As the Commerce Commission's banking market study gets underway, Gareth Vaughan looks at the impact of regulation on competition

As the Commerce Commission embarks on a personal banking services market study, its team will be looking into barriers to new competitors, innovation, switching between banks and profitability.

Another factor that'll come under consideration is regulation. That is; to what extent does regulation hamper competition in the banking sector?

We know this because Commerce Commission Chairman John Small told interest.co.nz last month the market study will look at bank regulation and regulatory capital rules.

A market study, remember, is defined by the Commission as an in-depth and independent study into the factors affecting competition for particular goods or services, to find out how well competition is working and whether it could be improved.

A consumer perspective

Consumer NZ Chief Executive Jon Duffy says if you look at both the residential building supplies and retail grocery market studies, regulatory requirements played quite a big role. Zoning requirements for supermarkets preventing them from being built close together, and the Resource Management Act making it difficult for products to compete with incumbent manufacturers such as GIB maker Winstone Wallboards, a Fletcher Building unit, were key issues.

Two areas of regulation Duffy expects to feature in the banking market study are the Credit Contracts and Consumer Finance Act (CCCFA) and the Anti-Money Laundering and Countering Financing of Terrorism Act (AML/CFT Act).

"I'm sure that some of the AML requirements and the CCCFA stuff will be teased out by the Commission in a similar way," Duffy says.

"I think some of the KYC [know your customer] requirements under the AML legislation, particularly small personal banking stuff. Some of it feels like you're smashing a walnut with a sledgehammer."

In terms of responsible lending rules under the CCCFA, Duffy says he "absolutely agrees" with the rationale that lenders should have requirements on them to do appropriate affordability assessments that make sure they're not setting people up to fail when they lend to them.

"Whether that makes it difficult for customers who may not necessarily have great credit history, or may not necessarily have the capability to service some types of lending, whether it makes it difficult for them to shop around, I think it probably does. And therefore the range of options they have in front of them is smaller than other customers with a greater capability to service higher levels of debt or other conditions on lending," says Duffy. 

He suggests additional issues where regulations may hinder competition will be "teased out through the course of the market study."

"Because the Commission will come out with a preliminary issues paper that will identify areas where it has concerns. And I'm sure once that's out banks will go 'well, we do this because we're required by this piece of legislation or that piece of legislation'," says Duffy.

Bank switching; how does it work?

"Very simple." "Very easy." These were among the responses from interest.co.nz commenters when I asked this week for readers' experiences of shifting their business to a new bank.

Despite that, not many New Zealand bank customers do it. With no official figures made public, the best we have is Consumer NZ’s annual banking survey. The latest one shows the number of people switching banks at 4%, unchanged year-on-year. (Consumer NZ surveyed 2,022 people with the result based on nationally representative data).

The low numbers of New Zealanders switching banks is likely to be a key area probed by the Commission.

As interest.co.nz reported in March, a simple bank switching process managed by the bank the customer is moving to was established in 2010. In 2014 the Productivity Commission noted no public data was available on the number of customers moving between NZ banks even though banks were understood to get monthly data on the volume of customers switching between them.

Such information, the Productivity Commission said; "would help demonstrate the effectiveness of the current switching process and give consumers greater confidence about the ease of switching banks - hence sharpening the overall level of competition between banks."

Nine years later this data still isn't publicly available with Payments NZ, the bank-owned company that oversees the payments system, saying in March; "we don’t hold, or plan to hold, data on the number of customers who switch banks as this type of information is commercially sensitive."

So how does a bank go about the switching process? And what role does regulation play?

A TSB spokeswoman says switching to the bank via its online digital application takes about 20 to 30 minutes for most people. TSB staff will then be in touch within three business days to complete the application.

"We’ll make it easy for customers by working with their current bank to arrange everything needed to switch to us, including any accounts and payments they'd like to transfer. Unlike most other banks, we don’t require home loan customers to bring over their other banking to us, which is one less thing for people to do when switching home loans," the TSB spokeswoman says.

TSB, like all banks, is required to comply with the CCCFA.

"To meet our obligations as a responsible lender under the CCCFA, we make inquiries to be sure that the loan is likely to meet the applicant's needs and objectives. We also make sure that we're giving applicants the right information at the right time to help them to make informed decisions, know what they're agreeing to, and can keep track of their debts," the TSB spokeswoman says.  

