Either way, attention put on bank profits will circle back to the environment successive governments and regulators have created for banks to operate in.
This will raise two key questions:
1. Did the Government and Reserve Bank do too much to help banks support the economy when Covid-19 came along?
2. Is the right regulatory balance being struck to ensure we have a strong and efficient financial system that supports innovation?
The Covid effect
One could argue that in hindsight, the Government and Reserve Bank (RBNZ) misdiagnosed the economic problems that would stem from Covid-19.
Creating policies at haste, in an exceptionally uncertain environment in early 2020, they feared the health crisis would turn into a financial crisis, whereby trades wouldn’t settle and demand for credit would plummet.
These risks looked real in March and April 2020, as equity prices sank and bond markets seized up.
While actions regulators took to maintain financial stability worked, the slashing of interest rates and provision of various government support packages meant the problem ended up being that there was too much demand in the economy in relation to supply, which was constrained by the fact it was difficult to move people and goods around the world.
Nonetheless, all this stimulus benefited the banks.
Demand for mortgages soared, as those who weren’t trying to buy a home were extending their mortgages to do renovations, buy cars, etc.
The Reserve Bank’s decision to completely remove loan-to-value ratio (LVR) restrictions for nearly a year only made it easier for investors in particular to borrow and buy up a storm.
Come December 2020, the housing market was steaming hot, all things considered.
Nonetheless, the situation with the virus was still uncertain, so the RBNZ launched another programme aimed at further suppressing interest rates.
It started creating money and lending it to banks at the official cash rate (OCR) via a Funding for Lending Programme (FLP).
The RBNZ didn’t want banks’ struggle to attract funding from term depositors in a very low interest rate environment to prevent them from lowering interest rates. So, it offered to help fund them.
By the time the programme concluded in December 2022, the RBNZ had lent banks $19 billion.
The RBNZ was widely criticised for implementing a programme that wasn’t required. Even the bank acknowledged it should’ve given itself the ability to end the FLP early.
The issue, from a competition point of view, is that the FLP’s criteria prevented small banks, credit unions and finance companies from accessing funding.
The other programme the RBNZ used to lower interest rates – its Large-Scale Asset Purchase (LSAP) programme – also benefited the big banks.
The programme saw the RBNZ buy $53b of New Zealand Government Bonds from banks. The aim of becoming such an active player in the bond market was to lower interest rates and soothe dysfunction in the market.
Not only did this fuel demand for credit, but the transactions saw banks’ accounts held by the RBNZ soar six-fold to $48b in January. The pinch is, the RBNZ pays the banks interest at the OCR on these balances, and the OCR is rising.
As for the Government, its efforts to ensure businesses had access to credit when Covid-19 hit effectively helped de-risk banks.
The Crown ended up guaranteeing 80 per cent of $2.9b worth of mostly bank loans to businesses via its Business Finance Guarantee Scheme.
However, a Treasury-commissioned review of the scheme found it wasn’t really necessary, even though it was helpful, and non-banks could’ve been included in it from the start. Indeed, only 3 per cent of loans written under the scheme were by non-banks.
Before throwing too many stones at the Government and Reserve Bank, it’s important to consider what would’ve happened if they didn’t do enough to support the economy. Or, if their policymaking was perfectly curated, considering secondary objectives like supporting competition in the finance sector, but came too late once confidence was shot.
Nonetheless, it’s worth acknowledging their efforts saw the big guys benefit, and the little banks, credit unions, building societies and finance companies left to their own devices.
Regulatory impact
As for how regulation has affected competition – this is a topic too large to do justice in this piece.
Following the 2008 Global Financial Crisis, which saw more than 50 finance companies in New Zealand either go into liquidation, receivership or have payments frozen, regulation of banks and non-bank deposit takers lifted substantially.
This didn’t restrict new entrants to the market. The number of banks registered in New Zealand increased from 17 to 27 over this time.
But regulators are always faced with the tough task of ensuring regulation is proportionate to risk.
This issue is being thrashed out as the Government designs a deposit insurance scheme, enshrined in the Deposit Takers Bill.
Once established, the scheme will see banks and non-bank deposit takers pay levies into a fund that would be used to reimburse depositors in the event of their deposit taker collapsing.
Banks want to pay lower levies than finance companies, because they’re less likely to run into trouble. Meanwhile non-bank deposit takers want to pay less, because the risk posed to the financial system as a whole from one of them collapsing would be much lower than a bank failure.
In a submission to Parliament’s Finance and Expenditure Committee, a group of 13 non-bank deposit-takers late last year argued the levies were potentially “one of the greatest risks to their ongoing viability under the new regime”.
The group feared high compliance costs, and “regulatory creep” associated with the broader reform programme the insurance scheme is part of, would “exacerbate the decline of diversity and competition in the sector and further concentrate our financial system into the four large foreign-owned banks”.
Designing a deposit insurance scheme is complex. But clearly, the Government should ensure it supports, rather than hinders, competition in the sector.
Broader issues
Any investigation that takes place into bank profits will inevitably put government policymaking and regulation in the spotlight.
As well as focusing on the specifics, such as those discussed in this piece, it’ll also raise some bigger, long-standing issues.
For example, would there be more competition if consumers were more financially literate, and knew how to shop around to get the best deals?
An open banking regime, which is still painstakingly being designed, would likely only improve competition if consumers engaged enough to capitalise on the benefits more data sharing and better use of technology could facilitate.
Then there’s the issue around the development of New Zealand’s capital markets. Would we be less reliant on banks for mortgages and term deposits if there were a greater range of alternative investment options?
There are a number of big questions to be asked around how the environment in which banks operate has been created. Focus on this is crucial, but should not detract from an equally forensic analysis of banks’ own actions.
