Interest.co.nz's submission to the Opposition's banking inquiry

By Bernard Hickey Executive Summary Interest.co.nz's data shows banks are not boosting profits by charging high mortgage rates, but they are cutting business lending and helping to unbalance the economy. Interest.co.nz is a free news and information website for savers and borrowers to compare interest rates and find the latest financial news. It has monitored all retail interest rate changes daily for all New Zealand's financial institutions since 1999 and sells data on these changes to banks, finance companies and the Reserve Bank. It also sells advertising to banks and others on the website, which is free to all and used by over 100,000 people a month. Data gathered by interest.co.nz shows banks' net interest margins and profitability (as opposed to total profits) have fallen in the last year and have been falling since 2004. This is despite an apparent widening of margins between retail interest rates and wholesale rates. Hot competition for term deposits and higher foreign funding costs have squeezed margins.

Also contrary to public perception, some banks have booked losses on mortgage break fees and are reducing their fees for dishonored payments. Surprisingly, Kiwibank has been the only major bank to have not reduced its profit margins in the last year. Its break fees are the highest. However, the Big Four banks are far from perfect. Interest.co.nz argues they have effectively been subsidizing relatively low mortgage rates over recent years by charging relatively high business and credit card interest rates. This trend worsened in the last year. Banks have reverted to conservatism by encouraging lending against land and property in farming and housing, while reducing lending to businesses that rely on cash flows and chattels for security. This is further damaging the tradeable sector and many small to medium business employers. This slump in business lending in 2009 is further skewing an unbalanced economy towards property investment and consumption, and away from business investment and exporting. Interest.co.nz argues that the banking industry is much more competitive than almost all major sectors in the economy and is not profiteering. Banks are however responding to fiscal, monetary and prudential policy settings that are driving New Zealand Inc deeper into foreign debt and undermining the productive capacity it needs to service that debt and grow incomes. We argue this is a long term death spiral that can only be arrested by structural reform to remove the bias to property investing and to encourage banks to lend to businesses, while savers can invest equity in businesses. The Reserve Bank could also use its capital adequacy setting powers more aggressively to help reverse this pro-property bias in banking. New Zealand needs a broader, simpler tax system that encourages business investment in the tradeable sectors and discourages unproductive property investment. We favour a land tax. The risks of continued inaction are a sovereign credit rating downgrade and a loss of foreign investor confidence. This could force Australia to step in to formalize its existing informal underwriting of New Zealand's economy and to demand control of our banking regulation. This would lead to an eventual capitulation to an Australian-led Trans-Tasman monetary and banking system with the associated loss of sovereignty. Here is the PowerPoint presentation made to the Banking Inquiry. Here is a companion submission by Interest.co.nz Publisher David Chaston.

Who is interest.co.nz? Interest.co.nz was launched by Publisher David Chaston in its current form in 1999 as a free interest rate comparison service online. Since then it has built up a database of thousands of interest rate changes, financial reports and detail on debentures, call accounts, term deposits, cash PIEs, floating mortgages, fixed mortgages, car loans, credit cards, personal loans and bonds. Before the demise of dozens of finance companies, interest.co.nz covered interest rate announcements from over 100 deposit taking and lending institutions. Interest.co.nz's data analysts gather information from websites, faxes, emails and press releases. An automated software "˜robot' checks financial institutions' websites regularly for rate changes. In early 2008 Managing Editor Bernard Hickey joined interest.co.nz and added news and commentary to expand the service. Interest.co.nz now has 7 staff, including two data analysts, a video producer and two journalists. Over 100,000 people visit interest.co.nz every month and generate between 0.5 million and 1 million page impressions a month. Readers check rates comparisons tables, news and commentary. They also generate more than 100 comments a day on issues such as monetary policy, tax issues, the property market and banking regulation. Our report on the announcement of this inquiry generated 56 comments