"We need to verify the identity of each applicant, and also collect information to get a picture of their financial position – this can include details of their employment and income information. We ask for information to understand their regular expenses, as well as information about their liabilities, such as credit cards or existing loans, and assets, such as existing properties and investments. To meet our obligations under the CCCFA, we may need applicants to provide bank statements and pay slips to help us to verify the information provided through the application, which can be supplied electronically."

An ASB spokeswoman says responsible lending requirements mean there are a number of checks are required to meet regulatory obligations for home lending.

"These checks apply to any customer, regardless of whether they are refinancing an existing mortgage with another bank or are applying for a home loan for the first time."

"Information we ask customers to provide includes borrower identification and verification of income, certain living expenses and fixed financial commitments such as other loans, debt or credit cards. We may require a registered valuation of the property and for customers with an existing home loan we will also need bank statements showing their home loan repayment history," the ASB spokeswoman says.

"We have a dedicated team of home loan experts available to discuss options and help with this process. There is no obligation for anyone wanting to refinance their home loan to ASB to move any other banking, customers would just need an ASB transactional account to make loan repayments."

A small bank's perspective

Mark Wilkshire, CEO of The Co-operative Bank, says whether barriers to switching between banks are perceived or actual, the reality is a relatively small numbers of people actually do switch banks. This, he says, is estimated to be around 250,000 people per year with Consumer NZ reporting in May that "only 4% of New Zealanders switched banks last year," adding "75% say the process was easy."

"No-one likes personal admin, and we do have an industry standard where you can go to your new bank and request a change by using a switching bank request, but there must be other ways to reduce friction," Wilkshire says.

"Consumer regulation has a valuable role, but can add to friction, particularly if lending is involved. AML is absolutely necessary, but having every bank do the same ID checks for the same customer seems very inefficient. There must be better digital identity solutions that can go beyond any individual bank," Wilkshire adds. 

Although bank account number portability, as has occurred in telecommunications, may be hard to replicate, Wilkshire suggests the technical challenge "would seem solvable for a country that once led the world in electronic point of sale transactions [Eftpos]."

"For lending customers, one of the good things about the loan-to-value ratio (LVR) restrictions is that the limits don’t apply to a customer doing a straight refinance from one bank to another without any extra borrowing.  A low equity deal is still a low equity deal when it moves, but it doesn’t count for the new bank’s LVR limits on new business flow.  The rationale behind that is sound, if the loan already exists no more risk is being added to the system by just changing provider," says Wilkshire.

"The CCCFA doesn’t have the same logic, so a new provider even for a straight home loan switch must go through a completely new process, which is much more involved than rolling over with their existing bank."

The capital issue

Wilkshire says he often speaks to people who wonder why smaller banks haven’t taken more market share off the big banks. One of the key reasons for this is the capital required to grow, he says. 

"Capital is one of the lesser known constraints, and the more you grow, the more capital you need."

He says the Reserve Bank's move to develop a capital instrument for mutually owned banks, such as The Co-operative Bank and SBS Bank, that could qualify as crucial Common Equity Tier 1 regulatory capital is a useful step.

"The market will determine if this [capital instrument] can be priced at a level that makes it practical," says Wilkshire. 

Interest.co.nz has written about both the advantageous capital position the big four Aussie owned banks have enjoyed over their smaller NZ rivals, and how the Reserve Bank's new regulatory capital requirements, which banks are currently phasing in level the playing field to a degree.

ANZ, ASB, BNZ and Westpac have been able to use their own models for measuring credit risk exposure and then get them approved by the Reserve Bank. Other banks have theirs prescribed by the Reserve Bank. Effectively this means the big four banks have been able to stretch their capital further boosting profitability.

The Reserve Bank's move to twice delay, during the early days of the Covid-19 pandemic, the starting date for the phasing in, over several years, of the new capital requirements, disappointed NZ owned banks with TSB CEO Donna Cooper telling interest.co.nz in 2020;

"TSB continues to support the Reserve Bank’s intention to introduce a regulatory regime that levels the uneven playing field between New Zealand and Australian-owned banks. Under the current regime, the NZ-owned banks are materially disadvantaged. In residential [housing] lending, we’re required to hold on average 45% more capital than Australian-owned banks, for the same risk. That has a significant impact on how we operate compared to the Aussie banks, so we welcome our regulator’s intentions to try and balance that."

