Bollard says lack of banking competition may cost us

Reserve Bank Governor Dr Alan Bollard. Photo / Mark Mitchell

A lack of competition in the banking sector may have pushed up the cost of credit for households and businesses, Reserve Bank Governor Alan Bollard says.

In a speech to the Shareholders Association in Tauranga on Saturday he said New Zealand banks' average return on equity in the 2002 to 2007 period was the second highest among 23 OECD countries and their Australian parents' the third highest.

From a financial stability perspective the relative strength of the Australasian banks could be seen as desirable, Bollard said.

"However, the result could be seen as evidence that competition and contestability in the banking sector were lacking, enabling the banks to earn higher profits than would otherwise be the case."

He acknowledged that 2002 to 2007 saw a credit boom and that a longer period would be likely to reveal rates of return more in line with international norms.

The same survey had also found that New Zealand banks' operating costs were the second lowest in the sample.

"Some work we have done comparing the margins that banks charge on some financial products like residential mortgages suggest that the New Zealand banks have not earned interest margins that are particularly high relative to other countries. This would support the view that strong profitability was due to low operating costs rather than undue market power being exercised over customers."

However, as a former chairman of the Commerce Commission, Bollard is acutely aware that barriers to entry, to what in New Zealand are often highly concentrated markets, are a big factor in how competitive those markets are.

Regulatory barriers to entry in the banking sector are low by international standards, he said.

"However, the costs associated with establishing a new retail branch network in New Zealand appear to be high given the small scale of the market. Notwithstanding the success of Kiwibank in the retail market, the fact remains that it is difficult for new players to enter the New Zealand market and assume a competitive position, other than through direct acquisition of an existing bank or by specialising in a narrow market segment."

In addition customers face practical difficulties involved in switching banks.

"The customer inertia that this creates makes it difficult for new entrants to gain critical mass even if they price their offerings keenly."

However Bollard said regulatory changes brought in since the global financial crisis which are intended to create safer banks might be expected to lower rates of return over time.

Deeper capital markets might help to stimulate greater competition in the financial system. "All things considered, it seems unlikely that the rates of return in banking enjoyed over the past decade can be sustained in the future."