Gareth Vaughan takes a look at how the Commerce Commission's suggestion of strengthening Kiwibank to enable it to better compete with its Aussie owned rivals could be accomplished

Guess how much more capital than Kiwibank the smallest of New Zealand's big four Australian-owned banks holds?

Try an eye watering $7.166 billion. 

Yep, Westpac NZ's total capital, as of its latest disclosure, weighs in at $10.051 billion. Kiwibank's? A somewhat lower sum of $2.885 billion. 

ANZ NZ, the country's biggest bank, is at $17.216 billion, BNZ at $12.510 billion and ASB at $10.936 billion.

The reason I'm listing these numbers is to give some context to the Commerce Commission's recommendation the Government; "should consider what is necessary to make it [Kiwibank] a disruptive competitor, including how to provide it with access to more capital."(Emphasis mine).

The traditional concept of banking is banks borrow money through the likes of deposits and bonds, and then lend it out through the likes of home loans and to businesses at a high margin than what they borrow at. However, banks can create credit through their lending, beyond what they borrow, via the power of leverage.

Against this lending banks' must hold regulatory capital, with their requirements for this overseen by the Reserve Bank. As then-RBNZ Deputy Governor and Head of Financial Stability Grant Spencer put it in 2017 bank capital; "is the form of funding that stands first in line to absorb any losses that banks may incur. Having sufficient capital promotes financial stability by reducing the likelihood of bank insolvency and moderating the effect of credit cycles."

Regulatory capital is thus effectively insurance held against real and potential bad loans. In simple terms, the more capital a bank holds, the more lending it can do. Hence the idea that getting Kiwibank more capital would mean it could better compete with the big four by increasing lending, and thus competition.

Growth constrained

In more detail the Commerce Commission's draft report from its banking market study into competition for personal banking services says Kiwibank; "appears to have the greatest potential to constrain the major banks in the near term and disrupt a market that is otherwise stable due to lack of competition."

"However, Kiwibank does not yet have the necessary access to capital backing, or the systems, required to continuously challenge the major banks aggressively. Access to equity is a constraint on how fast Kiwibank can continue to grow. To change this, Kiwibank’s owner should consider increasing its access to capital and support a strategic refocus of Kiwibank’s efforts to compete more strongly with the major banks, which could involve significant systems development." 

Whilst the Commerce Commission's report just focuses on personal banking, especially mortgages and deposits, let's look at Kiwibank in the context of the broader banking sector.

Kiwibank's currently a home lender that also does some lending to small and medium sized businesses. It doesn't offer loans to the agriculture sector, and nor does it have institutional or corporate banking capacity. Treasury told me last year Kiwibank would need "a significant enterprise-wide capability uplift over many years" if it was to be in a position to bid to become the Government's core banking provider, which is currently Westpac NZ.

So where could a very significant capital infusion for Kiwibank come from? The Coalition Government, enforcing cost cutting and job losses on the public service and fretting about potential fiscal holes, doesn't appear a likely source. The NZ Super Fund and Accident Compensation Corporation, major long-term NZ investors, were Kiwibank shareholders but sold out to the Government in 2022. Overseas ownership probably wouldn't be a great fit with Kiwibank's brand and image as the little kiwi battler taking on the big Aussies.

Growth versus dividends

So what about a share market listing? Kiwibank has long been touted in some quarters as a good candidate for the NZX, where it would be welcomed with open arms.

ACT, one of three parties making up the Coalition, went into last year's election with a policy of listing 49% of the shares in a range of state-owned companies, including Kiwibank's parent company, on the share market.

Kiwibank CEO Steve Jurkovich told me last year he didn't think a move to such a mixed ownership model "would be that much of a hurdle for us," if it was to ever happen.

"Would that be a massive change for what we're trying to achieve and our purpose? I don't think so," Jurkovich said.

Jurkovich did say, however, a requirement for Kiwibank to pay a sizeable dividend - which share market investors or the Government may want - would be a significant change for the bank, if it was made. That's because retained earnings are Kiwibank's key means of increasing its regulatory capital, which it's required to grow in line with new Reserve Bank requirements being phased in by 2028.

