NZ's big banks may be 'fat, dumb and happy with an apathetic, stable customer base.' But what does that mean for competition?

Is New Zealand’s banking sector competitive?

We can see what looks like extraordinary profits being reported from the sector - more than $7 billion in profit reached for the first time ever in 2022.

We know our banking industry has four big Australian banks; Westpac, ANZ, BNZ and ASB, who hold about 85% of bank loans in New Zealand, the Reserve Bank says.

But there are far more registered banks in New Zealand, including TSB, government-owned Kiwibank, and the Co-operative Bank, which are NZ-owned.

Unlike the Aussie banks, the Reserve Bank says NZ-owned banks account for about 9% of bank lending.

So there is competition in NZ for banking; but is our market really competitive when such profit is made? Or is it a sign, in fact, of a healthy banking sector being rewarded for taking on risk?

Philip Stevens, director of economic research at the Productivity Commission, has been delving into competition issues for years in New Zealand, including as manager and chief advisor of economic strategy for the Ministry of Business, Innovation and Employment and its forerunner, the Ministry of Economic Development.

Economist Stevens warns there is no simple measure for competition. This is why he is backing a Commerce Commission market study into the sector.

But what we can do now, he says, is look at our banking sector and draw some conclusions.

New Zealand banking has the big four, or what Stevens calls an oligopoly - a market concentrated in a few big players, or more technically, a market where the top five firms hold more than 60% of market share.

A monopoly is one firm dominating a market, while the term familiar to New Zealanders because of our supermarket sector is duopoly, which is two firms dominating.

Why are the four Australian banks so big?

Stevens says with 17 registered banks in New Zealand barriers to entry like regulation don’t seem to be an issue. There are plenty of banks here, operating. 

The question then becomes, he says, why are the four Australian banks so big?

Economies of scale, the efficiencies and cost savings from having a big business, and historical factors could explain some of their size, Stevens says. 

Banks need large networks to run transactions, and they used to need networks of branches so their customers could make payments.

Those are lesser factors these days, Stevens says. So what could it be that keeps us with the big four?

“It may well be that there’s a sort of path dependency, or hysteresis, or just the fact that you get locked in [with a bank]. You can easily choose a shop for one transaction, and then change where you shop next time, but it's not like that with banking. People don’t want to switch for each transaction, so there is a kind of lock in.”

Stevens says banking is a risky business. Bigger banks like NZ’s big four can diversify their risk, and they can lend to lots of different people or businesses with different risk profiles, spreading risk.

The Australian banks may be diversifying their own risk in Australia by operating in New Zealand too.

For example, if the Australian economy tanks and mineral prices are low, the Aussie banks have New Zealand operations where maybe the price of milk is still high, and would be able to shift money between the two countries so the bank doesn’t fail, Stevens says.

“That’s another reason they are likely to be big.”

How concentrated is the banking sector?

The next question the economist says we need to think about is how concentrated our banking sector is to analyse how competitive it is. He says NZ’s industry isn’t as concentrated as people might think.

One measure used, a concentration ratio, looks at how much of a market share is held by three players, or five players, or eight players.

The higher the percentage is, and the lower the number of players there are, the more concentrated an industry is. 

A concentration ratio from 0% to 50% is considered low concentration, 50% to 80% concentration falls in the “medium” concentration ratio, high concentration is a concentration ratio from 80% to 100% - both the medium and high ratio indicate an oligopoly.

New Zealand banking of course has four big players dominating, not five or three, which is “interesting”, Stevens says.

Using World Bank data, Stevens says New Zealand’s banking concentration is about in the middle of the pack, with countries such as Finland and Portugal having a much higher concentration in banking.

“This shows the difficulty of just using one statistic … so we're not super concentrated. But we do have a high return on equity (RoE), which is the thing that people have been highlighting recently.”’

The recent KPMG annual financial services report found the New Zealand banking sector had a return on equity of 13.4%​ in 2022, compared to 15%​ on the companies in the NZ stock exchange’s top 50 index, the NZX50.

