Thursday 16 March 2023

Richard Meade on banking and competition

Prudential regulation requires banks to hold more capital than they would otherwise like to, so that there's less risk of default and less risk that the bank imposes bailout risk. 

New Zealand does not have deposit insurance, but some are of the view that there's an implicit guarantee of at least some sort - that the government would not let depositors be too badly hurt. The open-banking resolution mechanism would impose haircuts on depositors if there were still a shortfall after unsecured creditors and equity were burned through, and I don't think anybody really knows how big a haircut might prove politically intolerable. In that view, deposit insurance then just winds up requiring up-front payment for the insurance they're probably already getting for free. 

In any case, high capital requirements mean that banks have to hold a lot of capital; they have to compete for that capital against other potential uses of it. So you'll wind up with high nominal reported profits. And politicians will then point to high profit levels as reason for windfall taxes and the like, while ignoring return on equity. 

Those big numbers generate political demand to do things. And so it seems near-certain that the Minister of Commerce is going to ask ComCom to run a market study on the banks.

Over at The Conversation, Richard Meade raises a few points that need to be kept in mind:

  • The OCR sets a coordination point for pricing that could be considered price-fixing in other sectors; 
  • RBNZ's cheap wholesale funding during the worst part of Covid reduced the risk of meltdowns while preserving bank profitability;
  • RBNZ restrictions on entry, aimed at ensuring financial stability, also prevent competition.
He concludes with a few questions:
First, are growing bank profits due to banks acting anti-competitively, the Reserve Bank fighting inflation and preserving financial stability, or both?

Second, if bank profits are indeed excessive and due to anti-competitive behaviour, are there measures the commission could recommend and practically implement that would improve outcomes?

Finally, if bank profits are excessive, and at least partly due to the Reserve Bank doing its job, would interventions by the commission to improve competition worsen financial stability or frustrate the fight against inflation?

Answering these questions will need both the commission and the Reserve Bank to have serious conversations about how competition policy and banking regulation can be made to work together to achieve better outcomes for both bank customers and the wider economy. Little would be gained by improving bank competition if that reduces financial stability or worsens inflation.

I still think that a market study focused on barriers to entry, including account portability, could do some good. 

And I still think that that will not be what the Minister of Commerce asks for. I expect instead that the Minister wants show-trials of bank executives during the election campaign, during which they can be harangued just as the supermarket CEs were during that market study, with any report coming after the election. That kind of market study would focus on interest rate margins, mortgage interest rates and the like. 

The point would be to make it easier for the government to blame the banks, rather than bad government policy, for poor outcomes during the election - while trusting that ComCom wouldn't issue any final report until after the election. 

And the risk would be a whipping up of appetites for very bad policy and rash promises during an election campaign. The draft supermarkets report was poorly done, and created an anchor point for populist expectations - and for legislation.

If I'm right, I hope that ComCom is able to push back on any weak terms of reference and propose something that could add value rather than do harm. 

And for a bit more on New Zealand's monetary policy mess, Bryce Wilkinson's report, out today, is a must-read. 

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