Alasdair Thompson: Banks risk business backlash

Opinion

The first bank prepared to break away from the others and put out an attractive interest rate offer to business, with normal lending criteria, could well grab an increased market share right now.

The advantage is there for the taking because business owners and managers are not happy with the banks. Businesses are concerned that banks are letting them down because bank loan interest rates have not come down anything like they have for households.

The same applies to credit card interest rates. That's the message we got from our just concluded round of briefings attended by 2500 member businesses north of Taupo.

Of lesser concern to them were the tighter lending criteria being applied. Nevertheless there were reports of tighter conditions and more stringent rules around covenants like earnings to interest cost ratios, tougher enforcement of personal guarantees and banks being unwilling to look past the impact of the new International Financial Reporting Standards (IFRIS), or take into consideration the impact of foreign exchange fluctuations on covenants.

The upside, of course, is that the tighter credit conditions have forced many businesses to restructure, reduce costs and increase productivity. They are also seeking to reduce stocks and debtors and inject more owner capital to reduce debt to banks. EMA is advising those exposed to "on-demand repayment" overdrafts to take steps to avoid that risk.

The strong feeling overall is that, with non-bank lending drying up, the banks have gained more collective or monopoly power over business loan funding.

Few finance companies remain able or willing to act as second-tier business lenders, so banks are flexing their recently acquired power in business lending.

Business knows the factors influencing the banks' pricing decisions are complex and involve a range of trade-offs. On the one hand, trading banks must ensure they earn an adequate rate of return on lending to reflect the underlying credit risk. On the other, if margins on business loans are unduly higher, relatively, this is likely to carry costs for the micro-economy and obstruct the stimulation of the economy through monetary policy.

While the pricing of the banks' fixed-rate lending products is reasonable given the underlying costs of funds, taking into account the margins typically earned on them over time, the pricing of floating-rate mortgages appears unusually high. The 9.82 per cent base lending rate for SMEs also appears high.

At the heart of the issue is the question why have the banks not passed on cuts to the Official Cash Rate (OCR) more fully since the OCR remains a significant factor in setting the banks' cost of money.

Instead, when charging for new loans and credit facilities, or on existing floating rate loans, the banks have focused primarily on the average cost of raising funds from across all their funding sources, rather than on the cost of raising funds at the margin.

The cost of this marginal funding has risen to 100-150 basis points over the OCR rate, whereas before the global financial crisis they were about 20-30 points higher. That means upwards of 100-150 basis points of the 575-point cut in the OCR has been negated by the banks' increased funding spread.

In turn this means the 575-point OCR cut has been reduced by 100-150 basis points to about 425-475 points, which is basically what has happened for house mortgages, but business loans came down only 250 points.

The Reserve Bank has reported that a large part of its cuts to the OCR has been passed on to households and to business borrowing rates, but the marginal costs of funding for banks has increased relative to the OCR.

The OCR has gone down by 575 points but the base lending rate for small to medium-size businesses (97 per cent of businesses in New Zealand) has fallen only 250 basis points from the peak in 2008-09; credit card interest rates have fallen by only 190 points.

To summarise, business believes business base loan interest rates at 9.82 per cent are too high, given that the OCR has come down by 575 points, the 90-day bill rate is down by 630 points, and floating house mortgage rates are down by 430 points. But loans to smaller business are down by only 250 points.

Though the level of impaired business loans is up, it's not as high as at other times when business loan interest rate margins were lower.

The banks need to do more than "spin" their way out of this. They need to remember that there will be a price for them to pay if their business customers feel cheated.

* Alasdair Thompson is chief executive of the Employers and Manufacturers Association (Northern). www.ema.co.nz