Interest.co.nz sells interest rate data and competitor analysis to banks, other institutions and the Reserve Bank. It also sells rates tables and news feeds to media companies, while selling display and classified advertising to banks, finance companies and others. Our advertising rates are the highest on the Internet in New Zealand and our front page is sold out until October. Interest.co.nz won the 2009 Qantas Media Award for best business news site in May. Bank funding costs have risen around 50-150 bps since September apart from OCR Anyone watching how the Official Cash Rate and floating mortgage rates moved in the last year would quickly conclude the banks are raking in extra profits. Why else would the margins between retail and wholesale rates have blown out so much? There are two good reasons, but more on that later. Firstly, let's look at the gap between the 90 day bill rate and the average bank floating mortgage rate. These two rates tracked each other closely until mid 2008 and the financial crisis forced many banks to start charging each other a margin above the wholesale rate to lend to each other. Secondly, the relationship between the two year swaps rate and the average two year fixed mortgage rate was both close and closely watched up until mid 2008, given the two year fixed rate mortgage was the rate of choice during the housing boom of 2003 to 2008. At its peak over 87% of home loans were fixed rate loans with an average maturity of close to 18 months. At the face it seems like the banks are just pocketing an extra 150 basis points in profit, but they're not as we show below in figures on net interest margins. Two major factors are increasing bank funding costs. Firstly, the extended financial crisis from August onwards pushed up the premiums that foreign banks demand from New Zealand banks whenever our banks borrow in international wholesale markets, or more correctly, roll over that debt every 90 days. Getting data to find out what these "˜extra' margins are is difficult. There are a couple of proxies that can be used, including the Credit Default Swaps prices for Australasian corporates. It is best for working out what premiums are charged for longer term bond offerings. This chart to the left showed margins had dropped from over 200 basis points during the depths of the crisis to around 100 basis points now, but were still significantly above pre-crisis levels of under 50 basis points. The Reserve Bank also showed some figures in its July 6 analysis of bank margins estimating the gap between Libor and overnight rates to give a proxy. That showed this margin rising to over 300 basis points at the peak in September before dropping back to around 75 basis points. Most banks say this current "˜extra' margin on wholesale funding is still between 50-100 basis points above pre-crisis levels. Secondly, banks are now having to pay a higher margin to the Official Cash Rate to raise term deposits. There are two reasons for this. Firstly, the Big Four banks have found it harder to raise funds on international wholesale markets and have been forced to raise funds from local "˜Mum and Dad' savers. However, "˜Mums and Dads' have balked at term deposit rates anywhere near the OCR at its current record low of 2.5%. They will not accept less than 4% for no other reason than it's "˜too low'. This has forced banks to pay up to 250 basis points above the OCR. This is unprecedented. The second reason is the Reserve Bank's long-foreshadowed push to get the Big Four banks to rely less on "˜hot' wholesale money. On June 30 it announced it wanted banks to find 75% of their "˜core funding' from longer term wholesale bond issues and local depositors. The Reserve Bank itself said this was likely to push up retail interest rates by around 10-20 basis points because the banking system then had a "˜core funding ratio' of 70%. Net interest margins for the Big 4 are falling, not rising

These higher foreign funding and domestic funding costs have actually reduced the Big 4's net interest margins in the last year and they are signaling further falls. Not all the Big 4 plus Kiwibank have reported for the June quarter yet, but here is a table compiled from the latest bank reports. The data is culled from bank General Disclosure Statements. It includes net interest margins as a percentage of total assets, which measures profit from borrowing and lending, rather than from other factors such as higher fees or lower costs. It also includes net profit in total as a percentage of total assets and absolute net profit. This table makes clear that all the Big 4 have sacrificed both net interest margins and profit because of both higher funding costs and higher bad loan costs. The only major bank not to see its net interest margin fall in the last year was Kiwibank, largely because it has been immune to the rise in foreign funding costs and was able, at least initially, to reduce its