Andrew Body & Simon Jensen look at how to boost bank lending to businesses and improve productivity

By Andrew Body & Simon Jensen*

New Zealand has tipped into recession despite near record immigration – serving to highlight some of the economic problems the country faces. One of the biggest of which is New Zealand's inability to improve its productivity.

New Zealand’s poor productivity impacts the lives of everyone.

But just in case you need convincing, here are some facts. According to the OECD, in 1970 New Zealand labour productivity (real GDP per hour worked) was 40% more than the United Kingdom and over twice that of Turkey. Today our productivity is about the same as the UK and Turkey is more productive than us. Recent analysis by Treasury staff shows that since 1970, New Zealand’s productivity has reduced by about 38% compared to an average of countries in the OECD in 1970.

Just as worryingly, our per capita income growth has been from arguably non-repeatable gains such as demographic changes and cheaper imports, rather than productivity growth.

Amongst our family, friends and workmates we have seen annual net citizen migration to Australia and other developed countries for the last 20 years equivalent on average to a town the size of Fielding. These people are many of our best and brightest and they have found better and more productive lives elsewhere.

For those of us staying, we are experiencing a cost-of-living crisis that is, in significant part, a result of our poor productivity.

Doing something now

While education, infrastructure, regulation and fiscal management are key causes of our poor productivity, they are big ships to turn around. It will take a decade to raise education standards, two decades to catch up on our infrastructure deficit, a decade to reorganise public sector leadership necessary to fix chronic regulatory failure, and a decade to zero budget the Government’s fiscal position back into shape.

This all assumes a political determination to grind away at these problems and substantial bi-partisanship in identifying and implementing solutions. Big assumptions.

A post-election government may have no more than six months to determine its success (barring responses to accidents and emergencies). If it hasn’t taken real action (excluding reviews and planning by government officials, who will often have quite entrenched biases in favour of the status quo) then it is very unlikely to achieve much.

So here is the case for some things that should be done immediately.

We have a low inward foreign direct investment problem that is not compensated for by abundant reasonably priced credit and, in particular, bank lending. It is likely to be more politically palatable to fix the lending problem than the foreign direct investment problem and that is where we should start.

Reserve Bank (RBNZ) data series C5 shows that while bank residential mortgage lending has grown from about $60 billion in 2000 to $343 billion in 2023, bank business lending has only grown from about $40 billion to $120 billion.

Growth in business lending has been under a third of that in residential mortgage lending.

SME credit is tough

In the all-important SME (small and medium) business sector, where 60% of employees work for the 160,000 businesses that have fewer than 100 employees, there has been virtually no credit growth since the RBNZ’s detailed S35 data series began in 2016. SME non-property related lending was $33 billion in December 2016 and $39 billion in May 2023. Note that nearly $80 billion of total business lending is not to SMEs.

Over the same period residential mortgage lending grew from $230 billion to $340 billion. SME funding is mostly reinvested profits and what the owners can borrow using their property as security. A credit allocation death-zone exists for businesses with enterprise values between about $2 million and $50 million because banks are concerned about difficulties that may arise when these businesses seek recapitalisation or sale.

Bank lending to what the RBNZ calls the “corporate” sector, which includes SMEs, is hamstrung by the RBNZ’s risk weights for bank lending. Risk weights are the most important numbers in bank prudential management alongside the capital ratio and determine the risk adjusted assets that the RBNZ’s capital ratio is applied to and in turn determine the amount of equity a bank must have to match its lending.

Impact of RBNZ risk weights

Risk weights have a substantial impact on the cost and structure of bank lending (30 year table mortgage versus five year balloon repayment) and are a key reason banks have focused on mortgage lending with low capital requirements and low marginal costs, as opposed to corporate lending which requires more capital and have higher marginal costs.

We have analysed the ANZ, ASB and Westpac disclosure statements since 2008, BNZ’s disclosure statements don’t provide the necessary information, to compare their credit experience to their risk weightings.

Our analysis suggests that compared to residential mortgage lending, corporate lending is about 190% more risky (measured by the impairment charge), but the RBNZ’s corporate risk weights are about 230% larger. This means that the RBNZ’s settings are penalising corporate borrowers and particularly SME’s by creating higher than justifiable borrowing costs.

Excess borrowing costs for SMEs resulting from this regulatory failure could be very substantial. These high rates will also cause projects that should be economic to not proceed.

Poor housing tenure innovation

Another example of an area in which RBNZ’s risk weights are causing otherwise economic projects to not proceed is in the supply of new housing. The RBNZ has effectively stopped most tenure innovation, which in turn directly affects productivity. When you see congestion on our roads you are really seeing a poorly performing residential development market.

Innovative tenures like cooperative housing, papakāinga and build-to-rent projects are largely uneconomic because the RBNZ will not consider whether lending to these tenures should be residential mortgage lending instead of corporate lending for risk weight purposes. By way of example, housing cooperatives are very common in Europe and North America. New Zealand and Australia are distant outliers amongst developed economies in the housing cooperatives sector.

