The banking sector's influence across the economy is massive. It influences the price of credit, the availability of credit and where credit is directed, it helps businesses manage risk, and helps process billions of transactions.
Banks manage about $450 billion of loans and $350 billion of deposits. They are investors and involved in complicated deals and transactions. Banks are critical players in the major transitions the Government talks about across the economy.
A well-functioning bank sector is at the epicentre of a robust economy.
The banks deserve plaudits on many levels; they've helped New Zealand through numerous cycles, invest millions back into New Zealand, pay a lot of tax (as they should), are innovators, highly efficient and were more sensible at the top of this business cycle restricting credit growth.
Banks have been paying more attention to their funding (a dollar coming in the door via a deposit to finance the credit going out the door), which has helped lessen offshore funding dependence (though some of this has been regulator encouraged, too). The funding gap highlights a fundamental weakness in the economy; a lack of a strong domestic savings pool for investment to be funded.
The banking sector is undergoing significant changes, which will have major implications for the economy.
When I first joined the banking sector in 1999, the pecking order starting with looking after your people and staff, as they looked after the customer. If the customer was looked after, the shareholder would be rewarded.
Customer satisfaction scores were looked at before the financials by the chief executive. It was a long game, not a short-term profit-driven one.
That got lost over the years (not just in banking) and is at the heart of the reform and changes that are taking place as culture and conduct comes under the spotlight by regulators on both sides of the Tasman.
The Reserve Bank has launched the Bank Financial Strength Dashboard to make it easier for customers to monitor banks. That's promoting transparency, which influences behaviours.
New Zealand has high levels of debt. Borrowings are about 150 per cent of the economy or gross domestic product (GDP). Household debt is 166 per cent of disposable income. Dairy sector debt is high.
The ability to leverage up and obtain credit has been one factor driving asset prices and growth for a long time. It's easier to borrow when leverage is low; New Zealand's is not.
Debt accumulation has helped fuel asset prices, which increased wealth, and spending. Rising house prices / equity have been a key source of credit for small businesses.
Business sector lending has dropped as a share of total lending, whereas housing lending's share has increased over the past 20 years. That's a trend in the wrong direction if you want a productive economy.
The debt funnel now looks full. We can still borrow, but more in line with growth in the economy and incomes as opposed to in advance. If we behave and borrow less, loan-to-value restrictions get relaxed. They are tightened when we do not.
Credit growth has been more subdued since the global financial crisis, but the process and rules around credit facilitation are being tightened.
The economy is late in the business cycle and growth is slowing. Auckland house prices are falling. Banks' rigour on servicing rather than security will increase. Banks' appetite for borrowers with credit policy exceptions will decrease in a slowing economy.
Falling Auckland house prices and rising building costs are a bad combination for developer margins. Some tough conversations are either taking place or set to take place between banks and the dairy sector with farm values falling in price, costs rising and uncertainty over Government policy.
Banks will require more information on borrower's personal situation. Income verification has been standard for years, with less scrutiny over expenditure. Expenditure is now being more actively scrutinised. This is being made easier by technology tools and access to personal financial information.
Borrowers need to be aware what they are consenting to when providing access to information and to ensure the information provided is being used for the purpose intended.
The conduct issues in Australia will have a knock-on effect in New Zealand as demands for more responsible lending take hold. More scrutiny on remuneration, culture and tougher regulation will flow on to New Zealand. Mortgage brokers are set to be paid for by borrowers, not banks. One wonders if borrowers will be prepared to pay.
There is an opportunity for strongly focused relationship banking models which understand their customers' situations better and the risks, and as a result can provide tailored banking products and services which are not constrained to the black box – YES/NO lending decision.
Open banking – a secure way of giving new service providers access to consumers and businesses financial information - needs to be embraced and accelerated. Information is power. Forcing banks to give up data will make it easier for competitors to gnaw at their markets. Fintechs are knocking at the door. Consumers will be the winners. It's surprising to see the Government fixated with petrol and electricity companies. But maybe they are the entree.
New Zealand has one of the most profitable banking sectors in the world. Strong profitability is a good thing but a pre-tax return on equity in excess of 20 per cent raises eyebrows. The Reserve Bank puts some of that down to underinvestment in core IT infrastructure and risk management systems in New Zealand. That's sending banks a clear message.
Open banking is problematic for the banking industry and it is in the industry's interests to slow the pace of reform. Reform needs to be government and not industry led. Open banking will benefit businesses and consumers. The Government just should get it done.
Credit card reform is also long overdue.
The Reserve Bank of New Zealand (RBNZ) is proposing banks hold more capital, to the tune of about $20 billion, to improve the resilience of the sector and economy. If banks try to maintain their existing return on equity on that capital, it could force interest rates up close to 1 percentage point and see bank profits jump more than $4 billion.
That shouldn't happen. Shareholders can be expected to take a haircut on their return on equity.
But banks will lift margins, too, sharing the burden with shareholders. What share will be interesting. One suspects banks will want shareholders to bear less of the burden.
If expanded bank margins lift final borrowing costs which has an impact on the economy, the RBNZ will likely offset this via a lower Official Cash Rate. This will help exporters. A lower currency could mean slightly higher interest rates on average but not materially higher.
Changes across the banking sector are massive. Credit is 1.5 times GDP; credit reform via culture, the regulator, the economic cycle and behaviour shifts will have a big impact on the economy.
- Cameron Bagrie is Managing Director and Chief Economist
Bagrie Economics. He was formerly chief economist at the ANZ