The Reserve Bank took bank capital settings too far, and New Zealand banks are making incredible returns relative to the volatility of their returns, favouring residential mortgages over lending into the productive part of the economy. We are “banking” on houses.
Minus 0.3%. That is the average decline in capital productivity per year since 1996.
Capital productivity reflects how well the capital stock is allocated, managed, and utilised to generate value. It is an indicator of the return on investment and affects the competitiveness of New Zealand in the global market.
Minus 8.7%. That is the decline in the level of New Zealand capital efficiency since 1996. That is the market sector alone and does not include most of government.
Minus 6.6%. That is the decline in capital productivity between 2022 and 2024.
It’s easy to point the finger at the Government - and we often do. Yet, there are some major listed companies that have destroyed a lot of shareholder value of late and over time.
It is time we also focused on the Performance of the Boardroom.
Then there is the role of the Reserve Bank and Banks. You do not get wealthy selling more expensive houses to each other.
It’s easy to point the finger at government and we often do. Yet, there are some major listed companies that have destroyed a lot of shareholder value of late and over time.
Is it really that bad?
The economy is the same size as it was three years ago. Per capita wise the economy is down 4% from its peak. Construction is suffering. Wage inflation is not keeping pace with general inflation so cost of living pressures are intense.
Yet building consents per 1000 resident are in line with the historical average since 1966. Total bank profits are $10 billion. The unemployment rate is hardly scary at 5.3%.
Maybe it’s been too easy to blame the economy. People’s memory of a what a real downturn looks like is short.
The business sector bore the brunt of the 2023 and 2024 downturn because they were slow to cut costs. Labour (compensation of employees) share of the economic pie spiked, and operating surplus (returns to capital) declined. That rotation is now reversing.
It hurts when you fall from dizzy heights or detox from less sugar candy - high government spending, ridiculously low interest rates and quantitative easing. But that is a part of normality.
How good are we at management and around the boardroom table?
Not good, according to the OECD’s 2022 Economic Survey of New Zealand.
That survey noted that “Managerial practices in New Zealand lag behind other advanced OECD economies, holding back the adoption and effective uses of digital technologies.
“The deficit in management skills results in low dynamic capabilities, which is holding back New Zealand firms from grasping changes in business environments and investing in strategic intangible capital to capture new business opportunities or respond to threats.
“Management boards in New Zealand’s firms are often more focused on preserving existing value and regulatory compliance than on growth strategies that involve productivity-enhancing investments and international expansion.
“In particular, there is a shortage of board members with rich managerial experience as opposed to a preponderance of those from accounting and legal backgrounds.”
The consequences have been two-fold. Poor risk management of a downturn and a failure to innovate and embrace change.
Do we need to see more shareholder activism driving performance? I say yes. From the fund management industry especially.
After embracing reform in the 1980s and rejecting import licensing and subsidies which dampened competition, it feels like New Zealand has gone 360 degrees on some levels, with many industries such as the grocery sector more powerful and consolidated. Weak competition just inhibits innovation and drives complacency.
What’s normal?
As the world embraces geo-strategic and geo-political imperatives at the expense of a commercial dictated model, the era known as The Great Moderation (1993-2019), which involved globalisation, declining interest rate trends, low inflation and low volatility, has moved behind us.
Abundance is being replaced by scarcity. Political leadership by populism leadership. A liner world is now non-linear as AI hits. Demographics are no longer a tailwind.
Many countries are facing declining trends in productivity and the International Monetary Fund’s chief economist has referred to dissatisfied populations which drives voters towards the political periphery.
Life will go on, but most of the workforce’s and managements experience resides with a period of period of stability, reasonable certainty and low volatility.
Getting the Reserve Bank ‘back on track’
The Reserve Bank is a critical institution, and their reputation has been dented in recent years. The departure of the Governor and Chair are only a part of the problem.
Warning bells were being raised years ago with the imposition of higher capital requirements on banks (now set to be reversed), a focus on periphery as opposed to core central bank issues, and a board that did not appear to have the requisite skills in banking and macroeconomics. The handling of the departure of the Governor suggests insufficient constructive tension around the board-room table. Where are the questions about losses on the large scale asset programme?
Monetary policy over many decades may has controlled inflation but exacerbated asset [house] price rises, and bailed out asset owners in many instances. Now, house prices are stagnant as deleveraging takes hold. The solution is likely to be even lower rates in the interest of getting growth. That will come with an expense of further division within society.
Expect pressure on central banks to intensify as economic and social trade-offs intensify. The US Federal Reserve is case in point, with inflation saying do not change rates but a weakening labour market calling for lower rates. There is speculation of a third mandate; moderate long-term interest rates.
Banking
You are not going to drive a high productivity economy if the banking sector is channelling more money into low productive assets and are risk averse.
Banks recorded $10 billion of profit and an impairment expense of 0.08% during the 2024 recession.
Home lending has gone from 50% of bank lending in 2000 to more than 63% now.
The OECD noted in their 2024 Economic Survey of New Zealand that: “These high levels of profitability are unlikely to be explained solely by the riskiness of conducting a banking business in a small market like New Zealand, as the standard deviation of pre-tax returns is relatively low, suggesting low risk taking among banks.”
The net interest margin across the banking sector has been stable around 2.35 percentage points for the past two years but is 30 basis points higher than it was in 2021.
Is the current state of banking is fit for purpose and aligned with where New Zealand needs to go to increase living standards? Increasingly focused lending on housing is not the right direction in the long-term for the economy but it’s good for near-term bank profits.
Business investment has the potential to be a key driver of growth and productivity over the coming decade. My fear is that we lack the banking sector to back that sort of growth.
The bottom line
The taking and managing of risk is one part of the living standards equation we do not talk about enough. There are many parties at the table and all need to play a constructive part.
The taking and managing of risk is one part of the living standards equation we do not talk about enough. There are many parties at the table and all need to play a constructive part.
Cameron Bagrie is lead economist at Bagrie Economics.