term deposit rates in line with the OCR. This chart shows a longer term picture. It is compiled from RBNZ data. The intense competition for home loan growth and the launch of Kiwibank drove a squeezing of bank margins across New Zealand and was a factor making home loans more affordable, at least until the extra credit pushed up house prices in front of the buyers. Banks are subsidizing cheap mortgages with expensive business lending The big 4 banks, however, are not perfect. The last year has intensified their focus on lending to salary and wage earners, and to farmers, against property and land. They are increasingly risk averse when lending to limited liability businesses secured by cashflows, minimal chattels and some form of intellectual property. Business lending is seen as difficult and risky. One major bank CEO has told us their bank lending officers are not well trained enough to assess the risks of business lending. This has exacerbated an inherent cross-subsidy within banks that has reduced mortgage rates and increased business lending rates. Reserve Bank figures show the business base lending rate has fallen by 230 basis points from 12.2% to 9.9% over the last year while the floating mortgage rate for first customers has fallen 450 basis points to 6.4%. This has been reflected in a significant tightening of credit by banks to small to medium businesses, but not to farming. Housing lending has continued to grow over the last year and has accelerated again in the last 6 months, helping fire up the housing market again. So far in calendar 2009, bank lending for home loans has risen NZ$3.2 billion to NZ$164.8 billion, while farm lending has risen NZ$3.1 billion to NZ$46.6 billion. Meanwhile, business lending has fallen NZ$3 billion to NZ$78.0 billion. This juxtaposition of where banks have lent so far this year explains much about how unbalanced the New Zealand economy has become. It's the rules rather than the players that need reform Despite the Reserve Banks attempts to force the banks not to borrow so much from offshore "˜hot' money markets, this is still happening. New Zealand's foreign debt jumped NZ$5.9 billion in the March quarter, lifting it to 140.9% of GDP from 137.8% of GDP in one quarter. It is up from 117.7% of GDP two years ago. The banks are responding to a set of structural signals in their bias towards property and land lending. Home loans now make up 55% of bank lending, up from 48% 10 years ago. One thing worth noting is that total bank profits have doubled since 1999, outpacing the economy's 75% growth in nominal terms, but in line with the doubling in house prices, the doubling of mortgage debt and the more than doubling of foreign debt. The tax system's free ride for housing and land speculation, along with the poor performance of equity and other investment markets, have seen the banks respond by offering "˜loss-leading' prices to grow lending in areas with the lowest hanging fruit. The changes to the regulatory arrangements for capital adequacy have also deepened the bias to property lending. The long foreshadowed shift to Basel II  meant banks were effectively allowed to set their own capital requirements based on past loan loss records. This meant they had to hold much less precious capital for home loans than business loans. The Reserve Bank has imposed a 15% regulatory surcharge to boost the capital set aside for home loans. They should use this tool even more to rectify the imbalance. Meanwhile policymakers should change the structural settings that encourage demand for home loans. Interest.co.nz believes a flatter, broader tax system that encourages business and productive investment and discourages consumption and property investment should be introduced. We believe a land tax is the simplest way to "˜put a price' on such property speculation. The alternative is a loss of sovereignty (and a sovereign rating downgrade) The risks of continued inaction are a sovereign credit rating downgrade and a loss of foreign investor confidence as our foreign debt continues to grow while our productive capacity withers. This could force Australia to step in to formalize its existing informal underwriting of New Zealand's economy and to demand control of our banking regulation. ANZ alone pumped NZ$10 billion of fresh capital across the Tasman during the financial crisis of the last year. New Zealand was the biggest drain on the Australian banks during the last 12 months and was a factor prompting them to raise A$20 billion in fresh equity from Australian savers through its pension system. Any suggestion that the New Zealand banking tail could wag the Australian banking dog would quickly result in political and regulatory intervention. This would lead to an eventual capitulation to an Australian-led Trans-Tasman monetary and banking system with the associated loss of sovereignty. Many thanks for the opportunity to make this submission.