In the meantime SBS Bank has started running down its agriculture loan book and reducing exposure to commercial property lending.

"We can't get the return on capital that the Aussie banks can through these portfolios," SBS Bank CEO Shaun Drylie told interest.co.nz in 2021. "They would be holding at times half the capital against that lending that we're holding based on the standardised model that we use and the advanced [internal] models that they're able to use."

"We made the decision to put that capital into other areas such as the home lending book, our consumer finance book and growing our subsidiaries," Drylie said.

In December 2019 Reserve Bank Governor Adrian Orr told interest.co.nz that reining in the use of the so-called internal models by the big four banks and allowing smaller banks to use new types of capital would benefit competition, and was a "positive externality" to the Reserve Bank's increases to bank capital requirements. Banks must phase in the capital changes by 2028.

A mortgage broker's perspective

David Cunningham, CEO of mortgage broker Squirrel, says regulation does play a role in limiting competition.

"But I’d say at the margin overall, say the last 5% to 10%. The volume of switching remains at about a quarter of all loans that Squirrel settles, which has barely changed looking back over the last five years," Cunningham says.

The financial advice regime has driven more customers to mortgage advisers because banks have very few qualified advisers, Cunningham adds. 

In its recent interim financial results ANZ NZ, the country's biggest bank, said 48% of its home loan portfolio was broker originated up from 42% two years earlier. In February Kiwibank CEO Steve Jurkovich said Kiwibank gets about 55% of its mortgages from third parties, and he reckons this could ultimately rise as high as 85%.

Cunningham says AML requirements "are pretty simple, and probably easier than five years ago as you can do much of it digitally, and we’ve always had ‘know your customer’ requirements."

"High interest rates do impact switching if the new affordability test rates are above existing rates a customer is paying. It can make you hostage to one lender. [And] tax policy does impact investment property," says Cunningham.

The NBDT perspective

A group of non-bank deposit takers (NBDTs) featuring building societies, credit unions and finance companies, welcomed news of the market study. NBDTs are licensed and prudentially regulated by the Reserve Bank.

Speaking on behalf of 12 NDDTs, Daniel McGrath, the CEO of Xceda Finance, says putting a spotlight on how New Zealanders access banking services, and the barriers to competition in the market, is a good thing for customers and the industry.

McGrath also highlighted the new Deposit Takers Act. The Act will introduce a single regulatory regime for banks and NBDTs and establish a deposit compensation scheme from late 2024, which he says will allow consumers to have confidence their money in banks and NBDTs is safe.

“The Act is a tangible way in which competition can be fostered in the NZ banking sector. By including NBDTs in the same supervisory regime as the banks, it allows customers to have confidence in a wider range of financial institutions; not just the main banks,” McGrath says.

“It also encourages more New Zealand owned banks and NBDTs to grow and provide credible alternatives for customers. The key is to ensure they aren’t stifled by the same level of regulations as the big banks, but by a proportionate regulatory framework that encourages growth,” says McGrath.

What does a market study bring to the party?

In terms of what a market study brings to the competition debate, Duffy says the biggest advantage of this approach is it creates an evidence base and answers some of the more hypothetical questions floating around.

"You get an organisation with the powers and the expertise that the Commission has to come in and really look under the hood and produce independent analysis of how the market's operating. Then you've got a starting point for a discussion to go 'alright, while the Commission said there's nothing to see here,' or the Commission said, 'hey there are these structural problems or these other types of problems within these markets, what are solutions to those problems?' And at the moment we can't have that debate in banking because we haven't done that underlying analysis," Duffy says.

"It is the safest and most methodical [approach], because this is an extremely important sector. We don't want to be doing a half baked effort on this and recommending changes where they're not needed, or that won't deliver the desired effect. We've got to be really careful here because this is a critical sector that has to be working well for New Zealanders."

*Also see; Tally ho! Commerce Commission probe into retail banking competition underway. And; How the RBNZ, Payments NZ & the Government have contributed to holding back competition in NZ banking.

*This article was first published in our email for paying subscribers early on Thursday morning. See here for more details and how to subscribe.