Westpac had a RoE for 2022 of 12.66%​, while our biggest bank, ANZ, booked a RoE of 14.79% and ASB reported a healthy RoE of 15.16%​ while BNZ’s was 13.5%​.

The picture across the Tasman looks different, with lower RoE.

ANZ reported an RoE of 10.4%​ compared to 14.79%​ in New Zealand, for example, while Westpac’s RoE gap saw it report RoE in Australia of 7.5%.

Competition could be a factor, as could risk, Stevens says. Higher risk needs higher returns.

Debt reliance

The juicy RoE enjoyed by our banks could also be as a result of our low productivity economy, and investment in housing as assets.

New Zealand has a small equity market, and a small economy, Stevens says.

“Which kind of has two important implications for me. One is, firms themselves have to rely more heavily on debt finance rather than equity. That locks them in with their bank, whereas if they sold shares, anyone can own a share, and there is a very different kind of relationship with that. Then we have this issue, what we call asymmetric information, which is that the bank knows a lot about the firm. It's very hard for them to go to another [bank], because they're more risky for the other bank than they are to the current one, because the bank sees their money go in and out.”

On the other side of that equation, investors can’t buy shares or don’t want to, so they invest in housing. 

New Zealand has a highly leveraged housing market, high interest rates, high interest costs which makes them a riskier bet, Stevens says, and drives the need for higher returns.

Reserve Bank data shows 65% of bank lending goes to the household sector.

Stevens says high profits could also be a sign of a lack of competition, but they are also an incentive for competition.

“Effectively, there's lots of people competing, and the winner gets to be a monopoly.”

He says it's not unusual to have an oligopoly in banking, and competition in oligopolies often happen “in fits and starts”.

“You might have a long period of no competition and suddenly somebody moves you know, like the petrol company lowers its price … and then everybody else follows really quickly afterwards.”

Of course, there is also consumer behaviour to consider. And Stevens thinks this is important.

“The really key thing is consumers being able to compare and then be able to switch costlessly between things. That's the engine room of competition.”

We aren’t switching our banks much at all. Data from Consumer NZ’s banking survey shows about 4% of people switched banks across a year in its latest data.

Switching ain’t easy?

Consumer NZ chief executive Jon Duffy says based on its research, people see switching as difficult. 

“And if you think about it, or me personally contemplating if I was to switch my bank, the level of unwinding that needs to happen with automatic payments and debits and various other things. It is quite an undertaking to think about that. I think that makes customers sticky. Rather than switching people will keep a call bank account or pick up services from other banks instead.”

He says not switching has a detrimental impact on the service we're provided because banks can just "sit there kind of fat, dumb and happy and know that they've got an apathetic, stable customer base". 

“That doesn't necessarily mean they have to scrap for new clients. They've got a stable income that's coming in from those clients. And I'm talking here about personal banking. I think we see a lot more competition in the mortgage market. People do tend to come off their mortgage and have a good look at what the market offering is and potentially switch. This is what makes the prospect of a market study really interesting, and that there could be multiple markets within the banking sector that need to be carved out and examined.”

Open banking, or the ability to easily shift between banks, is well and truly back on the radar.

In November 2022 the-then Commerce Minister David Clark announced open banking would be introduced within two years.

The banking sector will be the first to implement a consumer data right framework, meaning banks must share customer information if they request it.

Clark said in November that open banking allows customers to shop around for better deals. 

“That means banks will also have to work harder to retain their customers, leading to savings for consumers.”

He has pointed out open banking is required for the Aussie parent companies of NZ's big banks, and is in use in the United Kingdom.

Banks 'not afraid'

Chief executive of the New Zealand Banking Association, Roger Beaumont, says banks aren’t afraid of open banking, but it is complex due to the sensitivity of people’s banking data.

“If you think about what your banking data contains, that tells an awful lot about you and your life. And so if you're opening that up to third parties, you want to be really solid in the framework and security and robustness of that security, before you start to pass on that data and customers, I think, also need to understand the significance of that.”

