By Bernard Hickey The Finance and Expenditure Committe's report on bank profits and interest rates sure caused a stir, mostly because it carried a whiff of officialdom and cited various comments from the Reserve Bank. The New Zealand Herald led with it and for at least a day it has dominated the news agenda. The noise is likely to spill over into the Reserve Bank's June quarter Monetary Policy Statement and Official Cash Rate announcement. But is the report based on fact? Are the criticisms valid? Most have assumed they are because it's an 'official report' based on comments from the Reserve Bank. But I think those assumptions can be criticised. Here's how I think the report is wrong on 8 counts.
1. Bank profits have fallen substantially, not marginally Here's what the committee said.
"We were very surprised to learn that despite the severe impact of the current recession on business and household liquidity, bank profits declined only marginally in the past year, and principally as a result of provisioning against future credit losses." The committee said it "would expect that the banking sector would take on a greater role in sharing the burden of the current recession."
This is wrong, particularly when you take into account the latest reports from the banks for periods up until March 31. The committee used referred to comments from the Reserve Bank based on data until the end of December. The latest reports show a significant fall in profits. Here's a breakdown of how the big four Australian-owned banks did up until March 31. ANZ National ANZ National's profit fell 29% to NZ$488 million in the six months to March 31 from NZ$692 million in the same period a year ago. It's net profit as a percentage of total profits fell to 0.8% from 1.1%, according to NZ National's Key Information Summary ANZ National's bad debt charges rose to NZ$285 million from NZ$93 million. ANZ National's total lending rose 1.2% from a year ago to NZ$93.72 billion. ANZ National reported its net interest margin for its New Zealand businesses fell 24 basis points to 210 basis points in the six months to March 31 from the same period a year ago. It was down 9 basis points from the September half. ASB ASB's net profit fell 26% to NZ$419 million in the 9 months to March 31 from NZ$567 million in the same period a year ago. Net interest income fell 4% to NZ$712 million from NZ$741 million. Yet it's lending (advances to customers) rose 14% to NZ$52.40 billion from NZ$45.95 billion a year ago. Net profit as a percentage of assets fell 30% to 0.7% from 1.0% the previous year according to ASB's Key Information Summary, yet its tier one capital ratio rose to 9.0% from 8.9% a year ago. Bad debts rose to NZ$147 million from NZ$18 million in the same period a year ago.
2. Bank profits are down because of margin contraction, not just bad debt charges Here's what the committee said:
"We were very surprised to learn that despite the severe impact of the current recession on business and household liquidity, bank profits declined only marginally in the past year, and principally as a result of provisioning against future credit losses."
The figures above show that a major portion of the fall in profits was linked to margin contraction. Banks are paying between 150-200 basis points more for their NZ$100 billion of overseas funding, particularly as they begin to lengthen the maturity of this debt at the request of the Reserve Bank. Also, banks are fighting hard with each other to attract term deposits, which are now offering rates significantly above the Official Cash Rate. That is squeezing margins further. 3. Banks have lent substantially through the Recession and have not tightened credit supply, They have expanded lending sharply. Here's what the committee said:
"The Reserve Bank noted that banks' behaviour tends to be pro-cyclical-providing easy access to credit in booms, tightening credit supply in downturns."
The banks have increased lending by 6% or more than NZ$17 billion in the last 12 months. Bank lending in America, UK and Europe has fallen sharply in some cases over the same period. The strength and continued lending of our banks has ensured our recession has been been relatively mild and our unemployment remains significantly lower than in the US, UK or continental Europe. Australia has been the best performing western economy in the last 6 months. That is no accident. It has the same banks as New Zealand. 4. Banks have passed on most of the OCR cuts to borrowers
"We are concerned that some banks have not passed on the latest 50-basis-point cut to the official cash rate (OCR) in their interest rates for floating mortgages. The Reserve Bank was disappointed at the response of the banks' floating mortgage rates to the latest OCR cut "” only two major banks, Westpac and ANZ National, have reduced their floating mortgage interest rates significantly," the Committee said, adding however that a large portion of the 575 basis points of cuts since mid 2008 had been passed on.
The committee's last caveat is accurate and undermines its basic argument that rate cuts have not been passed on to mortgage rates. Floating mortgage rates have dropped around 440 basis points to around 6.4% while the OCR has been cut 575 basis points. People should remember the OCR has been cut to a record low and significantly lower than it's ever been. The last cut was not passed on, but it was a cut in the OCR from 3% to 2.5%. 5. Banks have sacrificed profits to keep term deposit rates well above the OCR People also forget that the other side of the rate cutting coin are the cuts in term deposit rates. Six month term deposit rates have dropped only 400 basis points and have been rising slightly since January, despite significant further cuts in the OCR. This is squeezing bank margins because deposit rates are now significantly above the OCR. The margin between the 6 month term deposit rate has blown out to around 150 basis points from less than 15 when the OCR was 8.25%. 6. The government is not subsidising the major banks with the guarantees
"In view of the relative resilience of profits in the banking sector, we are concerned that taxpayers are, in effect, subsidising banks through the Government's retail deposit guarantee scheme."
This is simply not true. The big banks pay a fee of 10 basis points for the retail guarantee. Over the two years of the guarantee the banks are likely to pay a combined NZ$135 million in fees for a guarantee they don't think they need. The guarantee was foisted on them at a time of unprecedented financial turmoil because Kevin Rudd has a rush of blood to the head one weekend. The great irony (and it's a painful one for banks who have not lost a single dollar of deposits) is that they pay a fee but finance companies don't. 7. Australian-owned banks are not treating New Zealand and Australian customers differently
The Committee also said it was vital the "Australasian banks treat Australian and New Zealand firms on an equal footing."
The Reserve Bank is watching this issue, but has said businesses on both sides of the Tasman are finding it harder to get the easy credit they obtained before the credit crunch. 8. Bank profits are down just as much as other corporate profits As detailed above, bank profits have fallen as much other businesses. This persistent view that bank profits are rising or flat is simply not true. The numbers above show that. The committee knew it could make some popular claims and not have to back it up with legislative proposals that would have to be challenged in the court of public opinion and in parliament. Finance Minister Bill English said as much earlier today when he said customers should use their power as consumers to express their disproval. That can be translated as English knowing he either does not want to or can't change the rules to force the banks to cut rates and profits.