The Ministry of Housing and Urban Development recognises the importance of housing cooperatives, and economic analysis and credit experience suggests that housing cooperatives are less risky than freehold tenure. As a consequence, their risk weights should be lower than residential mortgage lending. Instead, despite having had it carefully explained to them, the RBNZ insists on attributing high corporate risk weights to lending to housing cooperatives.

Even worse than this, these housing tenures are treated as corporate exposures, which makes it nearly impossible for the banks to advance funds that have a table mortgage payment profile that reflects the asset’s cash profile. Unhelpfully, the RBNZ’s innovation has been to assist in the development of the reverse mortgage product – a product that is complicated, not particularly transparent and expensive.

Conservative RBNZ prudential management is a problem for productivity

In short, the RBNZ’s very conservative and inflexible bank prudential management is creating expensive distortions for business, poor housing innovation and making a substantial contribution to poor productivity and inflation in New Zealand.

New Zealand's poorly operating credit markets for businesses should deeply concern politicians of all stripes and is something an incoming government should address within their first six months.

The principal cause of the inefficient credit markets in New Zealand is the approach of our regulators. Whether you look at credit market regulation through the lens of financial inclusion, equity and affordability or through the lens of competition, efficiency, innovation and productivity, the outcomes don't differ much.

The implicit view of the RBNZ and banks alike that lending to businesses represents some existential threat to financial stability is wrong. Business lending loan impairment in recent history is immaterial relative to the equity capital employed by the banks. New Zealand’s four Australian owned banks have a combined book value of equity of about $50 billion. Based on the market values of their parents the market value of the New Zealand banks is closer to $80 billion. Their total credit impairment charge, across all categories of lending, in 2022 was $323 million, less than 1% of their equity – a rounding error.

Culture change at the RBNZ

The notion held by many politicians that the RBNZ’s approach to bank prudential management should be independent, like monetary policy, is also wrong. Parliament and the executive are perfectly entitled and indeed should carefully set and monitor the rules in the banking system. While it is not appropriate to interfere in enforcement actions by regulators, officials do need to be monitored and accountable where they have delegated authority to make rules. The Financial Markets Authority has a board that is equipped to do this, the RBNZ does not.

The RBNZ’s activities in bank prudential management are subject to particular biases which have constantly held New Zealand back. For example, New Zealand being the last country in the OECD to introduce deposit insurance.

In short, culture change is required in the RBNZ’s prudential management and that requires more expert governance to actively challenge the entrenched biases of RBNZ officials involved in prudential regulation.

The Commerce Commission's market study is a step to more closely inspect some of New Zealand's regulatory shortcomings, but this is unfortunately only limited to personal banking services. This limited scope ignores the somewhat fungible relationship between SMEs and personal banking services and the substantial opportunity to improve productivity. The study’s limited scope suggests that the Government and the Commerce Commission don’t understand the important relationship between SMEs and personal banking services, or worse still have made an expedient and short-sighted choice to limit the scope.

Quick change please

There are some significant challenges to be dealt with in our bank prudential regulatory regime that will require imagination and risk taking. Challenges like bank entry and innovation are sadly longer-term challenges. For now, there are some things that can be done in the first six months of a new government that could make an immediate difference and at least start New Zealand on its way to productive improvement.

Our suggestions for quick change by a new government are:

1. The Minister of Finance directs the RBNZ to create a prudential management committee that is responsible for all the RBNZ’s prudential management and then amend the RBNZ Act to give that committee full legal effect. The committee should comprise a majority of independent members (similar to the Bank of England).

2. The Minister of Finance directs RBNZ to transparently review risk weightings for business and alternative housing tenures with the objective of stimulating growth in these sectors. The Minister of Finance can use the Financial Policy Remit to do this. The RBNZ should be required to use risk weightings like it uses countercyclical capital and macroprudential policy – but in a much more targeted way to create growth in productivity by only adjusting the settings for things that improve productivity like business lending and alternative housing tenures (rather than fuelling another housing boom).

3. An independent chair is appointed to the Council of Financial Regulators and that body is directed to quickly identify all financial regulation that is negatively impacting productivity, so that Parliament can remove it (and legislation be amended to enable this).

4. As part of this review resources within our regulators should be reviewed with the goal of reducing their budgets back to pre-pandemic levels (inflation adjusted). This should in turn release resources in the private sector (probably by a factor of 5:1) by reducing the regulatory engagement and compliance burden on them.

There aren’t many free hits in New Zealand’s productivity. Most gains will take years of patiently weeding out the problems in the economy. But years of excessively conservative bank prudential management by the RBNZ make fixing the problems a hit worth taking and the new government should take a full swing.

*Andrew Body is a company director, active investor and investment banker. He has an MCom in economics and an LLB from the University of Auckland.

**Simon Jensen is a legal consultant with a BCom in accounting and LLB from the University of Auckland.