By Gareth Vaughan
Ask Cameron Bagrie how to improve business and rural banking and some words reoccur in his answers. Three of them are "risk", "productivity", and "bankability."
With two parliamentary select committees to hold an inquiry into banking competition, the business and rural banking markets will feature, unlike in the Commerce Commission probe into competition just in personal banking. In the latest episode of interest.co.nz's Of Interest podcast, Bagrie, now of Bagrie Economics and Chaperon and formerly ANZ NZ's chief economist, speaks about why banks favour housing lending over lending to the business and rural sectors, and why it would be good to entice them to change this and how it could be done.
At the top of the select committee inquiry's terms of reference ought to be balance between the pricing of risk versus the taking of risk by banks, and how that's impacting productivity, Bagrie says.
"I think we need to have a really good, hard debate about where the money is actually going, the composition of bank lending, whether it's short-term behaviour versus a long-term growth maximising strategy. Let's have a serious conversation about risk going forward, because risk is a big enabler. It's not open season on risk, but risk is an enabler of innovation, driving productivity. It just seems like we've screwed things far too far towards a low risk approach, and ultimately we pay the price for that over time," Bagrie says.
"I go back to the fundamentals of banking. The fundamentals of banking is pricing for risk and taking risk. And what we're seeing out there at the moment is that SMEs and farmers are certainly being priced for risk... Let's have a look at return on equities out of the banks by segment, not the aggregate top down number. Let's break it down into personal lending, including home lending. Let's have a look at business lending. Let's have a look at farm lending and the institutional [loan] book, and have a look at where those ROEs [returns on equity] actually sit. And I think we're going to be surprised how high those ROEs are for certain segments."
"The key here is to go through each segment and look at the risk adjusted returns," he says.
Figures from the International Monetary Fund show housing lending at 35% to 40% of total bank lending in some countries, whereas in NZ it's nearer 65%, having risen significantly over the past five years.
Bagrie also argues that banks' regulatory capital settings encourage them towards housing lending instead of business and rural lending, when there's "more productivity bang for your buck" when you're lending into the business sector.
"We need to have a look at this through the eyes of economic efficiency, economic growth, productivity, innovation. Because when you make banks a lot more safer, there's a price that you pay on the other side."
"The whole process of credit intermediation is a pretty critical part of economic development. And I don't think we've got financial system settings right on a whole lot of areas," he says.
Financial system settings and banking don't tend to be areas thought of when people think about what to do to make NZ a better place economically in regard to taking risk and driving productivity growth, Bagrie says.
"We sort of overlook what's a fundamentally essential one and that's that flow, that process of credit intermediation, [it] is absolutely essential. The Prime Minister has been talking a lot about encouraging the taking of risk...Well, yeah, in order for firms to take risk, you need the financial system to be prepared to take risk."
In the podcast Bagrie also talks about NZ businesses having a bankability problem and how to rectify this, the role of the Reserve Bank's regulatory capital settings, banks' becoming more vanilla, the rise and rise of bank profits over the past 30 years or so, the low level of banks' non-performing loans, the need for better competition policy across the economy, how housing lending has grown as a percentage of total NZ bank lending over the past 20-odd years, and especially over the past five years, Australian influence at the big four banks, open banking, his thoughts on the idea of a Business Growth Fund, and more.
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We used to know how to do this.. An excerpt from the 1950 Stats Yearbook...
The Corporation administers the State Advances [for]:
- Mortgages in respect of advances to settlers or workers under the State Advances Act, 1913:
- Mortgages in respect of advances under the Rural Advances Act, 1926:
- Debentures or other securities vested in the State Advances Superintendent in respect of advances to local authorities...
- Crown mortgages in respect of advances to ex-servicemen of the 1914–1918 war...
The Rural Intermediate Credit Board provides a source from which farmers could obtain loan finance on favourable terms for such purposes as the purchase of stock and plant and farm improvements.
What can we infer then, that has caused this aversion of risk over time? Obviously housing has been highly profitable for banks for the last 30 years, however dare there any stats around the portfolio percentages held by certain banks, or as a general trend across say the last 50 years? Has the '87 stock market crash resulted in losses for banks leading to their aversion of risk since? What key events or governmental changes have occurred to sway to this trend?
When the state takes on the risk in place of banks or private entities - watch the risk taking explode. It’s hard to balance and maintain the controls.
We saw this in covid, and also pre-1980’s where a whole bunch of Agri debt had to be forgiven because it was essentially defaulted.
Yes in theory, as our housing market became more and more leveraged over the past 20 years, the required rate of return on the mortgages of these home loans should have been increasing, not decreasing - because the risk of a default or the loan becoming bad are/were increasing/not decreasing (higher debt amounts vs incomes = higher risk of default if a black swan arrives).
