Much has been written from a bank perspective about the winds of change currently gusting through the banking sector, including by us, but at least as important is what the changes will mean for borrowers.
The impact for bank customers should be generally positive as that is the intention behind most of the regulatory reforms and will be a key motivation behind the adoption of the new technologies on offer. But there may also be some negative effects.
We apply a borrower lens to the five key change drivers we identified in our recent publication The banking industry: a look ahead. They are:
- The structural redesign of the domestic banking sector by the Reserve Bank of New Zealand (RBNZ);
- Technological innovation;
- Increased volatility of, and intra-bank competition for, deposits;
- The growing importance of social licence; and
- The expansion of the banks’ front line enforcement role.
By and large the changes proposed by the RBNZ will improve the New Zealand banking system, making it safer and more self-sufficient.
The deposit compensation scheme, in particular, will confer a general economic benefit by helping to reduce the risk of bank runs. However the guarantee will only apply to deposits up to a $100,000 limit so will be of limited benefit to most corporate customers.
And the new requirement that the local subsidiaries of overseas banks must be able to function on their own, even if the parent bank collapses, will raise compliance costs – cost increases that would be passed on to the borrower.
Local branches of overseas banks will still be permitted to undertake wholesale lending under the proposed RBNZ branch policy review. However, exclusion from the retail sector may cause some global banks to rethink their presence in the New Zealand market entirely.
Technology changes should generally be positive for customers, providing greater opportunities and more reliable and flexible payment processes. We look at the big four.
Central bank digital currency
The RBNZ is putting considerable resource into creating a local central bank digital currency (CBDC) for wholesale and retail use. Over 60 countries have launched or will launch a CBDC and the international experience is that it should increase innovation and competition, improve the resilience of the payment system and assist in cross border payments.
It can also provide a valuable alternative in times of uncertainty as customers may able to transfer their deposits from a bank to the CBDC very easily. However, this could be something of a two-edged sword, as the increased customer control will also increase the potential for bank runs.
Private crypto currencies
New Zealand is still in the early stages of its regulation of crypto currencies. The extent to which they take off here will depend on whether the experience in other jurisdictions is predominantly positive or negative.
Real time payments technologies
Improved and more flexible payment processes will significantly help corporate customers, particularly those that operate seven days per week. Banks now process payments during normal hours over weekends with the aim of moving to a real-time settlement system further down the track.
Open banking will allow customers to move more easily between banks. This will create greater competition and should also allow greater innovation and integration between banks and third parties resulting in better customer products. Open banking has cross-party support in Parliament and so will likely be progressed whatever the election result.
AI is another thing to watch out for, although it’s still too early to tell what it will do to the banking sector.
Increased competition for deposits will require banks to up their game, both in terms of products and returns for customers. The flip side, however, is that banks may focus more on borrower risk, both in relation to individual borrowers and sectors.
Bank balance sheets are under pressure from a range of factors:
- The increased volatility of deposits and the rising capital requirements set by the RBNZ, both of which will increase banks’ reliance on wholesale funding from domestic and international markets;
- The uncertainties in the Deposit Takers Act around the treatment of creditors, in particular the interplay between the depositor compensation scheme and bank resolution, and the lack of clarity around the framework for the RBNZ’s preferred open bank resolution process;
- The potential changes to capital design regulation as the RBNZ seeks to restore confidence in regulatory capital investments after recent crises such as the forced Credit Suisse-UBS merger;
- The unclear frameworks applying to depositor compensation and bank resolution;
- The expected changes to capital design regulation as the RBNZ seeks to restore confidence in regulatory capital investments after recent crises such as the forced Credit Suisse-UBS merger; and
- Potential moves by the RBNZ to limit banks' use of mortgage loans and highly rated bonds to meet liquidity requirements and to encourage them instead to hold more government bonds (increasing demand for such securities and potentially reducing funding options for other issuers).
The combination of these trends highlights the need for efficient asset use, borrower risk assessment, and exploring new income-producing assets like fintech investments. Adapting to regulatory changes and improving the customer experience will be crucial for banks to retain customers and deter them from seeking alternative providers.
Banks already have a strong focus on green/sustainability linked funding and there is likely to be further innovation in this area – e.g., climate bonds, products linked to clean transportation and wastewater management, and sustainability linked loans being used in the context of export credit financings. Sustainability linked agri-finance and other corporate loans are also becoming widespread.
For borrowers, banks will be increasingly interested in levels of climate risk reporting.
Banks will focus on their customers’ behaviour and will expect to see their customers following best ESG practice across the whole organisation, not just climate impact. This includes financial products like social bonds, or improvements of Māori access to capital. Banks will want to see that customers are committed to sustainability in the widest sense, not just to obtain a pricing benefit on their loans.
While the banks have generally been very supportive of their customers throughout the COVID years, the recessionary environment may bring some of that to an end. There is a limit to how long banks can support customers in distress, and we expect to see an increase in corporate insolvencies. Banks will need to move on some customers to manage their responsibilities to shareholders.
An increased focus on fraud will generally be beneficial for customers and will mitigate against the use of money-laundering, terrorism-financing and scams. The downside is potential delays in payment processing while the banks investigate transactions.
We have seen both of these effects arising from the changes made to the Credit Contracts and Consumer Finance Act and regulations in December 2021. This is an ongoing efficiency issue.
Banks will also be aware of the rise in climate activism and the increase in regulatory interest, both internationally and within New Zealand, so will be vigilant in ensuring that their criteria around green lending are robust against the risk of green washing.
In Australia, class actions have been taken by shareholders using corporate governance processes to demand environmental accountability of banks. Commonwealth Bank of Australia was recently ordered to give shareholders access to documents explaining its decision to finance an oil and gas development.
- Expect to see increased competition for deposits but also – potentially – increased costs of borrowing (not just from the high official cash rate) as banks pass through the cost of significant regulatory change.
- Real time payment technology and CBDCs will provide increased flexibility and faster funds flow. They have real potential to make your cross-border payments quicker and easier (though increased fraud protection could still slow funds down).
- ESG is a big area of growth and innovation – but expect high levels of monitoring and accountability.
- The ongoing support banks are offering distressed customers may start to wear thin given the recessionary outlook.