We need more banks, not bigger banks

We’ve let banks, rather than the government, create most of our money. But they’ve been creating too much and for the wrong things. The result is unprecented levels of debt and years more of our lives spent repaying it.

Following is a possible—and achievable—future for banking in New Zealand. Our aim is two-fold: To show there are better alternatives to the system we have today and outline the steps we could take to get there.

The starting point is that our banks have got too big. We propose to fix this by increasing the number and variety of banks.

The second point is that big change is coming whether we plan for it or ‘leave it to the market’. Technology developments will force big changes in both banking and money. Our view is that we must anticipate and channel these changes because, left to the market, some of them will be damaging.

To respond to change, we need a destination we can agree on. What banking system do we want?

The problem

New Zealand has one of the most concentrated and least competitive banking markets in the world—just four foreign-owned banks control 85% of all lending. Our banks are neither safer nor better because of this. They take a bigger slice of the economy while reducing services.

The loss of competition is most stark in mortgage lending. Today, four banks hold about 90% of mortgages, but before deregulation in the 1980s, they were minor players (just seven per cent in the 1960s). The market was mostly a diverse group of smaller players, such as savings banks and building societies, often community-owned and embedded in their regions.

Those big banks (called trading banks at the time) grew massively as they took over the smaller banks and pumped more money into the speculative economy, driving up house prices and increasing inequality, while the productive economy, where goods are produced and wages paid, was starved of capital.

Far from size making these banks safer, we are now more exposed to catastrophic bank failure—failure at a scale that can bring the entire banking system and economy to its knees. Forthcoming technology-driven change will further increase the risk to these ‘legacy’ banks. Each of these big banks carries about as much debt as the New Zealand Government. They are now too big to fail— “Systemically Important Banks” in the Reserve Bank’s benign labelling.

The acknowledgement that they cannot be left to fail causes more problems: It creates moral hazard for the big banks as they operate with an effective government guarantee. And it heightens risk for smaller banks since in times of crisis depositors are more likely to run to the too-big-to-fail banks with their implicit government guarantees.

The result: less competition condemns us to even greater dependence on these bloated, protected, too-big-to-fail banks.

A solution

Resize the banks and encourage new competition

Tinkering with a flawed system won’t deliver the change we need. It’s time to unwind the forced consolidation of the 1980s and 90s that reduced competition and choice and led to our current problems.

We need change that ensures our biggest banks are no longer too big to fail, competition is restored, new banking entrants are encouraged, and retail customers and regions get the banking services they need.

To start the process of change, our too-big-to-fail banks should be separated to better service two distinct markets with different needs:

• Retail banking—for consumers and small businesses, offering payment services, savings, mortgages and small business banking
• Corporate and wholesale banking—for corporations, institutions and investors with more sophisticated needs

Once separate, these two distinct areas of banking can be regulated in ways suited to each sector’s needs and with a banking culture to match. This will make them better for their customers, encourage competition, and strengthen our banking system as a handful of too-big-to-fail banks are replaced by smaller banks with less systemic risk.

Can this be done?

Banks and their lobbyists will protest that it’s too risky and complex, but there are precedents for this approach. In the UK, which has a highly-concentrated banking market like ours, the Bank of England has forced the big banks to separate retail operations from their other banking. In New Zealand, a similar scenario occurred when separation was forced on our dominant telecommunications provider. Telecom was split into a wholesale operation, Chorus, and a retail business, Spark, leading to greater competition and improved services.

Won’t smaller banks make banking less safe?

No small bank has ever failed in New Zealand—the savings banks, cooperatives and building societies for decades have been rock-solid. There has been only one banking failure in over a century, the Bank of New Zealand in 1990. (Some finance companies have failed, but they operate differently and are more lightly regulated than banks.) Importantly, if a small bank did fail, the impact would be much more manageable than the loss of a big bank. A forthcoming deposit guarantee scheme will further protect depositors’ money.

Can the economy support more banks?

The four big Australian banks generate huge profits—almost as much as the combined profits of our fifty biggest companies. With better regulation, some of this profit could support more competition and greater innovation—and some could be returned to the productive economy and households as the deadweight loss of these oversized profits is cut. In 2022, just one bank, ANZ, generated $2.3 billion in profits—that’s enough profit to support 17 Kiwibanks ($131 million profit) or 115 banks like the Co-operative Bank ($20 million profit), the bank with the most satisfied customers in Consumer’s annual banking survey.