"We've been really clear that when there's a regulatory requirement for extra capital, we need to cut our cloth to suit that so we can grow at certain levels. We need to create enough retained earnings to do so. If you change that plan and want more dividends, then what you're probably signalling is a bit of a departure from wanting a bigger Kiwibank that's having more impact. So I think it's a pretty big, fundamental change. And ultimately, of course, if you grow Kiwibank then the New Zealand Crown has a more valuable asset," Jurkovich said.

There's also the issue of ACT's coalition partners. NZ First, interestingly, went into the election with a vague policy of creating a government guarantee to boost the capital of NZ owned banks. And National leader and Prime Minister Christopher Luxon's on-record saying asset sales aren't on the agenda. Luxon, of course, was Air New Zealand CEO when the previous National-led government sold down its stake in the national carrier.

How much money could a share market listing raise? And what would investors want?

If Kiwibank was listed on the share market, how much money could this raise? The sale of Kiwibank's parent company in 2022 was valued at $2.1 billion. Mark Lister, Investment Director at Craigs Investment Partners, says a simple back of the envelope ballpark calculation suggests Kiwibank could theoretically be worth around $2 billion, or a bit more, if listed on the share market. Lister notes a partial sell-down could see the opportunity taken to raise new capital at the same time, to help Kiwibank "have a good crack at the Aussie banks."

A share market listing would excite retail "mum and dad" investors. But what do institutional, or professional, investors think?

Harbour Asset Management's Andrew Bascand and Simon Pannett say as fund managers, they would naturally welcome Kiwibank’s public listing.

"But we would only likely find a listed Kiwibank significantly attractive as an investment if it was competing to win consumers rationally and earning a cash profit significantly above its cost of capital. It is already earning a slightly higher net interest margin than the major banks. The real focus for investors investing in the bank sector is the prospective path for profitability and lifting return on equity into the double digits," Bascand and Pannett say.

"Kiwibank recently has been reporting a return on equity in the 7% to 8% range. Banking benefits from scale given the significant fixed cost investment in technology and compliance. Further scale could take Kiwibank closer to required returns. The major banks experienced a return on equity of closer to 12% in their New Zealand businesses in 2023."

So a share market listing could raise a decent chunk of money to help Kiwibank better compete with the big four. However, the contrast between Jurkovich's comments on dividends and the Bascand and Pannett focus on profitability is interesting. If Kiwibank listed, could tension emerge between the new shareholders potentially wanting decent dividends, and the Commerce Commission's idea of making the bank a greater competitive force, which would require it to continue retaining earnings to boost capital if it was to expand and better compete with the big four?

In a recent Of Interest podcast episode I asked Commerce Commission Chairman John Small this question.

"There's a lot of things that have to fall into line in order for a bank to position itself as a disruptor, as a bank that's aiming for market share. I don't really buy the idea that you couldn't pay a reasonable dividend commensurate with the risk and also grow. And this partly goes to our conclusions about profitability," Small said.

"We think there's probably something in there, that there's a margin in there so that investors can get a reasonable return if it was to be capitalised that way. And if it wasn't to be capitalised that way, that the Government would get a reasonable return whilst still growing a bank. So I don't think it's infeasible. We don't think it's infeasible."

Options unlikely to be on the table

If Small is right, that a share market listing could enable Kiwibank to both grow into a significant competitor with the big four and return acceptable dividends to its shareholders, this would still take considerable time of course.

I find myself somewhat sceptical that a reasonable long-term balance could be struck between Kiwibank growing into a true, across the board banking competitor to the big four, and shareholders' expectations for returns on their investment.

There is, of course, a much simpler option to boost Kiwibank's capital. The Reserve Bank creating billions of dollars with a few keystrokes on a computer keyboard and placing it in Kiwibank's settlement account with the central bank on the proviso it's used over a period of years to ramp up competition with the big four Aussie banks. Somehow though I can't see this happening...

Thus a share market float may be the most realistic opportunity, even if a challenging and uncertain one, for a capital constrained Kiwibank to beef up and close the gap to the big four banks.

*This article was first published in our email for paying subscribers early on Monday morning. See here for more details and how to subscribe.