Banks’ preparations for tough times could dampen profits

Westpac increased its provisions by the largest amount in the March quarter, followed by ANZ. Photo / Dean Purcell

Bank profits might keep coming off their highs if the economy continues to deteriorate this year.

Accountants at advisory firm KPMG are watching to see how much banks increase their provisions for borrowers who fail to meet their loan repayment obligations.

A number of borrowers are yet to refix their loans onto higher interest rates. The broader economic impact of having more households with squeezed budgets (possibly for a prolonged period) is also yet to cause more job losses.

New Zealand banks collectively increased their impaired asset expenses by $202 million, to $327m, between the December 2022 and March 2023 quarters.

As a percentage of operating income, the expense rose from 2.8 to 7.6 per cent between the two quarters.

The jump was mainly driven by banks increasing their provisions for expected losses, according to the Reserve Bank (RBNZ).

Westpac increased its provisions by the largest amount between the December and March quarters - 27.5 per cent - followed by ANZ with a 12.9 per cent lift.

KPMG believed banks would continue increasing their provisions this year, saying it would keep an eye on the extent to which these expected credit losses eventuate.

In its latest quarterly Financial Institutions Performance Survey, it said that provision levels were a leading indicator that could point to whether high interest rates would in fact only cause a shallow recession.

For example, if banks lift their provisions for bad debts a lot more, this could suggest they expect a deeper recession, and vice versa.

KPMG noted higher provisions eat into bank profits.

After peaking at $1.89 billion in the September quarter, New Zealand banks’ profit after tax fell to $1.67b in the March quarter.

The sector’s net interest margin (a key profitability measure) also came off its recent high, nudging down to 2.35 per cent in the March quarter.

KPMG partner John Kensington couldn’t say whether bank profits would continue to slide, noting: “This largely depends on whether or not we’ve come to the end of the interest rate rising cycle, how deep of a recession we slip into, and how this affects the sector’s provisioning.

“The RBNZ is facing a very delicate balancing act with the measures it’s putting in place to encourage the right level of economic slowdown.”

ANZ’s former chief economist Cameron Bagrie this month told the Herald that while increasing provisions showed that banks were preparing for tough times, the focus should be on actual losses or impairments.

RBNZ data suggests there was an uptick in borrowers who ran into trouble in April compared with the 18 months prior.

However, at 0.5 per cent, the “non-performing loans to all loans” ratio was the same as what it was in 2019, when interest rates were relatively low and the economy was performing quite well.

Bagrie believed the second half of this year and 2024 would be a “tough story”, but made the point that while impairment expenses could go up, banks tended to be able to reclaim their money.

“Banks seldom lose money,” he said.

Jenée Tibshraeny is the Herald’s Wellington Business Editor, based in the parliamentary press gallery. She specialises in government and Reserve Bank policymaking, economics and banking.