You can, of course, already switch bank. Most bank sites have a how to switch page, and it has long been boasted that New Zealanders can change bank in five working days just by filling out a form.

The reality can be more complex than filling out a web form. Take the changes to the Credit Contracts and Consumer Finance Act as an example, which saw consumers’ spending put under the microscope for lending and outraged wannabe borrowers declined loans for buying takeaways or streaming services.

If you know you are going to have to divulge every dollar you fritter, or have your financial life forensically pulled apart to shop around for a new mortgage or loan, that becomes a barrier to changing bank.

The government has since “clarified” the rules and tweaked the legislation, but it shows a few useful things. Regulation that is intended to protect consumers can have unintended negative consequences, throw up barriers for competition and push consumers into staying sticky with their existing bank.

“If you want a new mortgage, banks do want to see that history of behaviour and activity. But that's a good example of where open banking in play will make that analysis by a competitor bank a whole lot easier. Because the data exchange will be a whole lot simpler than filling out a whole lot of paper forms or going through a painful process,” Beaumont says.

Regulation and the cost of it is a key issue for the sector, the bank lobby group boss says. He says that's probably the most consistent theme he hears from banks.

“Just the sheer impost of regulatory requirements and reform, and the workload that that puts on their infrastructure. It's an enormous challenge. And the quid pro quo of those regulatory obligations is that the thing that drops off the to-do list is customer-centric innovations. Because when you think about the technology system of a bank, when you've got the hood up, if you like, on the IT systems, there's only so much at one time that you can safely do without sort of putting too much strain on those technology systems.”

Beaumont says the industry is waiting to see what the open banking legislation looks like because they won’t want to have to make changes twice.

As for the sector’s competitiveness, much like Stevens, Beaumont highlights how many banks are operating here as a sign there’s plenty of competition.

“There’s no bars on the door [to halt new entrants]”, he says. “New Zealand has 17 registered retail banks. That’s an enormous amount of choice for New Zealanders to decide where they want to bank.”

Beaumont says there's nothing restricting anybody from changing banks, other than probably the perception of it being harder than it actually is in reality.

“And so, my message is simple, but actually, you should shop around you should make sure that you're getting the best deal for you. And then go and go and hunt that out and find it because there's nothing to stop you from switching banks.”

Not convinced

Council of Trade Unions economist Craig Renney says open banking enables competition, but it doesn’t create it.

He says it still requires consumers to be savvy about understanding what is available in the market, and some customers can get access to better deals than others which aren’t advertised.

“If that's the case, then how does an individual navigate the mortgage market or the savings market or some other markets without that information?”

Renney says Kiwibank’s struggles to make significant inroads into the big four’s dominance shows competing isn’t easy and any bank wanting to take on the big four needs deep, deep, pockets.

He says the Australian-owned banks in New Zealand have done consistently well, and questions why they earn so much compared with their parents across the Tasman.

Renney doesn’t think New Zealanders are particularly enamoured with the big four, they are seen as “an amorphous blob” and you land with a bank because that’s where you got a mortgage.

“The New Zealand market is essentially in equilibrium with the banks, offering very similar rates to each other on various things because we don't move around enormously and because that market equilibrium benefits those larger providers.”

Wanted: A market study

Like Stevens, Renney wants to see a market study - as soon as possible - by the Commerce Commission into banking.

Duffy agrees, and says the banks’ profits mean they warrant a market study which would dig into how competitive the sector is. 

“The really important thing that comes from an independent agency like the Commerce Commission doing a study is they've actually got no skin in the game here. They're not motivated to fight for or against excessive profitability, they to do an impartial assessment in the same way as a court of law.”

He says the banking industry is exactly where the supermarket sector was before its market study. There is a sense things aren’t quite working.

“A market study is an impartial evidential baseline of what's going on in a market.”

Such a study would help to answer the question posed at the outset - is New Zealand’s banking industry competitive? Stevens says we just don’t know unless we really look, and we can’t rely on any one measure to tell the full story.

We can’t use one data point. We need to do a study, he says.