insight | 1 of 2 in series

Continuing disruption

12 March 2020

This is the first instalment in our five-part Finance – trends and insights series.

Rising disruption and diversity

Increasingly the key to success in the New Zealand financial sector will be an ability to anticipate and manage disruptive change – both market-led and regulatory.

Digital disruption – including the Government’s push to accelerate the adoption of “open banking”, the rise of digital currencies, the increased adoption of buy now, pay later lending platforms, and the potential arrival in New Zealand of the neobank – will continue to challenge established business models.

These waves will crash into the mayhem created by the coronavirus epidemic and already strong change currents generated by the implementation of the Reserve Bank of New Zealand (RBNZ) new capital requirements and the impending passage of the Financial Markets (Conduct of Institutions) Amendment Bill.

The Bill is now with the finance and expenditure committee, to be reported back by 23 June 2020. It supplies the legislative response to the recommendations arising out of the 2018 industry conduct and culture review by the RBNZ and the Financial Markets Authority (FMA).

So what can you expect over the next 12 months? We offer you our view on the likely trends and developments. The overwhelming theme will be an increased diversity in funding providers, funding formats and funding options.

Market-led changes

Digital currencies

The arrival of the Central Bank Digital Currency (CBDC) is increasingly a matter not of ‘if’ but of ‘when’. A recent Bank of International Settlements report found that 70% of surveyed economies were either already undertaking or planning to undertake CBDC research.

This includes the RBNZ although, like many other central banks, it remains cautious and has yet to fully commit to the idea.

The CBDC is a response to:

  • the increasing “normalisation” of cryptocurrencies – in particular, Facebook’s plan, announced last year, to launch Libra, and
  • the use of cryptocurrency formats to circumvent regulators and the anti-money laundering regime.

Unlike other cryptocurrencies, CBDCs will be fully regulated and will be recognised as legal tender. The concept is that they will be traditional money in digital form. They will offer significant advantages over the competition – such as making payment systems more efficient through reducing transfer and settlement times, and increasing consumer confidence.

Buy now, pay later

Buy now, pay later (BNPL) service providers have found a ready market in New Zealand with:

  • over 1,200 Kiwi businesses offering BNPL options, including Afterpay, PartPay, Laybuy and Oxipay
  • Westpac New Zealand research indicating that more than 220,000 New Zealanders have signed up for the services of BNPL providers, and
  • NZ Post reporting that approximately 20% of clothing and footwear purchases in 2019 were through BNPL systems.

BNPL services are inexpensive compared with traditional credit card fees (although if a payment is missed, the customer can incur late payment fees and may incur other penalties), and the application process is simpler than for credit cards.

BNPLs provide short term finance to consumers, but do not charge interest or credit fees or take any security interests so do not fall under the Credit Contracts and Consumer Finance Act (CCCFA). This may change, as the CCCFA provides flexibility for particular agreements to be declared by regulations to be a consumer credit contract. For now, however, the Minister is disinclined to intervene as there is little evidence of harm from BNPL products.

In response to increased criticisms in Australia about the lack of regulatory oversight of BNPL providers, the Australian Financial Industry Association recently drafted a voluntary Code of Practice for public consultation.

The draft Code proposes consumer protections such as “fair, reasonable and capped” late fees, a minimum user age of 18, and a possible freeze of late fees in cases of financial hardship. However, this has not stilled the demand for regulation with critics pointing out that industry codes are not legally enforceable and that the Code was drafted by the largest providers in the market.

Peer-to-peer

The peer-to-peer (P2P) market in New Zealand is well-established, and on the move.

P2P platforms connect borrowers with retail (e.g. “mum and dad”) investors. They offer the borrower lower interest rates for personal loans than finance companies or banks, and the investor potential returns higher than are available on term deposit.

The FMA report on the New Zealand P2P market for the year ending 30 June 2019 showed an increase of 36% over the year in the number of first time borrowers, and that 38% of all registered investors had open investments. There are seven P2P licensed providers in New Zealand.

Harmoney was the first provider to get a licence and is the sector leader, facilitating 72% of all outstanding loans by value ($547m) in the year ending 30 June 2019, and employing around 115 people. However, it announced in February this year that it will look to wholesale sources for all future fundings. We expect Harmoney’s departure from the retail borrowing market will set off a competition battle among the remaining six providers.

Squirrel Money, the third largest P2P provider with $15m market share, is planning to make property investments available to retail investors. Expected interest rate returns will be: 4% p.a. (variable) for residential property loans, 5% p.a. (variable) for business property loans, and 6%-7% p.a. (fixed) for personal loans.

