The Labour Government’s decision to direct the Commerce Commission to investigate the retail banking sector may be politically motivated, but that doesn’t mean it’s a bad idea.
New Zealand’s banks have been fairly profitable for decades and it’s not a coincidence the extra scrutiny comes as voters are fretting about high interest rates.
When mortgage rates come up on the campaign trail, Labour can redirect the conversation towards competition in the banking sector. Even though that’s not the reason rates are high.
But just because the timing has a political aspect doesn’t mean there isn’t merit in the investigation. In a democracy, it can be difficult to separate populism from representation.
Households are struggling with high interest rates and have every right to expect the Government to make sure banks aren’t taking advantage of them.
The Reserve Bank (RBNZ), which is the prudential banking regulator, called attention to the profits of retail banks in its May financial stability report.
“The differences in risk-adjusted profitability may reflect a lack of competition. However, several other drivers are possible,” it said.
Other options include cost efficiency due to economies of scale, differences in the tax treatment of returns to shareholders in New Zealand and Australia, and not doing high cost, risky operations such as investment banking.
Profitable, but in a good way
The RBNZ wasn’t shy about saying profitable banks are good banks, at least from a financial stability perspective.
“A profitable banking system is beneficial for financial stability, as it enables banks to generate or attract the capital base needed to absorb potential losses over economic cycles.
At the same time, competition between banks has an important role in supporting an efficient, inclusive, and dynamic financial system,” it said.
Opposition leader Christopher Luxon supports the market study, while also being frustrated that Labour blocked a Parliamentary inquiry in favour of an election year market study.
It's not clear whether that is because he thinks the sector needs scrutiny, or just not wanting to be cast in the role of ‘Big Bank guy’, but it shows broad public support for the study.
In comments to the media, National has been careful to talk about how regulations have added costs for consumers and even imply they could be blocking entrants.
David Cunningham, chief executive of Squirrel, said regulation and legislation made it hard for challenger banks to succeed and pushed the big banks into a “sea of sameness”.
“Although the Reserve Bank has an important role in ensuring the stability of the financial system, it’s also one of the greatest culprits behind the lack of competition in banking”.
HSBC’s recent decision to leave the NZ market was likely due to an RBNZ consultation paper which proposed restricting foreign bank branches from doing retail banking, he said. (HSBC said otherwise).
Regulation barriers
It was only two years ago that Westpac New Zealand was threatening to leave the market after the RBNZ increased the capital requirements on Australian banks and strengthened its outsourcing policy.
The bank was unhappy about the increased regulatory burden and was considering a sale.
When it ultimately backed down, one equity analyst said this was the right decision as mid double-digit returns on equity made NZ a good place to bank.
That’s a better return than banks earn in other markets.
The RBNZ said the average for the big four banks was 15.3% across the five years ended 2022, compared with 7.4% for small local banks and 11.3% for large banks in similar countries.
The same four banks that made a 15.3% return in NZ, only make 12.9% in Australia.
Readers, media, and politicians should remember that these are big businesses with huge amounts of capital, so their nominal profits are also very large numbers — $7.18 billion last year, to be specific.
But nominal profits can bounce around year-to-year as accounting practices, such as setting aside money for expected losses or interest rate hedges, impact reported earnings.
The New Zealand Banking Association said local banks were resilient because they were highly regulated, well capitalised, and profitable.
A market study will at least shine a light on whether that profitability can be justified.
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