We supported our written submission with an oral presentation to the select committee on banking competition on the 19th February 2025. (Full submission is below.)
Following the recent Commerce Commission Market Study into banking competition, Parliament has embarked on its own inquiry. While much of it covers common ground, the Select Committee inquiry includes business and rural banking, a couple of areas that were outside the Commerce Commission’s terms of reference for its retail banking-focussed study.
Our Finance and Expenditure Select Committee submission focussed on three of the Committee’s questions:
- Why has productive sector lending declined as a share of lending?
- What barriers prevent competition?
- Has the Reserve Bank’s focus on “financial stability” impeded the development of competitiveness?
Our submission follows.
Why has productive sector lending declined as a share of lending?
Why there has been a change in the proportion of lending to the productive sector relative to residential mortgage lending?
The short answer to the Committee’s question is that we changed our economy to produce this result and redesigned banking to deliver it. We shifted the economy four decades ago from public-led investment to private consumption. Fixing the banking component needs wider context.
Getting the foundations right
A useful starting point is to look at the wider context in which banking operates and the nature of the changes made since the 1980s.
In 1990, household and business debt were roughly equal at about 25% of GDP each. Today, business debt remains about a quarter of GDP while household debt is now close to 100%, a four-fold increase for little productive gain.
There are two main reasons why productive lending has fallen well behind residential mortgages as a share of lending:
- Banking rules changed—making it easier for the formerly business-focused trading banks to lend to households; and cheaper because the regulator requires less capital against a housing loan. Business lending fell in importance as their focus changed from being minor players in the residential mortgage market—just seven per cent in the mid 1960s—to holding 90% today. This article from the late Brian Gaynor explains what happened and its impact.
- Fiscal rules changed—shrinking the money entering the economy from government sources. It was topped up by the expansion of private money and, in the absence of any government directives, this was mostly created through residential mortgage lending. Tight fiscal policy and high, mostly unproductive private debt are directly linked (see charts below). The government has been able to “put it (the economy) on the (household) mortgage”.
Charts showing how governments ‘put it on the mortgage’
The following charts show changes in the government’s role in financing the economy over the past four decades and its impact on the private sector, especially households where the majority of new money entered the economy.
Most of this new money was introduced by banks encouraged by both fiscal restraint and loose monetary policy to expand lending through residential mortgages—mostly the unproductive reselling of houses to one another and financing household deficits and consumer spending through wealth effects.
Chart 1: Private debt has risen in lockstep with falling public debt and vice versa
Chart 2: Sectoral balances showing NZ households running deficits as the government runs surpluses and vice versa
Chart 3: Sectoral banking system assets (as at 31 March 2022)
Switching from a consumption to an investment economy
- The economy designed four decades ago—and the banking and money system to support it—was a consumption economy. After years as ‘takers not makers’ we must now make the switch back to an investment economy.
- The question of why bank lending for the productive sector has declined has to be addressed in this wider context. While the banking reforms were sold to the public as a better way to finance investment, the opposite happened by design and regulation.
- To encourage more investment, we don’t just need finance, we need to free up resources in the real economy for investment rather than consumption uses.
- Classically, in times of high investment, the tools governments use to free up this space are a mix of taxes, savings incentives and regulatory restrictions on some forms of activity.
- Investment in public infrastructure is publicly driven and in many cases publicly financed. A healthier mix of public and private money here will also help to rebalance the unproductive private indebtedness. Instead of putting it on the mortgage, the government can start repaying it.
Where will the money come from?
- Household debt forms the bulk of our fiat money supply (broad money, M2). It’s widely believed that the government issues our money but while it can, it chooses to outsource almost all of it—98% is issued by banks, mostly through mortgage lending. There’s room for some rebalancing of this mix of public and private money.
- The actual process of bank money creation is well-explained in this document from the Reserve Bank: Money creation in New Zealand (PDF).
- Money and the role of banks in the economy are widely misunderstood, including by policy makers such former Reserve Bank Governor Don Brash who defends the discredited textbook explanation. As the Bank of England diplomatically puts it: ‘The reality of how money is created today differs from the description found in some economics textbooks: Rather than banks receiving deposits when households save and then lending them out, bank lending creates deposits.’ These misunderstandings lead to poor policy decisions.
