And what does it mean for one bank in particular?

Last week, audit firm KPMG published its quarterly Financial Institutions Performance Survey (or FIPS). It featured the deteriorating profitability of New Zealand’s banks. Bad news of course, and the New Zealand financial press quickly jumped on the survey. Radio New Zealand printed a headline sporting a 20 percent fall in profits. Interest.co.nz reported that New Zealand-owned banks are particularly hard-hit.

Despite the media coverage, this quarter’s FIPS is surprisingly superficial. I mean, there was a time that we relied on firms such as KPMG to inform us about the state of the New Zealand banking sector. But, hey, today, anyone with access to the RBNZ Bank Financial Strength Dashboard can replicate KPMG’s analysis. See the graph below: with some additional RBNZ data from pre-dashboard times, I too can show a drop in bank profits. The Return on Equity data shown below paint a bleak picture of NZ bank profitability.

That, however, won’t cut it as a meaningful analysis. In Covid times, we all would expect bank profitability to decline. KPMG merely states the obvious. With so much free data, both the financial press and KPMG could reveal more. I will get to that.

What I found disturbing is that KPMG uncritically sustains the narrative that New Zealand’s banks are resilient thanks to their efforts to grow capital: “The banks have been building up … capital buffers.”

I have seen that message a couple of times, but it is not really true. Yes, capital has increased since the Global Financial Crisis:

But since 2018, banks have hardly shored up their capital ratios:

Which is interesting for two reasons. Firstly, banks tend to increase capital ratios in anticipation of upcoming augmented capital requirements. This has been documented by many empirical studies. Since March 2017, the RBNZ made it abundantly clear that it would increase capital requirements.

So, if the plan to increase capital requirements was credible, then we should observe an increase in capital ratios. But, the data shows that Total Capital ratios dropped since 2018.

Banks, apparently, did not find the RBNZ capital plans sufficiently credible to take action.

Secondly, the narrative that New Zealand banks today are resilient because of efforts to grow capital originates from Governor Orr. Just look at the presentation of the latest Financial Stability report, where Orr literally claims that banks have “preempted that decision and timetable” [on higher bank capital]. The graph above however shows zero evidence to support that claim. Under the aegis of Governor Orr, the aggregate Total Capital ratio, the dashed line, has dropped.

Whatever happened to New Zealand bank capital, the heavy lifting of capital increases was done after 2009 and definitively before the arrival of Adrian Orr as Governor.

Kiwibank playing with fire

Even more worrying, since Adrian Orr commenced as governor of the Reserve Bank, one bank in particular has behaved as if the capital plans are only a bad dream. That bank is Kiwibank. Its Total Capital ratio dropped from 15.4 in 2018 percent to 13.0 percent now. That is significant.

But there is more. Kiwibank must have dropped its capital ratio deliberately. In bank-speak: Kiwibank has decided to increase its risk appetite. Arguably to increase profitability and growth. See the graphs below. They compare Kiwibank with similar-sized but rock-solid Rabobank. The horizontal axis shows bank size (Total Assets, Risk-Weighted Assets, respectively. The last graph shows the Total Capital ratio instead of the CET1 ratio). The bubbles increase in size over time.

It is clear from the graphs below that Kiwibank exposed itself to more risk and at the same time lowered its Total Capital ratio. This, likely, in an attempt to grow market share and hopefully become more profitable. The graphs below show that Kiwibank’s size has increased. Well done.

But Kiwibank is playing with fire. It has taken on more risk to increase growth and profitability. Unfortunately, it now faces weaker profits. Kiwibank’s Return on Equity dropped from 9.4 percent in March 2018 to a paltry 4.4 percent in March of this year. That is not sustainable in the long run.

Which makes me wonder what the Reserve Bank is bringing to the table. It spent lots of resources on that wicked capital plan. At the same time, our bank supervisor seems blind to the fact that at least one bank has become more vulnerable.

Eyes wide shut?