Yesterday, the Reserve Bank published its May Financial Stability Report (FSR). It’s always an interesting read, and I guess that RBNZ employees enjoy contributing to this publication. I will not dwell too long on the report, as the message is very Blue Peter: “New Zealand’s financial system is well placed to handle the increasing interest rate environment and international financial market disruptions.”

The Happy Six

The New Zealand financial system is resilient indeed. It has been so for a long time, and it will continue to be so for many years. It is also a profitable system, and there is no indication that the RBNZ wants to change that. The graph from the FSR below helps illustrate why:

According to the FSR, the graph suggests that risk does not fully explain the relatively higher returns of New Zealand banks. Fair enough. However, I found the countries to the right fascinating: Australia, Canada, Hong Kong, Singapore, and our country. These are five of the “Happy Six,” which, according to Calomirs and Haber, provide abundant credit without major crises. To the left are countries where banks fail at taxpayers’ expense. In short, it looks like there is limited room for cakeism in banking. We cannot have lower bank profits and a stable financial system at the same time. It is therefore no surprise to read how the RBNZ explains the resilience of the New Zealand financial system: “The short fixing profile of New Zealand banks’ lending means that in effect, the risk of interest rate fluctuations is borne by borrowers over the term of their borrowing, rather than by the banking system.” New Zealanders contribute to bank profitability and financial stability at the same time.

What about small banks?

At the macro level, the New Zealand banking system is resilient. But there are differences between banks. Kiwibank, for example, seems to struggle. Its main capital (CET1) ratio has steadily declined since 2018. In addition, the large banks are properly profitable, whereas the small banks hardly earn their cost of capital. See the graph below, which shows the Return on Equity using a traditional way of calculating (left) and the way the RBNZ calculates it (right, using CET1 as a denominator).

This, of course, is not sustainable. The small banks will struggle going forward. At one point, one of them may fall through the cracks.

Unfortunately, when prompted by Nicola Willis and Simon Watts this morning at the Financial Expenditure Committee meeting, the RBNZ hand-waved the interests of the small banks. A reference was made to the developing proportionality framework. But referring to recent U.S. experiences, Christian Hawkesby appeared sceptical about that initiative. It would not surprise me if the RBNZ will stick to its one-size-fits-all approach for some time. It has served New Zealand well. Why try to fix the system if it is not broken?