Driving rates to zero doesn't make any sense - it is counter the rules of finance. As risk rises, so should the required return.
Instead, the way that bankers have been operating the last 20 years is that, as risk increases, the required return has been dropping. This is really quite insane.
But this isn't what the RBNZ wanted - they wanted to cheat the rules of finance - they wanted to stimulate the market by increasing financial instability - by creating more risky lending (using lower and lower interest rates). - even though their mandate is to promote financial stability. They have done the opposite (in my humble opinion...)
Sigh.....
Cameron is right, of course. And so are a good number of commentators on this sight who have been screaming this very thing for a decade and more; util they were blue in the face. And what's happened? Nothing. And nothing will. Why? Because it might upset voters if we had to make anywhere near the modest changes that this article outlines.
Nope. I'm, afraid it's going to take a financial catastrophe in New Zealand to nullify what's been created over the last 30–40 years. No one more than me would love to see the OCR fall IF the result was much of what's suggested above; productive risk taking. But as any change in the OCR will only lead to more of what we have = our national financial security sacrificed at the altar of The Property Prices God, there will only be one way for the OCR to go - up.
And so are a good number of commentators on this sight who have been screaming this very thing for a decade and more; util they were blue in the face.
Yes. The mighty Audaxes has often highlighted what blokey Bagrie seems to be talking about at a very late stage (in all fairness, his professional life is shaped by the goals of retail banks). Also, what Bagrie doesn't point out is what the typical outcomes are when bank credit is allocated to non-productive activity: inflation without growth; boom-bust cycles; and banking crises.
Furthermore, Bagrie talks about the "past 30 years". Quiz time: What happened in the 90s that spurred the Anglosphere banks to focus on housing as a magic money tree?
Basel Accords beginning 88, Reserve Bank Act 89, = beginning of exponential growth of money supply, along with a reduction of interest rates and a removal of investment incentives for asset classes other than property.
And what made housing thereafter the investment of choice was the removal of the cost of existing houses, the cost of land, and the cost of servicing a mortgage from the CPI by Bolger and Shipley which enabled house prices to double every 9 years without affecting inflation or interest rates. Pure malevolent genius..
The housing crisis has been manufactured but the root cause is after all neoliberalism.
I don't believe it's perception at all.
Sure by the textbook definition of neoliberalism you're right, but the real definition should include the impacts of neoliberalism in some way which is the increase in inequity, the trickle up of wealth, and the favouring of capital over labour.
That's why CPI has been manipulated to show half the level than it would if calculated the same way as 1980.
That means wage growth (tied to CPI) is negative in real terms, and interest rates are artificially low, and asset gains are artificially high.
And to top it off those capital gains aren't even taxed in NZ.
Whether or not that is part of the definition of neoliberalism, the fact is it should as much as free markets, globalisation and so on.
Google says
credit intermediation services are: (i) presentation or proposal of credit agreements to consumers; (ii) assistance to consumers, by undertaking preparatory work or other pre-contractual administration in respect of credit agreements; and (iii) concluding credit agreements with consumers on behalf of creditors ...
Banks don't take deposits and they never lend money. They are in the business of purchasing securities. When one gets a bank loan, the loan contract is a promissory note. The bank purchases that contract from the borrower. Now the bank owes the borrower money and it creates a record of the money it owes, which we call deposits - source.
Banks have migrated away from lending to productive business enterprises because the risk weights can be as high as 150%. Thus around 60% of NZ bank lending is dedicated to residential property mortgages owed by one third of already wealthy households
Banks have migrated away from lending to productive business enterprises because the risk weights can be as high as 150%. Thus around 60% of NZ bank lending is dedicated to residential property mortgages owed by one third of already wealthy households
Bingo
Short Answer: The aggregation of smaller loans into a fund - supposedly to spread risk - so that units in the fund can be on-sold as 'low-risk / low-return'. Why? Mainly so the initial lenders can get the risk off their balance sheets while continuing to collect fees.
a pictorial representation from the New York Fed: https://www.newyorkfed.org/medialibrary/media/research/economists/adria…
Overseas - especially in rapidly developing countries - past and present - they have banks with names like ...
xxxx Development Bank
xxxx Industrial Bank
xxxx Commercial Bank
xxxx Merchants Bank
xxxx Agri Bank
xxxx Housing Bank
xxxx Community Bank
There's a simple reason for this: These banks specialize in assessing risk and lending to specific sectors of the economy. I.e. they are specialists. To grow their profits, they must grow their specialist sector of the economy.
Now compare these names to our banks ... See anything indicating a specific expertise in their names? None what so ever!
