Reserve Bank warns the big banks' not to cut costs too far in a weak lending market to boost profit

By Gareth Vaughan

The Reserve Bank is warning banks that, although it's appropriate to focus on cost containment during the current period of weak lending growth, they shouldn't cut costs to a level where they're exposed to "greater" operational risks.

The central bank makes these comments in the latest edition of its twice yearly Financial Stability Report, released yesterday.

"In an environment of lower credit growth, banks are likely to increasingly focus on containing costs to generate profit growth," the Reserve Bank says.

"While this is clearly appropriate in an environment of lower asset growth, it will be important that banks do not cut costs to an extent that exposes them to greater operational risk."

Sydney-based banking analysts at investment bank UBS recently suggested the days of staff cuts and branch closures could return at the big Australian banks, including their New Zealand subsidiaries,  as they were now "structurally challenged."

The analysts argued the tailwinds of a leveraging economy driving strong balance sheet growth, readily available funding, fee hikes and rallying markets, all appeared to have run their course.

Just this week it emerged that Westpac was cutting 188 IT jobs in Australia, and BNZ's parent, National Australia Bank, was cutting 135 business banking jobs.

In this year's annual results ANZ was the only one of the big four New Zealand banks to record a drop in operating expenses,  down 3% to NZ$1.498 billion, despite the NZ$111 million post tax cost of putting both ANZ and National Bank staff onto one core banking system. ANZ NZ's staff numbers fell by 142 to 9,270 in the year to September.

Westpac New Zealand's annual operating expenses rose 5% to NZ$784 million with its employees down by 123 to 4,575.  ASB's operating expenses rose 9% to NZ$721 million and BNZ's rose 2% to NZ$747 million.

Meanwhile, the Reserve Bank notes that the banks' net interest margins have continued to increase from the lows of mid-2009. This year's annual results from the big four banks have all shown rising margins. ANZ's up 11 basis points to 2.38%, Westpac's up 22 basis points to 2.33%, BNZ's up 14 basis points to 2.30%, and ASB's up 40 basis points to 2.08%. 

"Over the past two years banks have been able to progressively re-price loans as they have switched from fixed to floating rates, allowing them to return net interest margins to around the level that was prevailing immediately prior to the global financial crisis," the Reserve Bank says.

"An increase in lending margins on business and rural loans has also contributed to the recent rise." The Reserve Bank monitors bank interest margins here.

Combined, the big four made profit of NZ$2.778 billion in their 2011 financial years. That's NZ$78 million, or 3%, higher than their combined profit in the boom year of 2007, and it came against a backdrop of anemic lending growth. Reserve Bank figures show agriculture debt fell 0.8%, business credit rose just 1.5%, and total household claims inched up 1.1% in the year to September. That compares with 14.9%, 13.3% and 12.2%, respectively, in 2007.

Nonetheless, the central bank suggests it's unlikely bank profitability will fully recover to pre-crisis levels - when returns on equity rose above 20%, or even into the 30s in ANZ's case, compared with the mid to high teens now, as the pre-crisis profitability was driven by "unsustainable credit growth."

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