IT, branch costs, regulation, innovation in a weak lending environment drive up bank costs

By Gareth Vaughan

Seven of the country's main eight retail banks recorded a June quarter rise in operating expenses, with four in double digits and five increases of 8% or more, as they splash out on information technology (IT) upgrades, prepare for new regulation, try to secure business in a deleveraging environment, and absorb last October's GST hike.

The biggest increase in expenses came at rural lender Rabobank, where June quarter operating expenses increased NZ$5.1 million, or 26% from the same period of last year to NZ$24.1 million. The next biggest percentage rise came at TSB Bank, up NZ$1.5 million, or 17%, to NZ$10.6 million, followed by SBS Bank (which acquired the Hastings Building Society last October) up NZ$1.55 million, or 14% to NZ$12.9 million, and Kiwibank up NZ$6.8 million, or 13%, to NZ$60.5 million.

Of the big banks, Westpac's expenses rose the most, NZ$14 million, or 8%, to NZ$191 million, followed by ASB up NZ$9 million, or 5%, to NZ$197 million. Excluding a NZ$102 million charge taken over the nine months to June stemming from putting the ANZ and National banks onto a single core banking system, ANZ's June quarter expenses rose NZ$5 million, or 1%, to NZ$394 million. BNZ was the only bank to record a fall, with its expenses down NZ$1 million, or 0.5%, to NZ$198 million.

KPMG partner John Kensington, who oversees the auditing firm's Financial Institutions Performance Survey, said one of the main drivers of rising expenses is the updating and upgrading of core banking systems. There's also preparations for new regulations such as the Reserve Bank's open bank resolution policy and new anti-money laundering legislation and increased emphasis, post the global financial crisis, on risk management.

Cost of product innovations at a time of anemic lending growth adds up

Then there's the opening of new branches and refurbishment of existing ones and the related additional staff, plus product innovations in a market where lending growth, where there is any, is anemic at best.

"If you go back four or five years there was just rampant demand for money as people wanted to borrow," Kensington said. "That's not happening (now) so they're having to look at other areas and other ways of getting the consumer dollar."

Reserve Bank sector credit data shows agriculture debt rose just NZ$50 million in the June quarter to NZ$47.251 billion, business debt rose just NZ$16 million to NZ$72.348 billion and total household claims, which includes home loans and consumer loans, rose NZ$712 million to NZ$184.103 billion.

"There's a bit of recalibration going on in the sense that the banks are experiencing a very flat (lending) time and they can't just rely on the lending book growing so they have to get used to this new environment where the lending book is not going to grow 8 or 10% a year," said Kensington. "So they need to be thinking  'well how do we do business in this new environment where we cannot automatically rely on lending book growth'."

"They're always wanting to give their customers new products, or at least get access to more data to work out what they can or should be selling to their customers, and obviously that's particularly important at a time when lending is slowing," Kensington added.

ASB CEO Barbara Chapman recently told interest.co.nz ASB's 10% rise in annual operating expenses to NZ$733 million was due to the addition of about 200 staff, the opening of nine new branches and technology investment. KPMG's last annual Financial Institutions Performance Survey showed an annual industry wide rise of 849 bank employees.

The only banks to increase operating earnings, or operating income, at a higher percentage than their expenses in the quarter were the big four - ANZ, ASB, BNZ and Westpac - and Kiwibank, with the state owned bank delivering the biggest percentage rise in operating income of 29%, or NZ$21.3 million, to NZ$93.8 million.

GST rise adds to costs

PricewaterhouseCoopers partner Sam Shuttleworth, who oversees his firm's Banking Perspectives reports, says the banks June quarter costs were probably lifted, year-on-year,  by 1.5% to 2% on last October's GST, or goods and services tax, hike alone to 15% from 12.5%.

Shuttleworth said unlike normal retailers for whom selling goods is a taxable activity in that they can claim back inputs for tax purposes associated with developing their products other than wages, while banks can't.

"If you look what a typical bank does, a lot of their supply of services is pretty much interest," Shuttleworth said.

"Mortgage interest is either exempt or zero rated because so much of their actual income does not attract GST, ie the person buying or using the service doesn't pay GST so they can't claim a lot of their costs including GST. So it ends up being a cost to the business."

Shuttleworth also said technology was driving product innovations and subsequent expenses with the likes of iPhone applications being rolled out and banks striving to get greater accessibility to customers in the modern digital world through new areas like social media.

"How you used to access your bank account five years ago versus how you can do it now -- it's miles apart," Shuttleworth said.

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