How not to break the banks

By Rob O'Neill

Stress tests show it would take an extraordinary series of events for New Zealand’s banks to fail, Rob O’Neill reports.
Deutsche Bank's Frankfurt headquarters. Photo / AP
Deutsche Bank's Frankfurt headquarters. Photo / AP

The international banking system remains under the long cloud of the global financial crisis. Some giants have been savaged, while others - most notably Deutsche Bank - are selling assets to meet potentially crippling bad-behaviour penalties.

In that context, Kiwis can take heart at the state of our banks which, through a mix of solid regulation and good management, easily pass the most extreme internal and external stress tests.

Given that, executives say, the most unpredictable threat to our banks would probably be a major cyber-attack.

Speaking at the Institute of Finance Professionals (Infinz) conference in Auckland last week, former Commonwealth Bank of Australia chief executive and chair of Fletcher Building Sir Ralph Norris said there were obvious risks in our financial system at the moment, particularly if interest rates increase.

"There's no doubt people have been able to borrow significantly more money because of the lower servicing costs based around the interest rates we have now," he said.

"So if interest rates rise by two, three per cent, you are talking about interest costs rising 40 to 60 per cent on average.

"Many people will find that difficult to manage. It's incumbent upon the banks to ensure they are putting in appropriate buffers to protect against those outcomes."

Norris said we have to expect the unexpected.

"Few people predicted the GFC. We always have to be aware the unexpected can occur and often does occur. We have business cycles and the four most dangerous words are 'this time it's different'.

"Cycles are a fact of life."

In May, the Reserve Bank outlined three key risks to local banks: disruption in global financial markets; the banks' exposure to the dairy sector; and the booming housing market. Dairy is already showing signs of climbing out of its slump, easing some of that concern.

Antonia Watson, chief financial officer of ANZ in New Zealand, described our banks as "extremely resilient".

"The types of stress test we do on our bank now are a 50 per cent decline in house prices in Auckland, 40 per cent elsewhere, low dairy prices, 13 per cent unemployment, negative GDP ... you name it, we put it in there and we can't break the bank."

Liquidity requirements introduced in 2010 made sure local banks had enough money to survive a dislocation in offshore markets for long periods, she said.

"It's something that's way out there. You'd have to have a lot of different things that would all happen at once to really disrupt the banking system now to the extent of failure.

"There's lots of things that could happen economy-wise that could mean a drop in profits, but for a real bank failure or breach of capital ratios, we are talking about really, really rare events."

That isn't just the view of local banking insiders, Westpac treasurer Jim Reardon told the conference.

"Talking to one of the rating agencies after our last review, they pretty much admitted they'd tried all those metrics and they can't break a New Zealand bank," he said, giving kudos to the Reserve Bank for its loan-to-value (LVR) restrictions on home mortgage finance.

"I think there is risk in the system, but more around the profitability associated with the housing market.

"I think 'bubble' is overstating it. There is the potential for some kind of 'value vacuum' around investors going in at levels that can't be sustained from a rental viewpoint. If there's a pullback, there's going to be some tears, but I don't think that really risks capital for the banks."

We have business cycles and the four most dangerous words are 'this time it's different'.
Sir Ralph Norris

ASB's general manager treasury, Nigel Annett, said that when talking to investors, the most common question banks are asked is about the housing market, comparing it to countries such as Ireland which had seen major bubbles burst.

"I think the key difference is there was oversupply in those markets and a deterioration of lending standards. In Auckland there's no risk of oversupply in the current environment unless you get a major shift in migration.

"With the LVR restrictions, to find a scenario that breaks the banks you have to cobble together a whole bunch of different very rare events."

One of the factors that is making our banking sector so resilient is culture, which Norris described as the "building block" of any business.

"If you don't get the platform right, the culture right, then it is very difficult to get anything else right," he said.

"Conduct does tend to follow, but it's fair to say there are flaws and frailties and they get exposed."

Norris said that with the issues that had been revealed internationally over the past few years, you would expect customer satisfaction numbers would be low, but that was not the case.

Sir Ralph Norris. Photo / Supplied
Sir Ralph Norris. Photo / Supplied

"It's somewhat unusual, at the moment, customer service numbers at the banks are at all-time highs. Customers have a higher level of trust in their institutions than they ever have."

In Australia, for example, complaints in the banking sector are dwarfed by those in sectors such as energy and telecommunications. One of the keys was the way staff and executives were incentivised, he said.

People would accuse banks, perhaps oddly considering their business, of being too financially focused.

"People were being remunerated for wrong thing," Norris said. "It's easy to mortgage the future for present performance."

At ASB's parent bank, CBA, Norris shifted executive incentives to reflect customer satisfaction, to take away the focus on financial measures.

"If you look at this part of the world compared to Europe and the rest where banks have been fined tens of billions of dollars for misconduct - reflecting, I think, poor culture - that is significantly reflected in their customer satisfaction numbers."

What gets measured gets done, Norris said. Measuring culture was a good place to start.

Given all that, it seems the wild card in the deck is the threat of cyber-attack.

Banks have been under persistent attack for many years, Norris said. Every board of a company using technology needed to take advice on potential exposures and defences.

"They are going at banks all the time," he said. "There is a lot of co-operation between banks domestically and internationally."

So far, he said, breaches typically involved passwords, rather than sophisticated system hacking.

There was a saying about banks that got bandied about during the GFC and perhaps deserves another outing: "the only thing worse than a profitable bank is an unprofitable one."

Stress testing

A stress test is a simulation used to determine the ability of a financial institution to deal with crisis. Companies or regulators use stress tests to determine how robust a financial institution is in certain crash scenarios. Their use has become widespread since the global financial crisis of 2007. Many banks have failed such tests, especially those conducted by the European Central Bank.

- NZ Herald

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