- To summarise: Banks do not lend savings, they create new money (deposits) in the course of lending. The loan (a promise to repay) is an asset on a bank’s balance sheet; the deposit they make into the customer’s account is the corresponding liability. Money that didn’t exist prior to a customer signing the loan documents now exists and has increased the total assets and liabilities of the bank and the total money supply of the country.
- On the public finance side, a similar situation applies where the spending comes first and the taxation or borrowing follows. All new money starts as a liability on someone’s balance sheet. When the Treasury spends or the Reserve Bank issues notes and coins, it’s a liability for the government and an asset for businesses and households.
- Oddly, we are happy with the risk of having almost all of our money supply perched on the thinly capitalised balance sheets of four Australian-owned banks but reluctant to have more than a couple of per cent of it on the government balance sheet backed by every citizen in NZ.
What barriers prevent competition?
There are four related problems:
- Market concentration: the ‘oligopoly’
- Regulations that promote incumbents over new entrants
- Regulations that promote big banks over smaller banks
- Small business lending dumbed down to fit low cost (to banks), property-backed lending
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 with small businesses and regions being the biggest losers.
Regulatory settings support incumbents over new entrants and big banks over the smaller ones that could be key to serving regions and communities.
This is exacerbated by the implicit ‘too-big-to-fail’ Government guarantee enjoyed by the ‘oligopoly’ (as the Commerce Commission described the four biggest banks).
More banks, not bigger banks
- We need more banks, not bigger banks. Business lending is complex and should be built on relationships and trust. It shouldn’t be delivered in the same way as a standardised, “vanilla” product like a home mortgage but for too many small and regional businesses—and New Zealand is a small business economy—that is what happens now.
- 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.
- Before deregulation in the 1980s, the New Zealand market had a diverse group of banks, such as savings banks and building societies, often community-owned and embedded in their regions. It’s important to note that no small bank has failed in New Zealand. (Some finance companies have failed but these operate and are regulated differently.)
We can afford more banks and there’s safety in numbers
- There is plenty of profit in the market to support more banks and the innovation and choice they bring. The four big Australian banks generate almost as much profit as our fifty biggest companies combined. 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.
- For instance, 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.
- Far from size making the ‘oligopoly’ 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. Each of these big banks carries about as much debt as the New Zealand Government on their thinly-capitalised balance sheets.
- 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.
Solution: Separation into retail and business-focused banks
- Similar to the earlier market where savings (consumer) and trading (business) banks were kept separate and regulated differently, 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
- This will make them better for their customers (with small business and the regions being among the biggest winners), 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.
- A range of approaches can be taken. The UK has a highly-concentrated banking market like ours. The Bank of England has required the big banks to separate retail operations from their other banking through a process it calls ring-fencing. This is an operational separation rather than a full breakup but can provide a foundation for separate regulatory treatment.
- In New Zealand, there are precedents. Our dominant telecommunications provider, Telecom, was broken up into a wholesale operation, Chorus, and a retail business, Spark, leading to greater competition and improved services.
- The Commerce Commission’s own recent inquiry into supermarkets included breakup options among its considerations, including possible separation of wholesale and retail operations to support a more competitive market.
Turning KiwiBank into a disruptor—by making it smaller
- For sustainable competition, we need more banks, not bigger banks. A vibrant small-bank and fintech sector will collectively make a bigger dent on the oligolpoly’s 85% market share and are more likely to deliver ongoing competitive pressure.
- To turn Kiwibank into a long-term disruptor, it makes more sense to break it up into several smaller banks, each vested in regional or community public trust, than to simply make it bigger so that it can join the ranks of the ”business-as-usual” oligopoly—and more likely expand than reduce their share of the total market.
- The network of regional and iwi banks can be kickstarted in this way and supported in a “franchise” style by a central office providing shared banking services, technology and regulatory support, and specialised small business, rural and Māori banking expertise (a banking innovation hub, see below).
