Banks widen gap between revenue, GDP

16:00, Nov 24 2012

A six-fold increase in the amount owed to banks by households and businesses has dramatically increased the ratio of bank income to GDP since 1994.

For every three dollars New Zealand has added to its GDP since 1994, bank incomes have jumped by a dollar.

Reserve Bank figures show that GDP rose by $51.3 billion in the period from the end of 1994 to the end of 2011, while bank incomes rose by $14.9b over the same period.

Once again, bank profits are in the headlines, this time following a study by Massey University showing that the return on equity of banks is not excessive compared to that of many companies listed on the NZX stock exchange.

That led Bankers Association chief executive Kirk Hope to issue a statement saying it felt there were "a lot of views on bank profitability which were overstated".

But while the returns on equity may not be unusual, even former Reserve Bank governor Alan Bollard and Finance Minister Bill English have spoken about the high levels of profitability of our banks.


A mortgage debt splurge, similar to those that left many Western economies struggling, has been the main driver of bank income growth as a ratio of GDP in New Zealand.

The country's debt boom really took off around 2002 (see chart). Bank income to GDP peaked in 2008, breaching 20 per cent compared to 1994 when it was just 10 per cent of GDP.

Since then, global interest rates have crashed as a result of extreme weakness in the European and US economies.

Bank incomes dropped from $31.9b in 2008 to $23.5b last year, though the banks have continued making record profits as these are largely determined by the size of their loan book and the net interest margin between the rates they borrow at and the rates they charge to borrowers.

The decline in income pushed the bank income to GDP ratio back down to 17 per cent at the end of 2011, and in the process gave households a window of historically low interest rates in which to pay down debt.

It's an opportunity, English told Parliament earlier this month, that households were using wisely.

In answering a patsy question from a National backbencher, he said: "Treasury advises that after 10 years of households spending more than they earned, savings turned positive last year, with a modest savings rate of 0.2 per cent of household disposable income. This is expected to steadily increase over the next three years to around 3 per cent of disposable income being saved by 2015.

"This process may be assisted by the increase in KiwiSaver contribution rates on 1 April, 2013. As a result of better savings behaviour, household debt has fallen to 90 per cent of GDP this year from a peak of 97 per cent in 2010."

But while we are paying down debt, the country does not appear to be on track to return to the pre-2003 position of mortgage debt being lower in total than banks "other" forms of lending.

At the end of 1992, there was $8.5b more "other" debt than mortgage debt.

However, at the end of June, there was $37b more mortgage debt than "other" lending. The total lending on bank books was $54.7b at the end of 1992 compared to just under $309.5b at the end of June.

Loan volumes are continuing to rise, but the cost of loans is going up.

For borrowers the easy money and massive volume increases resulted in a dramatic drop of the real cost of mortgages, the net interest margin gap between the price the bank paid to borrow its money, and the price it was willing to lend it to property-buyers for.

Banks competed furiously, and gave away net interest margin in return for greater levels of business. Traditional mortgage terms were extended from 25 years to 30 years and more.

But as lending volumes have dropped, the Reserve Bank figures show a trend for banks to earn more off their loans.

In 1995 the net interest margin of the banks, according to Reserve Bank data, was 3 per cent. A bank borrowing at 3 per cent, say, could lend at 6 per cent.

By 2009 the net interest margin of the banks had dropped by nearly a third to 2.02 per cent, though as lending volumes have dropped and risk-averse investors have squirrelled their money away in bank deposits, banks have been able to gradually lift their net interest margins again.

At the end of 2010 it had risen to 2.13 per cent. By the end of 2011, it was at 2.23 per cent, and by the end of June this year, it was at 2.27 per cent.

Dr Claire Matthews, from Massey University's Centre for Banking Studies, said the study of bank returns on equity puts greater perspective around bank profits which were playing a bigger part in people's lives.

"The relationship is getting bigger because people have more money and also because of things like internet banking," she said.

Borrowers had increasingly moved to floating rate loans, and traditionally banks had earned higher margins off floating loans, she said.

Sunday Star Times