Neobanks

We expect that New Zealand will get its first neobank (or banks) this year, and that the RBNZ and the FMA will develop a framework to remove, or at least lower, some of the regulatory barriers to entry in order to promote competitiveness and consumer oriented banking services in New Zealand.

Neobanks have no physical presence and provide services solely through apps and online platforms. They are marketed as user-friendly ‘one stop shop’ providers, offering personalised services and detailed analytics with merchant and category breakdowns.

The banking sector in New Zealand lags in these tech-based capabilities, with many large banks looking to fintech start-ups or software firms for white-labelling arrangements.

Current market conditions are also advantageous – in particular the low interest rate environment and the recent conduct issues which have undermined public confidence in the large banks.

And the different product offering creates the scope for aggressive marketing:

  • Revolut, for example, has recently launched its mobile app here with a referral programme offering customers to ‘bump’ themselves up the waitlist by sending invitations for others to sign up, and
  • Volt (Australia’s first neobank) differentiates itself from the stringent requirements the mainstream banks impose on customers to qualify for the full amount of their advertised deposit rate by offering higher interest rates with no additional conditions (such as minimum deposits or withdrawal restrictions).

The experience internationally is of strong demand. In Europe and the UK, six neobanks were established between 2004 and 2010, rising to 45 between 2016 and 2019. Several have grown rapidly to become significant players over a relatively short timeframe – e.g. N26 (German) is now valued at $3.5b following expansion into the US, and Monzo (UK) is valued at $2.5b.

As neobanks mature and compete for market share, many have begun introducing a broader range of services such as investment capabilities (similar to New Zealand company, Sharesies), or travel insurance through partnerships with insurance firms (similar to the travel insurance offered through credit cards issued by large banks).

Regulation and policy led changes

Developments in Open Banking

We have listed this as a policy-led change only because Commerce Minister Kris Faafoi wrote an open letter to the banks late last year threatening legislation unless there is faster progress on the infrastructure to support open banking in New Zealand.

Authorities in the UK and Australia have legislated but Faafoi has thus far followed the approach taken by the previous National Government and left it to the industry to self-regulate.

He issued his ultimatum after becoming frustrated at the lack of action following the conclusion of the industry pilot by Payments NZ to develop the API Centre standards for Application Programming Interface (API) Providers. In the year ahead, we expect more APIs to be developed by the banks in cooperation with the Payments NZ API Centre.

Open banking refers to a standardised and secure framework for sharing bank customer data with trusted financial service providers, such as fintech and other technology companies. The idea is that it will enable a wide range of new financial products that will be timely and personalised to the consumer, resulting in significant economic and social benefits for both consumers and businesses.

But there are some potential downsides.

It is not axiomatic that taking business away from the traditional banks will lead to lower costs for the end consumer, and expanding the access to sensitive consumer information will create new opportunities for hacking and fraud.

Also, the profitability of some of New Zealand’s D-SIBs (domestic systemically important banks) may be threatened, forcing them to increase their cost of funding which, as they are the primary financiers to the country’s largest corporates, could increase consumer prices across the economy.

The rise of non-bank lenders

The RBNZ’s increased capital requirements will start applying from 1 July 2020 with full implementation by July 2027. They will affect the major retail banks’ balance sheets, risk appetite, lending and dividend policies and are expected to change the competitive dynamics of our financial system.

In the immediate future, the NBLIs may have a competitive edge, particularly if these impacts are intensified by a general retreat from risk as the banks respond to closer regulatory scrutiny and seek to rehabilitate public perception.

Among the anticipated effects are:

  • a greater reliance at the big end of town on non-bank lenders, including capital markets. KPMG’s Financial Institutions Performance Survey for 2019 showed another good year for the non-bank financial sector with net profit after tax up by 16.49%
  • increased activity from wholesale funded non-bank lending institutions (NBLIs), albeit off a low base. They now represent around 2% of the New Zealand financial market compared to between 6% and 8% in Australia and over 30% in Europe and the US. NBLIs have historically focused on personal, auto, non-conforming mortgage and asset finance loans but are now diversifying into the SME lending and other areas, and
  • a growing appetite among international banks, institutional and private debt investors to increase their exposure beyond their traditional markets and, in particular, to expand their mezzanine or non-conforming loan portfolios as they seek comparatively higher yields.

Although NBLIs are not generally subject to the RBNZ’s prudential supervision or capital adequacy requirements, and this is not expected to alter as a consequence of the RBNZ Act Phase 2 Review, they are not entirely immune from regulatory risk.

The RBNZ may be given residual “call in” powers that could extend to NBLIs, and they may be caught by a future expansion of the Financial Markets (Conduct of Institutions) Amendment Bill to a broader range of financial service providers.

Chapman Tripp has released a separate publication on the fallout for the sector from Covid-19. It is available here.

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