- A shared services approach will help these banks to grow, share costs of technology and provide the expertise and oversight to ensure they are sound.
- Collectively over time, these banks will expand and the share they take from the bigger banks will contribute to diversity and stability, reducing banking concentration.
- Instead of removing savings and capital from regions to place with a handful of centralised banks, customers will have a choice to use their savings to directly support development in their own communities.
- The problem with the alternative—using Kiwibank to challenge the oligopoly head-on by expanding its size—is not that it would fail, but that it would succeed and join the comfortable “business as usual” ranks of the oligopoly. We will simply end up with five big banks sharing 90 per cent of the market instead of four.
- This risk would be amplified if capital was introduced by private shareholders via a public listing or private placements. Kiwibank would be seen as a low risk dividend stock in a cosy oligopoly – like other formerly-public assets like Auckland Airport, Telecom (prior to its wholesale/retail split) and more recently the electricity gentailers.
Turning KiwiBank into a disruptor 2—a banking innovation hub
- With or without a break-up, Kiwibank can be a bigger disruptor by providing banking services to support smaller banks and new entrants. Like the break-up option above, this increases competition and choice by expanding the number and scale of smaller banks and fintechs rather than expanding a single “business-as-usual” bank to split the oligopoly five ways instead of four.
- It can do this by supporting an “innovation hub” for banking, making it easier, safer and more successful for small banks to grow and new banks to enter the market. More banks, not bigger banks is the best way to encourage competition in both price and services.
- Kiwibank (or more likely a spinoff unit) could play a key part in getting an innovation hub started, with its retail banking and regulatory expertise, and possible provision of banking services and products to fintechs and new entrants
- While Kiwibank’s technology credentials are modest (and it needs to bring forward its own open banking timetable), it can also provide branch banking expertise to help grow regional, cooperative and other forms of community banking services
- We were surprised to hear that private fintech investment in NZ was just $20M last year. For an industry that can both spur domestic banking competition and sell its products and services internationally, this shows an urgent need to kickstart investment in what could be a new billion-dollar technology export sector.
- Early-stage public investment could enter the industry through government innovation funds. A successful hub will quickly draw in private investment.
- An innovation hub approach could also make the banking system safer by helping new entrants—often with technology rather than banking backgrounds—upskill and adopt banking best practices.
- Kiwibank with the addition of such a unit could support most or all of the areas identified in the Commerce Commission’s Banking Market Study as barriers to entry and growth. For example:
- Opening and maintaining a business bank account
- Deposit accounts – holding deposits for fintech partners
- Technology provision – back office, API support, retail apps
- Regulatory support
- Agency arrangements for banking products
- The investment required by Kiwibank’s owners to pursue this strategy will be much less than the cost of capital and resources that would be needed to take on the oligopoly head-on.
Has the RBNZ’s focus on “financial stability” impeded the development of competitiveness
- The short answer is yes, and the proof is in the market that the Reserve Bank has shaped and preserved since the 1980s.
- Prior to the banking reforms of the 1980s, New Zealand had a diverse retail banking market where no institution or sector was dominant. If a bank had failed, none would have been big enough to bring the system down.
- The Reserve Bank took this sound and diverse retail banking market and turned it into an unsound and uncompetitive market in which four entrenched banks face little competition and are now too big to fail, effectively commanding a government guarantee.
- We believe that the Reserve Bank’s failures on both stability and competition fronts happened precisely because it did not properly consider competition when making its regulatory decisions.
- We do not believe that the Reserve Bank alone can change what amounts to a longstanding culture and groupthink. We would ask the Committee to appoint a joint Commerce Commission and Reserve Bank group to develop a new, pro-competition regulatory framework for banking.
- The Committee can refer to our two detailed submissions to the Commerce Commission market study for further detail on regulatory issues.
Resources
- Link to our submission to the Select Committee inquiry into banking competition (PDF)
- Select Committee web page: Inquiry into banking competition
- Positive Money’s submission to the Commerce Commission Market Study into banking competition (March and May 2024)
- Our Discussion Document: Reimagining Banking