One of the most important developments in recent decades has been the growing dominance of the trading banks in New Zealand and other countries.
These banks completely dominate the lending sector, have been primarily responsible for the housing market boom and are becoming more and more prominent in KiwiSaver, which is also supporting the housing market through its first home withdrawal scheme.
The banks are also extremely profitable. According to Reserve Bank statistics, our 20 trading banks had combined net earnings after tax of $5.1 billion for the 2015 calendar year, compared with $1.0 billion two decades earlier.
How have our trading banks become so dominant and so profitable in recent decades?
The banking sector was heavily regulated in the 1970s and early 1980s, when they operated under a myriad of Government regulations, ratio requirements and guidelines. These regulations and guidelines dictated the interest rates the banks could pay on deposits, who they could lend to and their lending growth rate.
The Minister of Finance and Reserve Bank Governor had more control over the banks than their board of directors or management teams.
The trading banks faced a huge number of restrictions including:
- They could not pay interest on deposits of 30 days or less under the “30 day” rule. This encouraged individuals to lend to non-bank financial institutions.
- The Government set the maximum interest rate the banks were allowed to offer on deposits between 30 days and three years. This rate had to be at least 0.5 percentage points below what the finance companies were allowed to offer.
- The banks were restricted to charging a maximum of 6 per cent on overdraft facilities.
The banks also operated under a reserve asset ratio scheme where they had to invest a percentage of their total borrowing in reserve assets, mainly Government or Reserve Bank securities.
This ratio, which was set by the Government on a monthly basis, had a high of 28.5 per cent of total borrowings in 1976. In the early 1980s it varied between 10 per cent and 24.5 per cent.
In addition, there were restrictions on the amount they could lend to households or individuals and they operated under qualitative guidelines whereby the Government asked them to give lending priority to farmers and exporters and a low priority to importers and property speculators.
The trading banks had to operate under a mass of debilitating and restrictive controls. However, they were not much worse off than most other financial institutions, which were also suffocating under a mass of rules, regulations, guidelines and political interference. On the positive side, the trading banks were the only financial institutions able to offer foreign exchange facilities and they also had a virtual monopoly in terms of cheque account services.
The election of the fourth Labour Government on July 14, 1984 was a watershed event for the economy, particularly the finance sector. Within days the new Government began to dismantle the regulations, ratio requirements and guidelines that had headlocked the trading banks for more than 50 years.
The new Government, with Sir Roger Douglas driving the economic agenda, quickly introduced the following changes:
- Four days after the July 1984 election, all control on borrowing and lending interest rates were abolished with the exception of the “30 day” rule
- The “30 day” rule was removed on August 30, enabling the banks to pay interest on deposits of 30 days or less
- The following day the 1 per cent monthly lending growth guideline was removed
- On November 18, all outstanding guidelines to the banks from the Reserve Bank were rescinded
- Finally, on February 11, 1985 all reserve asset ratio requirements were removed. Thus, in less than seven months, Sir Roger Douglas and the Labour Government had removed all trading bank controls. This allowed them to have unprecedented freedom to set borrowing and lending interest rates and to determine to whom they lent.
These measures have had a huge impact on the New Zealand economy and have allowed the four major trading banks — ANZ, ASB, Bank of New Zealand and Westpac — to be a dominant force in the domestic economy and to be extremely profitable.
For example, in March 1984 the trading banks, including their fully owned private savings banks, represented 47.5 per cent of the total assets of M3 institutions whereas they now represent a staggering 97 per cent. Meanwhile, the finance company sector’s share of M3 assets has declined from 18.4 per cent in 1984 to less than 3 per cent today.
Unfortunately, most of the massive increase in shareholder returns enjoyed by the banks has gone to Australia, as ASB, which was owned by a community trust, was sold to the Commonwealth Bank of Australia, and the Bank of New Zealand, which was government owned, was purchased by National Australia Bank.
Westpac has always been Australian owned, while ANZ sold 25 per cent of ANZ Banking Group (New Zealand) to 10,000 New Zealand investors in 1980 and the company listed on the NZX. ANZ made a successful takeover offer for ANZ Banking Group (New Zealand) in 1986 when it realised the positive implications of banking deregulation.
In the mid-1980s a number of New Zealand analysts were focusing on the “tepid” short-term earnings outlook for New Zealand’s only listed bank, while the parent company in Melbourne identified the fantastic long-term prospects for banks on this side of the Tasman.
The deregulation of the banking sector has resulted in a huge increase in lending as illustrated in the accompanying table.
Total bank lending has soared from just $6.5 billion in March 1984 to $407.3 billion, while changes to the lending mix have had a major impact on New Zealand. This aggressive lending was mainly funded by the banks borrowing heavily offshore.
The first point to note is the huge fall in lending to the manufacturing sector, from 24.5 per cent of total bank lending 30 years ago to only 2.8 per cent at present. This reflects the deregulation and demise of manufacturing, which was also the result of policy initiatives by Sir Roger Douglas and the fourth Labour Government.
Lending to the commerce, trade and finance sector has also decreased in percentage terms, while lending to financial institutions and services companies has increased. The latter two sectors have grown dramatically in recent decades.
But the biggest change has been the increase in residential mortgage lending from just $0.88 billion, or 13.6 per cent of total bank lending in 1984, to a massive $211.45 billion, representing 51.9 per cent of total lending, at the end of January.
When other personal loans are included, it brings New Zealanders’ total bank borrowings to $222.66 billion compared with just $1.73 billion 32 years ago.
The clear conclusion from this is that anyone who bought a house in the early 1980s has been extremely fortunate because aggressive bank lending has been a major contributor to the sustained rise in house prices over the past few decades.
As bank lending has become the life blood of the housing sector, then the banks will have to keep lending even if the market softens. If they don’t, then new buyers will not be able to borrow sufficient funds to enter the market and price falls could accelerate.
Most financial and investment advisers recommend that individuals and organisations should have widely diversified investment portfolios, yet our major banks are putting more and more emphasis on residential property lending.