All our major banks are generalists. They lend wherever they can make a buck ... with the highest ROI. They're generalists. They have no real interest in any sector. Or growing their loan books in a specific sector. For these banks - the first questions are always a) how much risk, and, b) how much will we make. They really don't have the focus or skills to answer the first question ... But they're damn fast answering the second question as they simply up the interest rates until they make the required ROI (which, as we know, makes them hugely profitable on the global scene).
Countries dominated by generalist banks do not grow as well countries that split their banking service by specialization. (The few exceptions to this rule is where the generalist banks are so big they have specialist 'departments' that would rival the size of specialist banks. Note that these 'departments' often don't show up on the balance sheets as the staff are often contractors and/or consultants.)
These specialist banks - much like investment classes overall - provide the full spectrum returns. From low-return / low risk (like TDs) to high risk / high returns (like some shares). Margins are likewise the full spectrum, from very low for things like residential mortgages, to very high for things like start-up funding. This point is worth keeping in mind when charlatan capitalists start comparing one bank to another and claiming that one is hugely inefficient and should be merged with another.
Many of these specialist banks were initially government funded, or more correctly, the government provided the seed capital and was happy to wait - as governments can - for the business to grow and eventually start providing a return based upon the risk profile of that specialization. (Note that for many governments direct returns from the specialist bank was of no interest if the sector grew and the government got their returns from tax.) Some countries even legislated where loans of different types must be taken out from but mostly - the name and the fact there was quasi-government backing was enough.
So why doesn't NZ have any large specialist banks? Put simply - De-regulation driven by neo-liberalist doctrine.
So Kiwis - you voted for a low growth, low productivity, low wage country.
You've got exactly what you voted for. That's nice isn't it? I mean, when governments deliver exactly what you voted for?
(Bit of a shame that most voters had no idea that was what they were voting for and most politicians were just as ignorant.)
Yup. Banks being banks. Or put another way - they all screw up.
For those that don't know:- Norinchukin Bank is a co-op (cooperative) bank. I.e. a 'share the profits with its customers bank'. What proportion of NZ's banking business is handled by co-ops? (Hint: pick an small % and you'll still be too high.)
Norinchukin Bank is a co-op (cooperative) bank.
Norinchukin works closely with Japan Agriculture (JA) and has massive influence over the whole supply chain.
- Founding: Norinchukin was founded in 1923 by the Japanese government to support the country’s agriculture industry
- Membership: The bank has over 5,612 agricultural, fishing, and forestry cooperatives as its members, including the Japan Agricultural Cooperatives (JA) and the Japan Fishery Cooperatives (JF).
- Mission: The bank’s mission is to contribute to the development of Japan’s economy and support the advancement of the agricultural, fisheries, and forestry industries through facilitated finance for its members.
- Lending and Investment: Norinchukin Bank lends funds to its members, agricultural, fishery, and forestry workers, and companies related to the agricultural, fisheries, and forestry industries.
A very important article that skirts the edge of one of the key issues in Western Economy's.
The heart of the issue is risk weightings set by the BIS and the RBNZ application of them. They heavily insentivise housing from an RWA perspective and if you're a bank CEO, that's what you are doing. It's how CBA put a gap on the market.
Change the capital risk weightings and you'll change lending behaviour overnight.
The ponzi has indeed been fueled on a no risk all reward model for the banks. That's why they are donkey deep in residential lending and glaze over if you try to explain a business to them. Their default response when you try to get a business loan is "how much is your house worth". Any changes here would torpedo the markets access to credit and a round of resignations from bank directors no longer able to cream the bonuses.
But how did we get conned into the model we have today...?
"What was not to like? Expand the money supply accordingly and perceived net worth doubles every 7-10 years. "
Because of where that money ends up.
Were the money to end up in more productive endeavors, the story would likely be very different.
So why does the new money end up in largely stagnant assets? A good place to start in answering that question is by drilling into our woeful tax system.
As a general rule, worldwide, CGTs are set quite low and eventually drift lower still.
Just an aside - In this context, 'low' also includes the numerous 'exclusions', like 'main home', (which renters and non-homeowners thinks is vastly unfair (and I'd agree)).
The primary reason is the outsized influence wealthy people have in policy making and the armies of lobbyists they send to get in law makers' faces.
Even Buffet thinks they're low.
You're only paying tax on the gain though, so no harm done if prices stay the same. Also, you would still get some of the capital gain for yourself given it wouldn't be 100% CGT, therefore you'd have every ability to move to a more affluent area, bigger city etc for a job, and likely to pay down the mortgage on the new place at the same or higher rate if you are going to have a greater salary. CGT should include the family home as well, as if it effects everyone the same then the disincentive part becomes a moot point.
Once again: its still the same asset with the same market value relative to other houses. The price variance simply reflects money as the medium of exchange, re/devalued by monetary and fiscal policies outside the control of the asset owners.
This artificially constructed & false "gain" is also one reason why CGTs generally exclude the family home.
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