Kiwi banks defy global trend

By Neville Bennett

Friday 13th December 2002

It's been a tough year for banks. Most big economies faltered, Japan deflated, September 11 hit tourism and aviation and global GDP growth fell from 3.1% in 2000 to 2.4% in 2001.

Globally, this more adverse environment reduced the credit quality of borrowers and produced significant credit defaults. In the US, credit-quality deterioration was reflected in a 44% increase of provisioning for credit losses.

In Australia, the four major players increased provisioning 57%. As a smaller and less diverse economy, it could be anticipated New Zealand could have effects that are even more adverse.

As it happened, the bad year had little impact on the local banking sector. They not only thrived but also developed. Economic growth increased, driven by higher priced commodity exports, more immigration and falling interest rates.

The most rapid changes are in methods of payment. Credit cards and eftpos have grown from a 32% share of transactions in 1997 to 50% in 2001. There is a marked decline in cheque usage, too, in response to lower charges for alternative transactions.

The use of ATMs has increased, and their numbers have increased subliminally while, as everyone knows, the number of bank branches has fallen. Yet, it is expected the number of branches will now plateau.

The number of eftpos terminals has grown 50% in five years but that must surely be tapering off.

Bank assets grew 5.3% overall in 2001, a slower rate than previously. The most dynamic sector was business lending but mortgages remained important. Business was buoyant in beef, lamb and dairy, but lending declined to forestry, wholesale and retail traders, hospitality and tourism.

The funding of these activities is changing significantly. The retail contribution, through individual investors making a deposit, has declined from 37% to 26% over five years. This reflects low savings records as well as alternatives that are more attractive in managed funds, insurance bonds, stocks and property.

This fund shortage has made banks more dependent on wholesale supply, whether from their owners or other wholesale suppliers. Wholesalers charge more than hapless domestic depositors do.

Nevertheless, profitability continues to advance remarkably. Over the five-year period, interest income has risen by a third, fees have also increased marginally, but the important gain has come from reducing operating costs. Net profits after tax doubled from $1.12 billion in 1997 to $2.18 billion in 2001.

The Reserve Bank's report* emphasises this success is not due to easing conditions. Banks have to pay more for funds and competition is putting pressure on their lending rates. Fee income is under pressure from cheaper electronic transfers.

The banks have found new areas of profit in distributing managed funds, insurance products and in foreign exchange trading, where the margins are high. Profits have remained high in part because the banks have been successful in avoiding bad loans. This is a complex area but the data seem to indicate New Zealand banks have a rate of "impaired assets" about a third of that in Europe, the US and Australia.

The difference is ascribed to superior risk management techniques but, in the light of a lack of data, one might remain a little sceptical. Alternative possibilities are of lending criteria being too tough and the New Zealand business mix being different and safer (fewer tech companies than elsewhere).

Moreover, the huge growth of "past due" assets is of concern. These are assets where payments of principal or interest has fallen late, perhaps by 90 days, but which banks expect to come right. There was a 315% increase of such assets last year and the total was a huge $1.1 billion.

The Reserve Bank does not admit a deterioration of asset quality, but it seems a possibility, and it is occurring at a time when banks are making record low provision for loan losses.

Banks continue to take some fairly big risks, especially in so-called "large exposures," when banks make a huge loan to large corporates. Some of these individual loans are equivalent to 40% of the bank's equity, and there were 20 such loans last year.

There were 12 in the 20-40% of equity category. Moreover, there were huge loans to "connected persons," probably directors.

These large exposures are probably quite safe but it is obvious non-performance would have considerable adverse consequences.

Banks are necessarily exposed to "market risks," that is, potential losses in the value of their assets due to unforeseen, and unprovisioned, changes in interest rates, exchange rates and equities. Major risks have to be reported to the Reserve Bank. None has occurred in the last three years. This is reassuring, as many banks overseas carry huge derivative positions in off balance sheet transactions.

Do the banks have adequate capital? This is not really a problem, as the major banks are branches of larger overseas banks, which have adequate capital. It is reassuring, nevertheless, that the banks have a total capital ratio of 10.8%.

Off-balance sheet risk exposures fell 15% in 2001 and remain a small part of risk weighted exposures.

This is to be expected, as branches do not have the entire skills, or leeway, of head offices. The credit ratings of the banks are good, 12 being AA- or above.

The Reserve Bank report correctly concludes the banks have performed well in a difficult year.

Profitability has increased through asset expansion and the containment of expenses. Perhaps it emphasises competition.

The report does not mention the profit to equity ratio but banks make a lucrative 25% on their capital.

Nice for shareholders but not universally brilliant for consumers, who continue to complain about fees and poor service.

* Denys Bruce, Developments in the New Zealand banking industry, Bulletin Vol 65, No 2, RBNZ

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