ComCom diagnoses the problem with NZ’s banking industry – but will its solutions offer a real fix?

The New Zealand Commerce Commission recently released a draft report on the state of personal banking services in New Zealand. Unsurprisingly, the market study found a marked lack of competition among the largest financial institutions in Aotearoa New Zealand.

But will the government bailout of Kiwibank in 2022 or the arrival of fintechs make any long-term difference? If the commission’s report is to be believed – probably not.

The four major banks (ANZ, ASB, BNZ and Westpac) own almost 90% of the assets of all banks in New Zealand. Kiwibank, founded in 2001 to be an industry disrupter, has not been able to consistently impose competitive pressure.

In reality, smaller banks and fintechs are limited by the structural advantage of big banks, the burden of regulation and compliance and difficulties on the customer side with switching providers.

The commission offers some solutions to New Zealand’s banking woes. But regulators need to ensure any course correction doesn’t expose customers to the instability seen in Spain and elsewhere.

Diagnosing the problem in NZ’s banking system

The commission deserves praise for releasing the draft report, which effectively highlights the lack of competition in New Zealand’s banking system. This deficiency has led to a lack of investment, innovation, and disruption, along with minimal customer switching.

A two-tier banking system has emerged, with the four big Australian-owned banks enjoying significantly higher profits and smaller banks lagging behind.

While diagnosing the problem is one thing, finding the right solution is another challenge. The report makes it clear there is no easy fix for the competition issues in New Zealand’s banking sector.

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A key reason for limited competition is the large size gap between the “big four” banks (ANZ, ASB, BNZ, Westpac), with combined assets of NZ$580 billion, and the smaller banks (Co-operative Bank, Heartland Bank, SBS, TSB), whose combined assets are $25 billion. This is a 24-fold difference. Let that sink in.

This vast size difference offers the big four banks important advantages, such as wholesale funding at lower cost. Moreover, fixed costs in banking are significant. They include the cost of ever-increasing regulation, systems, cybersecurity and the policing of money laundering. Against the backdrop of these high fixed costs, size provides significant economies of scale.

Large banks can also diversify more easily. If risks in the New Zealand banking system increase, large banks can spread their risks across the world. This measure is more onerous for banks with a domestic focus.

Size matters

Another problem is small banks with a domestic focus are, in practice, beholden to politicians, who may interfere with these banks for electoral reasons. In the aftermath of the commission’s report, New Zealand’s minister of finance Nicola Willis indicated a willingness to look into how the government could better capitalise Kiwibank.

Unfortunately, the benefits of size are difficult to undo: size matters in banking. A country like Spain has shown how small banks can pose a significant risk to financial stability.

The commission appears to recognise the benefits of size. Its report does not propose to break up the big banks. Instead, it recommends helping smaller banks, such as Kiwibank, by softening the burden of regulation (through the Proportionality Framework, for example), improving access to capital and lowering the weight given to certain risks.

Intervention poses risks

But the proposals to help smaller banks, no matter how well-intended, are concerning. These initiatives are reminiscent of the pre-global financial crisis (GFC) era when lower capital ratios were used to boost competition and extend excessive credit to aspiring home-owners.

Regulators in the years leading up to the GFC trusted principles-based regulation only to discover in 2008 such regulations were gamed at the expense of the most vulnerable of our society. And yet the term “principles-based” appeared on page 180 of the commission’s report. Almost as if little has been learnt since the GFC.

Equally concerning is the report’s trust in Kiwibank, the bank stuck in the middle between the big four and the smaller banks.

With a return on equity well below its cost of capital, the bank has shown lacklustre performance for some time now. Among the 10 largest banks in New Zealand, Kiwibank also has the second lowest common equity tier 1 capital ratio. This means the bank is vulnerable to shocks and may struggle to meet the increasing capital requirements going forward.

Infusing billions of dollars in the hope and expectation of turning the bank into a disrupter is playing with fire. Disruption implies an elevated risk that ultimately can affect the stability of the banking system.

Read more: Why now would be a good time for the Reserve Bank of New Zealand to publish stress test results for individual banks

Likewise, the idea aired by some to float 49% of Kiwibank’s shares is concerning, as it introduces a moral hazard problem: Kiwibank’s managers may take excessive risks, expecting the Crown to provide more capital. Floating shares also creates uncertainty among the new shareholders: at some time a government may regret the float and nationalise the bank, again.

Trying to help weaker banks through deregulation, infusing new capital, or lowering capital requirements may backfire. The commission should instead continue to promote an inclusive banking system that is modern and up-to-date and serves all of us well.

The proposals regarding real-time transfers, ease of switching, market transparency, open banking, fintech, consumer empowerment and any other initiative to improve the customer experience are definitively worth pursuing.

Our banking system is such that consumers will likely bear high costs for some years to come, but all those in our financial system should at least aim for one which is safe and enjoyable to use.