Falling interest margins amid a fiercely competitive lending market contributed to a downturn in the New Zealand banking sector's profitability in the final quarter of 2015, according to a report.
KPMG's Financial Institutions Performance Survey said the industry's combined profits fell from $1.3 billion in the September quarter to $1.1 billion in the final three months of the year.
Interest margins fell four basis points to 2.2 per cent in the quarter, it said, while declining trading income and unfavourable fair value movements of financial instruments also contributed to the profit dip.
John Kensington, KPMG's head of financial services, said the lending market had been challenging across the board.
"The banks are still finding it very hard to get good loans away to good customers. They're having to probably accept a slightly lower rate of interest than they would like."
The report said total assets in the banking sector continued to grow, lifting from $441 billion in the September quarter to a record $443 billion in the December quarter.
"All the survey participants continue to increase the value of their loan books with no signs of slowing down," KPMG said. "This was driven mainly by the continued momentum of the housing market and falling dairy prices which continue to put pressure on cash flows and the ability to service debt for farmers with loan repayments slowing and additional drawings occurring."
The survey found lending rose by $7.3 billion during the quarter, with favourable funding conditions resulting in a 5.4 per cent reduction in interest expenses.
"Of the major banks, Kiwibank, CBA [ASB] and Westpac had a combined $16 million increase in net profit after tax, while ANZ and BNZ combined for a $169 million decrease."
Kensington said the funding environment for banks had been challenging in early 2016, with market volatility contributing to higher wholesale funding costs.
A trend in falling profitability in the sector could continue over the course of this year.
"I think through this year the banks will fight competitively to get any good loans they can," Kensington said.
"[Consumer] borrowing rates are at an all-time low so banks will want to keep their books up - they want to get their volume - so they'll still be prepared to be very competitive."
He said banks would also come under pressure to pass on any further cuts to the official cash rate, should they occur.
The Reserve Bank cut the OCR by 25 basis points to 2.25 per cent in March and will make its latest rate announcement this morning.