Two of the world’s most successful economies are among the most highly-banked. The US has about 4800 banks, and Germany has 1900, with strong regional, small business and local banking cultures. By comparison, New Zealand has nine (plus a handful of foreign corporate banks without branches). Where the US has one bank for every 70,000 people and Germany has one bank for every 45,000 people, New Zealand has one bank for every 567,000 people.

There is plenty of room for more banks and the innovation and choice they bring.

Isn’t it more efficient to have a small number of big banks?

There are two ways to look at this question: What is best for banks, or what is best for the economy and our overall wellbeing. We got into this mess with changes that assumed what is good for banks is also good for our economy and wellbeing.

For example, many efficiency gains were achieved by reducing services—closing branches and cutting staff, making it harder to connect with real people. And banks boosted their revenue by expanding mortgage credit faster than the housing market needed, supercharging house price inflation. The costs are borne here, while the benefits are largely shipped offshore in higher dividends.

However, one area where scale is important is technology. A banking system today that encourages more banks should address this, perhaps by providing some sort of ‘shared services hub’ that smaller banks could tap into. There might be a role here for publicly-owned Kiwibank to spin off a shared services unit to support new banks with competitive technology, lower costs and reduced customer risk.

Households, communities and regions will be big winners—along with innovation

Banks can be development engines in their communities. Many of the new banks will be community or iwi-owned, reinvesting profits to support their communities, getting families into stable housing and helping local businesses grow. It’s a return to the more diverse market before deregulation in the 1980s forced small, mostly regional banks to merge and then get swallowed up by the four big Australian banks.

But it’s not about winding back the clock. More banks will also produce more opportunities for banking innovation, both directly and in partnerships—the reverse of the situation now, where foot-dragging incumbents have left us years behind markets like the UK in open banking and payment services.

Three steps to get us there

Three steps will move New Zealand’s banking system from the foreign-owned, top-heavy and unpopular system we have today to one rooted in the communities it serves and the productive economy it’s there to support.

1. Separate

The first step is to separate retail from corporate banking. This can be accomplished in several ways or a combination of ways.

One is by so-called operational separation, where the retail and corporate sides of the business operate separately while sharing ownership and some resources. The Bank of England has just done this in the UK, a process it calls ring-fencing.

A second way is changing rules to tip the balance towards smaller banks. This would help new entrants and might encourage some big banks to divest their retail arms to focus on the corporate and sophisticated investor markets. This approach would be the reverse of the 1980s deregulation that let loose foreign competition leading most of the small savings and regional banks to sell out to the big banks.

A third option is a government-mandated breakup. This is similar to the 2011 breakup of Telecom into Chorus (wholesale) and Spark (retail) or to one of the options proposed by the Commerce Commission for the supermarket sector.

2. Regulate

With separation, we can regulate the two sectors to suit their needs better. It opens the door to simplifying retail banking rules and changing its culture to make it more appropriate for consumer and small business banking. Meanwhile, corporate banks could serve large and sophisticated customers better as they escape many of the onerous rules there to protect consumers. Right now, we have the worst of both worlds.

3. Transform

With this foundation in place and the lobbying power and inertia of the big banks tamed, the final step is to open up the market to greater competition, innovation and diversity. FinTech (financial technology) and banking innovation will thrive with simplified rules, less inertia from big incumbent banks, and more banks to partner with. And steps can be taken to grow the number of regional, community and iwi banks, seeding local banks in every part of the country to serve their regions. Savers can choose to put their money to work where it will help their communities and empower local development and growth.

Kiwi Banking 2.0

The future shape of our banking system will affect most parts of our lives. We shouldn’t stumble into it or leave it to experts, vested interests or TINA (‘there is no alternative’). Ordinary Kiwis and civil society groups must be at the forefront of setting the outcomes we want and driving our elected representatives to deliver them.

Tinkering with small changes won’t fix the problems, though it’s where the lobbyists will try to lead us. The current system was designed to solve the problems of forty years ago. It has created new problems demanding new solutions, notably limited competition, a housing crisis fueled by too much credit, and poor support for regions and small businesses.

Then there is technology. A new wave of financial technology is on its way, encouraged by recent legislative and industry changes. It will deliver new services, especially for consumers and small businesses, while challenging incumbent banks—and potentially our monetary sovereignty.

It’s time for us to imagine the new system of money and banking we want, one that is fairer, more productive and benefits everyone, not just a few.

We’re part of an international movement for monetary reform.