Roger J Kerr lists eight reasons why the future for bank profitability may not be that bright. Your view?

 By Roger J Kerr

The profit margins of the Aussie banks who dominate the New Zealand banking market seems to be the major topic of discussion in the financial and economic media at the moment.

How dare those institutions make increased profits when everyone else is struggling to make a buck?

It pays to look behind the numbers before accusing the banks of being rapacious scrooges screwing the rest us.

A good part of the increased profitability was the write back of excessive provisions made the year before for doubtful debts (bad loans) that did not eventuate as bad as first feared.

Secondly, the artificial, unique and unsustainable situation of short-term interest rates remaining at 'emergency stimulus' levels of 2.5% for two and half years has encouraged mortgage borrowers to naturally go for the lowest rate, floating rate mortgages.

Thank-you, thank you say the banks to that as their lending margins above their cost of funds is greater for floating rates than fixed rate terms.

While the banks have had these two favourable winds to boost their net interest margins and thus profits over the past 12 months, a look ahead is not so rosy for them on the profitability front:-

- Write backs of over-providing for bad loans are one-off boosts to profits that do not repeat.

- New lending growth is very slow (if not zero), thus net interest margins will decrease going forward as new deposits taken in by the banks are invested in liquid market securities instead of higher margin earning corporate and retail loans.

- While continually delayed, eventually market interest rates will increase and mortgage borrowers will all rush back to fixed rate terms, thus the more intense competition reducing bank lending margins (compared to floating rate margins).

- Upcoming potential credit rating downgrades and Basel III banking regulatory requirements will again lift their own borrowing margins on longer term debt.

- Competition (pricing and term) from domestic corporate bond and international debt markets will keep big corporate borrowing demand from banks at a low level. The establishment of the Local Governing Funding Agency will reduce borrowing demand on banks from that sector.

- The Aussie banks here have all tapped the “Covered Bond” market to help reduce their overall borrowing costs, however they can only issue covered bonds up to maximum percentage of their total debt and most are already at that limit.

- Banks with a strong Asian network (such as HSBC) are more likely to capture new banking business related to international trade as NZ importers and exporters rely more heavily on that part of the world.

- Increased volatility in financial markets will be restricting bank trading and position taking limits and activity.

At the end of the day the competitive market will rule. If enough borrowers think that their bank lender is taking too big a margin off them, they will limit their borrowing or go elsewhere.

If their bank lender shafted them when the going became tough in 2009, that will also be remembered when it comes to refinancing time.

New Zealand borrowers and investors are not held hostage by the Aussie banks operating here and should not act as though they are.

There are plenty of alternatives if you do not like the behaviour of the big four Aussie banks.

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* Roger J Kerr runs Asia Pacific Risk Management. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com