Are banks immune to downturns?

Source: Radio New Zealand

A $1.26 half-year billion profit for ANZ. A $545 million half-year for Westpac. A $494m result for BNZ.

As New Zealand’s economy reels from one hit to the next, some commentators have asked whether the run of recent profits for banks show they are one of the few businesses that can turn a healthy profit no matter what.

David Cunningham, chief executive of Squirrel and former chief executive of The Co-Operative Bank, said it was fair to suggest that banks were generally able to make money regardless of the wider business environment.

“Imagine if a bank did nothing for a year, stopped lending, stopped doing anything for a year, they’d still make 90 percent of the profit.

“Every year, over 150 or 200 years for many banks, they build up an annuity stream and every year they’re topping that up. The banking sector will typically grow at around the nominal GDP rate. If you think of inflation at 3 percent and real growth at 2, so nominal GDP at 5, that’s pretty much what you’d expect banks to achieve consistently over time unless they’re in a big cost-cutting mode or in a high-growth sort of phase.”

He said there would be times when credit provisions and credit write-offs could affect the reported profits but it did not necessarily mean they lost money.

Many banks set aside large loan loss provisions heading into the Covid-19 pandemic, which then were reversed out.

“They’re providing against the risk that in future they will lose the money… [but] there’s a great saying, the only thing worse than a profitable bank is an unprofitable one.”

He said most customers would be most concerned that banks were supporting investment in the economy and helping people when they needed loans for things like buying houses.

“The question in New Zealand is, are they for a very low-risk business? I mean, it’s almost utility-like. Utilities tend to have predictable, long-run, fairly stable earnings. So is a return on equity sort of near a 13 percent, 14 percent for some of them fair, or, you know, is a return nearer 10 percent like the overall of yield of banks in Australia fairer?”

But Claire Matthews, a banking expert at Massey University, said it was not true that banks were unaffected by wider forces.

She noted Westpac’s result said its impairment provisions were due to worsening economic conditions and margin compression as the official cash rate dropped.

BNZ’s profit was down 38 percent, although largely because of a change in the way it accounts for software spending.

“The banks have managed not to lose money in recent recessions, which reflects careful financial management and the fact that we haven’t had a really substantial downturn. As I’ve said in the past, we don’t actually want the banks to make losses, but they do feel the impact of economic conditions. It is also worth remembering that they are usually affected later by economic downturns, because it takes time to work through to the banks.’

Generate investment specialist Greg Smith said earnings were sensitive in a nuanced way.

“They can generate profits through the cycle, but recent results from ANZ, NAB and Westpac show earnings are clearly being shaped by slower growth, higher bad debts, intense competition and the impact of higher interest rates. The Middle East is a factor.

“They can perform well early in a rate tightening cycle because they typically reprice mortgage rates quickly, while deposit rates adjust more slowly, which leads to a temporary expansion in net interest margins. That dynamic helped support profitability over the past couple of years.

“However, what we’re seeing now across ANZ, NAB and Westpac is the other side of that cycle starting to dominate. Higher rates are now feeding through to customers, with banks lifting provisions for bad debts and flagging stress in parts of the economy. Credit growth is slowing, with businesses and households pulling back. Competition for deposits and mortgages is intensifying, putting pressure back on margins. Profits remain high in absolute terms, but earnings growth is limited or declining.”

Sign up for Money with Susan Edmunds, a weekly newsletter covering all the things that affect how we make, spend and invest money.

Sign up for Ngā Pitopito Kōrero, a daily newsletter curated by our editors and delivered straight to your inbox every weekday.

– Published by EveningReport.nz and AsiaPacificReport.nz, see: MIL OSI in partnership with Radio New Zealand