A populist report

Comments on my post on the Commerce Commission draft report that examined New Zealand’s personal banking services kept me busy this week. I received some interesting emails and phone calls.

One thing that I missed from most of these interactions was the motivation of the Commerce Commission to write this report. Why did the Commerce Commission undertake a study of New Zealand’s personal banking services market, featuring important recommendations that can potentially disrupt financial stability? Some recommendations are about bank capital, which is the Reserve Bank’s turf. Why? Likewise, why the recommendation to recapitalise Kiwibank?

To understand why I am asking these questions, it is worthwhile again to mention the points made by Fernando Restoy:

… the political argument is based on the assumption that large institutions are less able or willing than smaller banks to offer credit and other services to retail customers or small businesses in local communities. However, to my knowledge, there is no compelling evidence that access to credit in concentrated banking systems (like those of France, Canada or the Netherlands) is generally more cumbersome than in countries with a more diversified banking industry (such as that of Germany)

and on proportionality

Yet, there is always a risk that the principle of proportionality could be misused to give a significant regulatory advantage to small institutions. As we have seen, this may not only be unwarranted from a prudential point of view but could also distort competition and prevent a necessary restructuring of the industry. Arguably, the latter effect may become particularly relevant when technological innovation is likely to disrupt the market …”

Fernando Restoy, who previously served as the Chair of the FROB, the Spanish Resolution Authority, before assuming the role of Deputy Governor of the Bank of Spain in 2012, knows something about banks big and small. With first-hand experience of Spain’s banking overhaul post-2008, Restoy sheds light on the country’s move to consolidate its fractured banking sector in response to the Global Financial Crisis.

Spain’s decision to streamline its banking landscape resulted in a more concentrated industry. Despite initial concerns, this transformation has proven effective, highlighting the potential benefits of such reforms.

It’s okay to be big

Hailing from the Netherlands, I am no stranger to a banking scene dominated by a select few. Despite three major players—ING, Rabobank, and ABN AMRO—controlling 85% of the market, there is surprisingly minimal pushback against their dominance.* This suggests that concentration does not rule out trust and satisfaction among consumers.

In this context, it is surprising that the Commerce Commission did not adopt a more optimistic stance on bank concentration and the role of large banks. Additionally, they seemed unwilling to entertain the notion that smaller banks could potentially hamper competition and innovation.

The Game of Banking Bargains

It appears that the Commerce Commission deliberately biased the report in favour of Kiwibank and the smaller players, while simultaneously disregarding the importance of financial stability.

I hear you say: “That is a brave accusation, Martien”, and my response would be that we have seen this before. To explain, it is worthwhile reading this paper by Charles Calomiris and Stephen Harber: The Political Foundations of Scarce and Unstable Credit. It was written in 2013, i.e. before the Trump administration.**

Calomiris and Haber delve into how political forces, especially populism, have historically shaped the banking systems, with a focus on the U.S. They introduce the “Game of Banking Bargains,” explaining that banking policies are the result of negotiations between governments and banks, which often reflect the prevailing populist sentiments. This game has led to various banking models, some more stable and inclusive than others.

The authors highlight a unique coalition in the US between agrarian populists, small bankers, and politicians, noting that such alliances have influenced banking policies to favour local interests, often at the cost of financial stability and efficiency. This coalition fostered a banking system that was noncompetitive, fragile, and inefficient in credit allocation, emphasizing local monopolies and limiting economic growth opportunities. The inefficiencies are still there, American banks still do paper checks.

Interestingly, the shift in banking policies during the 1990s, particularly with revisions to the Community Reinvestment Act under the Clinton administration, marked a significant change, pushing for a banking system that better supports low-income and minority communities, ensuring everyone gets a fair shot at financial services.

We all know how that ended:

Let’s make New Zealand’s small banks great!

Just reiterating a line from the previous paragraph: “a banking system that better supports low-income and minority communities, ensuring everyone gets a fair shot at financial services.” That rings a bell. The previous Labour government tried that too. See this 2019 post from the NZ Labour Party: “We know saving for a house deposit is a massive hurdle for first home-buyers. That’s why we’ve announced a new plan to lower the deposit required for a government-backed mortgage from 10% to 5%.” And this article from some years before: “Labour steps up attack on mortgage changes: Labour continued its attack on the new mortgage lending restrictions coming into force tomorrow by inviting media to meet an aspiring first home buyer the party said would be affected.”

Additionally, the Commerce Commission report’s suggestions in support of Kiwibank and the reduction of capital requirements for smaller banks tap into a populist theme: “Let’s make Kiwibank great again” and “It is time to take control from the Australian banks.”

Drawing parallels with the Commerce Commission’s recent report advocating for small banks, we can see how populist approaches to banking regulation, though well-intentioned, carry the risk of creating a fragmented and fragile banking sector (the Commission refers to a two-tier market). The US experience, as outlined by Calomiris and Haber, offers a cautionary tale of the complexities and potential pitfalls of populist banking policies, highlighting the importance of finding a balance that promotes stability, competition, and inclusiveness in the banking sector.

Lessons learnt?

To understand why the Commerce Commission wrote this report, with proposals that might affect financial stability and step into the Reserve Bank’s regulatory turf, it seems they aimed to appeal to the Labour electorate’s preferences, borrowing strategies from the American banking experience. Considering this comes a year after the fall of medium-sized “disrupter” Silicon Valley Bank and similar small entities, it raises some important questions about the report authors’ motivations.

*As an aside, ABN AMRO, the smallest of the three, is larger than the combined size of all banks in New Zealand: Even our Big 4 are not that large compared to global peers.

** Both authors also wrote a long-read version of that article: “Fragile by design: The political origins of banking crises and scarce credit.” Highly recommended.