Bernard Hickey: Haggle with your bank for returns

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Bank profitability in New Zealand is too high and we have to do something about it.

It's time regulators and customers hammered banks into producing fairer returns that help the economy grow healthier. That means lower mortgage rates and higher term deposit rates.

Don't take my word for it that the banks are too profitable. Reserve Bank Governor Alan Bollard said as much recently to the New Zealand Shareholders' Association in Tauranga.

"It seems unlikely that the rates of return in banking enjoyed over the past decade can be sustained in the future," Bollard said.

After-tax return on equity for the banks averaged around 18 per cent from 2002 to 2007. This made them the second most profitable banks of a sample of 22 OECD countries conducted by the Reserve Bank. They were even more profitable than their parents in Australia, who are third most profitable behind the Slovak Republic and New Zealand.

The last two weeks' of profit reports from ANZ, ASB and Westpac underline just how profitable these banks are again, despite the weak growth in the economy.

Banks have boosted their profits by quietly allowing their net interest profit margins to rise and they have seen their bad loan costs fall as the economy recovers.

Many may ask, how did the banks increase their margins at the same time that mortgage rates were unchanged?

Partly because banks pumped the effects of higher funding costs from the Lehman Bros crisis into their margins in 2008 and 2009 and haven't taken them back out as those wholesale market funding costs have fallen through late 2010 and early 2011.

Floating mortgages are also more profitable for the banks and there has been a big shift to floating from fixed over the last year. Close to 60 per cent of all mortgages are now floating because they are nominally cheaper for borrowers, but more profitable for banks.

On July 1, 2005, the margin (what the bank pays to borrow versus what it charges to customers) on a floating home loan rate was 1.87 per cent with the average bank floating rate at 8.90 per cent versus the 90-day bank bill rate of 7.03 per cent.

As of last Friday it was up almost 100 basis points to 2.85 per cent with the average bank floating rate at 5.73 per cent versus the 2.88 per cent 90-day bank bill rate.

On July 1, 2005, when fixed mortgages were still all the rage, the average margin between the two-year swap rate and two-year fixed-term home loan rate was just 0.92 per cent with the two-year swap rate 6.68 per cent and the average bank two-year fixed rate 7.60 per cent.

As of last Friday it had more than trebled to 3.07 per cent with the average two-year fixed rate at 6.41 per cent versus the 3.34 per cent swap rate.

Also, term deposit rates have slowly fallen through the year as competition between the banks for such deposits has eased. The average bank one-year term deposit rate has fallen 71 basis points this year.

All this means the banks' net interest margins are rising. ASB reported this week its net interest margin rose 40 basis points to 2.08 per cent this year. Reserve Bank figures show the banks' combined net interest margin has risen to 2.23 per cent by June from 1.87 per cent in September 2009.

New Zealanders need lower mortgage rates and higher term deposit rates. It's time the banks played their part.