the balance sheet it needs to actually compete. But nah, it's all just political posturing as usual. Sigh.
Why does the government fund local savings and loans banks, owned by the local councils, which can lend to locals for mortgages and businesses. Profits from the banks would be poured back into local infrastructure and it gives more local control over the growth of businesses. Each council is forced to use its local bank as the local depository for all council funds. Councils in turn could discount or remove rates from people who hold mortgages with the local community owned bank to be at a competitive advantage.
Found an institution similar to the Bank of North Dakota which provides the funding and acts as a wholesale bank providing loan guarantees and bank deposit insurance in the event one of these local banks collapses.
Solves the profit seeking banks extracting capital purely for shareholders, helps rebalance the books of local councils and provides a decentralized, local and personalized institution for each district to develop its respective economy.
Drive the big banks out of residential and force them to only be commercial banks through market competition.
Timely article in light of what is happening in the global banking sector. Especially the restrictions on new entities entering the sector in NZ. Unfortunately we are stuck with the big 4 Australian owned trading banks with no competition from any potential NZ owned trading entity as once again we are told our economy of too small as I understand it. I watched the latest CraigsIP update this morning emphasising how stable our banks are in NZ which is comforting. Good to know that least much thought is being put into maintaining stability and limiting profits for the banks. The thought of all that money going offshore is to Oz regularly and not being reinjected in NZ troubles me.
A personal experience in the last h with one of the big 4. Decided I needed an emergency stash of 5k in $200 notes so went down to draw it at the teller. Learnt the following. With questions i asked the teller she had to scuttle off and ask a higher authority in the branch. No $200 notes at the bank and couldn't obtain from their distributor. Evidently RBNZ is not supplying $200 notes any more. I asked $100 will do. Not enough in the bank. Come back on Thurs.
I wonder if the Fed has told RBNZ that $200 notes are too higher denomination and drop them out of circulation. Certainly 30 odd years ago the highest denomination in the US was $100 note and that hasn't changed. Its probably only worth $50 now.
Er, NZ has never had a $200 legal tender note. Probably why the bank didn't have any. Also makes it sound like your story is entirely invented.
https://en.wikipedia.org/wiki/Banknotes_of_the_New_Zealand_dollar
Story not invented. At no time did the bank say there have never been $200 available, it said they didn't have any and could only order $100. Just that I thought there were $200 notes but it still doesn't alter the rest of the story.
Since Covid lockdowns and the fear of catching covid from handling cash there has been a move a way from cash. I also use a debit card for the majority of transactions. Look at the number of people caught during the floods without cash as no ATMs available
It sounds to me you are in step with RBNZ who are attempting to do away with cash.
Not sure investigating the banking sector would achieve much at all . Im not even sure the RB rate hikes are conducive to productivity. What is glaringly obvious is the fact that government in general local and national are unable to run balanced books. It is true that recent exceptional circumstances have stressed the economy and that is most unfortunate. However there is no escaping the realty of the burden being placed on future generations. Many here focus on real estate and its ability to create wealth from nothing other than an initial investment. It could be argued much of what has occurred (capital gains by privateers) has left the taxpayer out of pocket. I see a recent article that a particular council will will raise rates but their goal will not be inline with the current inflation rate. It is not hard to see the banking industry rack up record profits given they provide the capital and are not held accountable for the social effect such might create . Where the system is falling over is in the costs of infrastructure and regulation failing to be underwritten and met by all the players, lenders included . Rate rises that are not in line with the debt carried by councils and government are offsets thrown onto the general population when everybody, non propertied , propertied owners their financiers should equitably be carrying the can.
Many here will not like this but the other side to a rising value should carry with it an equally rising rate charge. It is negligent to not also drag the financial sector into paying its due also. Record profits are fine but if such comes with social decay then perhaps its time the banks also coughed up a larger slice. Many here will feel NZ is over regulated . The idea that raising interest rates will achieve a flatter line creates in itself further complications . Already we are seeing demands for higher wages and increasing food prices likely further across the board into larger expenses. The idea that a recession will solve all societies ills is farcical. The problems are deep rooted and begin with the false economy many have been living here for quite some time. One might achieve more restraining the availability of credit to government and councils for example likewise to the general public... Hard times ahead this year for many but that is the past catching up with the future I suspect. Enquiry not necessary ... more tax required on those record bank profits.... problem solved... maybe a way of deterring credit use would be to place a tax on such....reality is credit does distort ....
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