Banks may have profited by $2b on customer call accounts through RBNZ using settlement accounts for its LSAP programme, consultant tells Commerce Commission

The Reserve Bank using settlement accounts for transmission of its Large Scale Asset Purchase (LSAP) programme during 2020-21 saw banks profit by about $2 billion, a consultant working on behalf of non-bank deposit takers (NBDTs) estimates.

The Exchange Settlement Account System (ESAS), owned and operated by the Reserve Bank (RBNZ), is the system for processing and settling payments between banks and other financial institutions. 

In a submission to the Commerce Commission's market study into personal banking services, Buddle Findlay consultant Simon Jensen notes the advantageous position banks have through their settlement accounts, something NBDTs don't have. NBDTs Jensen represents include building societies, credit unions and finance companies that take deposits from the public. NBDTs have long sought settlement account access, something being considered by the Reserve Bank through an ongoing review of its ESAS access policy and criteria.

"By using ESAS accounts to implement quantitative easing [the LSAP] during the Covid-19 pandemic in 2020, the banks immediately benefitted from holding substantial parts of their liquidity in ESAS accounts and benefited from receiving higher margins on their deposits (particularly because of the increase to the overnight [Official] Cash Rate from 0.25% to 5.5%). It gives them an immediate margin in a risk free, zero risk weighted on call asset being the ESAS account. We understand that it potentially accounts for around $2 billion of bank profits on customer call accounts – as well as giving them a risk-free margin on funds deposited with them by NBDTs," Jensen wrote.

"By contrast, NBDTs have to deposit their funds with the banks and maintain their liquidity with the banks. These are risk weighted at 20% and prudently structured over a period of maturities to maximise returns. They do not have the luxury of earning 5.5% on call in a zero risk weighted asset. Furthermore, during Covid when some needed to break deposits to manage liquidity risk or potentially access standby facilities with banks, it became reasonably apparent that the commercial banks were unwilling to allow them to break and unlikely to actually fund under standby facilities. In contrast the banks could rely on the RBNZ for not just access to ESAS funds but the various funding and standby funding it was prepared to provide them)."

"This means that banks have a material competitive advantage in the deposit and transactional banking market because of the easy risk-free margin available to them not available to NBDTs. Given ESAS accounts must always have credit balances there is no credit related reason for the RBNZ to deny access," wrote Jensen.

"As a result of holding liquidity in banks, the NBDTs return on investment for this liquidity is lower than if liquidity was held with the RBNZ in an ESAS Account (which would attract interest equal to the OCR rather than the commercial rates offered by the banks, and for capital purposes would be risk weighted at zero). In addition, the NBDTs are subsidising the earnings of the banks (who are able to deposit NBDT funds into their own ESAS accounts and earn higher margins)."

'A major competitive advantage'

Jensen said banks thus have "a major competitive advantage" over NBDTs, whose ability to continue to invest in and grow their personal banking services is hindered because they must hold liquidity in ways that significantly reduce their profitability.

"The RBNZ should be required to provide ESAS accounts to NBDTs as well as banks now. The RBNZ should also provide equivalent funding to that which it provides banks but, on a risk, adjusted basis so that NBDTs do not have to go through the expensive exercise of securitising mortgages but can provide similar security (e.g., under the trust deed) but also pay for the funding at a risk adjusted rate (i.e., higher than banks pay residential mortgage-backed funding)."

Settlement cash balances were relatively low and stable before the RBNZ launched its LSAP programme in March 2020 at the onset of the Covid-19 pandemic, averaging around $7.5 billion in the decade up to 2020. The introduction of the LSAP saw the RBNZ issue a significant volume of settlement cash in order to buy government and local government bonds. The RBNZ's subsequent Funding for Lending Programme, through which it loaned banks $19 billion at the OCR, further increased settlement cash balances.

Settlement account balances peaked above $56 billion in late 2022, with major banks such as ANZ and BNZ holding $10 billion or more in their individual accounts. Balances have declined as the RBNZ started selling down its LSAP government bond portfolio to Treasury's NZ Debt Management unit at a rate of $5 billion per fiscal year, but remain high. The most recent figure disclosed by the RBNZ is $44.913 billion as of the end of January.

Those with ESAS accounts include ANZ, ASB, ASX, BNZ, Bank of China, China Construction Bank, Citibank, HSBC, ICBC, Kiwibank, NZX, the RBNZ, TSB, CLS (Continuous Linked Settlement), the Local Government Funding Agency, Treasury's Debt Management Office, the NZ Super Fund, Rabobank and Westpac.

The Covid-era surge in settlement account balances has led to questions over whether ESAS account holders should continue being paid at the OCR.

The RBNZ says it receives regular approaches from a variety of institutions seeking access to ESAS, noting broader access could enable and encourage welcome innovation in the financial system but may also pose risks.

Jensen's comments were made in the submission answering the following question; 

'What are the specific regulatory requirements that most affect your ability to compete to provide customers with personal banking services? How and why?'

He said the Commerce Commission requested a group of NBDTs who attended a meeting last year provide specific responses on a series of topics.

Commerce Commission sets date for issuing of draft report

The Commerce Commission says it'll publish its market study draft report on March 21.

"This will include our preliminary findings and outline any options for recommendations to improve competition that we are considering. A public consultation process will follow release of the draft report, including submissions and a consultation conference hosted in Auckland and online," the Commerce Commission said.

It's required to publish its final report by August 20 this year.

"The final report may include recommendations that identify ways to improve competition in the sector for the long-term benefit of New Zealand consumers."

All deposits by repricing, source RBNZ

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