Profitability underpins economic growth

Published in KPMG’s Financial Institutions Performance Survey 2014 – 25 February 2015

Bank profits routinely attract attention in New Zealand. The numbers are not inconsiderable with an industry total of around $4.8 billion in 2014. Banks often face the question – are they making too much money?
Some commentators argue that any profits made by banks are excessive and unsustainable. Others say that banks make too much money and that this is unhealthy for the economy, while some argue that too much profit goes offshore.
Bank profits are in fact a key measure of the banking industry’s strength. This strength in turn underpins economic development by funding the needs of businesses and households, and allowing banks to continue to invest in New Zealand communities.
In 2014 banks spent $6.6 billion running their businesses in New Zealand. That includes employing over 25,000 people and paying a range of local businesses for goods and services. Banks also paid around $1.8 billion in tax, or the equivalent of the operating budget for the New Zealand Police.
The strength of our banking industry is internationally recognised. In its Global Competitiveness Report the World Economic Forum has rated our banks the second most sound in the world after Canada, two years running. This is important because it helps keep funding costs for banks lower and those rates can be passed on to New Zealand households and businesses.
The Association recently commissioned Massey University to undertake research to see whether bank profits, as measured by returns on equity, were high compared to major businesses listed on the New Zealand Stock Exchange 50. The research found that banks fell firmly in the middle of the range of returns on equity. Banks’ average return on equity in 2014 was 16.13 per cent. It is interesting to note that even smaller banks have balance sheets which are the same size or bigger than the largest NZX-listed companies.
Bank profits are largely a result of good management. Credit growth is relatively low at around five per cent. In this environment banks have had to carefully manage their operating costs. Average operating expenses as a proportion of operating income are down from 42.35 per cent in 2013 to 39.25 per cent in 2014. The reduction in bad debts is also an important part of the profits story, and reflects both the buoyant state of the New Zealand economy and banks’ responsible lending practices.
A major driver of good management is the highly competitive environment in which our banks operate. We see this in banking product innovation and customer service. Banks work hard to retain and attract customers. They also put a great deal of effort into technical innovation that responds to customer preferences through a range of banking channels.
Bank profits are mainly generated from the net interest margin. The average net interest margin for banks in 2014 was relatively stable at 2.24 per cent. That said, there has been pressure on margin since the Reserve Bank imposed lending limits on low equity loans because banks are competing more strongly in the higher equity category. Downward pressure on margin has also come from borrowers switching from floating home loan interest rates to less profitable fixed rates.
We have a diverse banking sector with a range of ownership models. For most banks some profit is retained to maintain the increased capital levels required by the Reserve Bank, both to meet international banking standards and to manage risk in particular sectors such as agricultural and household lending. For the foreign-owned banks, some of it is used to pay back parent banks that supported New Zealand banks, and therefore our economy, through the global financial crisis. And some goes back to the shareholders, which would include many KiwiSaver funds. With over two million KiwiSaver members, many New Zealanders benefit from their investment in these successful businesses.
While bank profits appear significant, so are the businesses that generate them, and the contribution those businesses make to New Zealand. In thinking about bank profits, it pays to consider the benefits those bank profits bring as a customer, a home or business owner, KiwiSaver and investor.
New Zealand banks continue to be among the best funded and regulated in the world. That has served us well through the economic recovery. The experience of our banks provides a stark comparison with many banks in Europe and the United States where bank failures and government bailouts have had a profound impact on local economies.