Martien Lubberink asks whether NZ banks are being used as cash cows for their bruised Aussie parents

By Martien Lubberink*

The Reserve Bank of New Zealand published its latest Financial Stability Report this week. Definitively laudable are the policy measures that it announces to tame the frothy Auckland property market.

However, the Reserve Bank presents a rather rosy view on the current state of NZ banks.

It appears to suggest that all is well with our banks. For example, it mentions that capital ratios are above regulatory minimum levels and that profitability has increased.

On both counts the Reserve Bank could have informed us differently.

Yes, capital ratios are above regulatory minimum levels. But the minimum levels are largely irrelevant.

The official Common Equity Tier 1 (CET1) requirement is 7% (the minimum 4.5% regulatory requirement plus the minimum 2.5% capital conservation buffer), and this is really the lower benchmark. Investors and regulators expect a CET1 ratio of at least 10%.

With a 10% benchmark in mind, the aggregate CET1 ratio of NZ banks of 10.7% fails to impress.

Moreover, the 10.7% is now clearly below the average European level, which stands at 12.1% for the largest European banks.

Also worrying is that capital ratios of NZ banks have declined for three of our five large banks, see Figure 5.2 from the Financial Stability Report below:

My more important worry is what happens with the profitability of NZ banks. The Reserve Bank mentions that profitability – measured by Return on Equity – has improved. This, for sure, is good news.

The problem is that the increased profitability appears to leak away. It does not translate into higher equity, which it normally should: firms use profits to increase equity.

So why is it that profits appear to leak away?

In order to understand this, I looked at ASB, the bank that has shown a dramatic decline in CET1 over the last five quarters, from 11.5% (March 2014) to 9.3% (March this year).

See the table below:

Profits increased, albeit slightly, but equity decreased (!) from $5.535 billion to $5.389 billion.

The table shows that ASB paid out its profits to help fund its owner, the Commonwealth Bank of Australia. This bank’s profits have come under pressure recently.

Over the last five quarters, ASB paid $1.315 billion to its owner, whereas it made profits of only $1.047 billion.

The behaviour of ASB shows a key vulnerability of New Zealand banks; they may be used to prop up their Oz parents.

This is bad, because it may limit the ability to lend and that may affect the New Zealand economy.

(It should be noted that ASB issued Additional Tier 1 capital of $600 million, which weakens the structure of regulatory capital. This may have prompted the Reserve Bank to take another look at the requirements that govern the structure of regulatory bank capital).

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*Dr Martien Lubberink is an Associate Professor in the School of Accounting and Commercial Law at Victoria University. He has worked the the central bank of the Netherlands where he contributed to the development of new regulatory capital standards and regulatory capital disclosure standards for banks worldwide and for banks in Europe (Basel III and CRD IV respectively).