Cameron Bagrie: Why and how the pricing of risk versus the taking of risk by banks needs to change

Economy Watch

Ask Cameron Bagrie how to improve business and rural banking and some words reoccur in his answers. Three of them are "risk", "productivity", and "bankability."

With two parliamentary select committees set to hold an inquiry into banking competition, the business and rural banking markets will feature, unlike in the Commerce Commission probe into competition in the personal banking market. In the latest episode of interest.co.nz's Of Interest podcast, Bagrie, now of Bagrie Economics and Chaperon and formerly ANZ NZ's chief economist, speaks about why banks favour housing lending over lending to the business and rural sectors, and whether it would be good to entice them to change this and how it could be done.

At the top of the select committee inquiry's terms of reference ought to be balance between the pricing of risk versus the taking of risk by banks, and how that's impacting productivity, Bagrie says.

"I think we need to have a really good, hard debate about where the money is actually going, the composition of bank lending, whether it's short-term behaviour versus a long-term growth maximising strategy. Let's have a serious conversation about risk going forward, because risk is a big enabler. It's not open season on risk, but risk is an enabler of innovation, driving productivity. It just seems like we've screwed things far too far towards a low risk approach, and ultimately we pay the price for that over time," Bagrie says.

"I go back to the fundamentals of banking. The fundamentals of banking is pricing for risk and taking risk. And what we're seeing out there at the moment is that SMEs and farmers are certainly being priced for risk... Let's have a look at return on equities out of the banks by segment, not the aggregate top down number. Let's break it down into personal lending, including home lending. Let's have a look at business lending. Let's have a look at farm lending and the institutional [loan] book, and have a look at where those ROEs [returns on equity] actually sit. And I think we're going to be surprised how high those ROEs are for certain segments."

"The key here is to go through each segment and look at the risk adjusted returns," he says.

Figures from the International Monetary Fund show housing lending at 35% to 40% of total bank lending in some countries, whereas in NZ it's nearer 65%, having risen significantly over the past five years.

Bagrie also argues that banks' regulatory capital settings encourage them towards housing lending instead of business and rural lending, when there's "more productivity bang for your buck" when you're lending into the business sector.

"We need to have a look at this through the eyes of economic efficiency, economic growth, productivity, innovation. Because when you make banks a lot more safer, there's a price that you pay on the other side."

"The whole process of credit intermediation is a pretty critical part of economic development. And I don't think we've got financial system settings right on a whole lot of areas," he says.

Financial system settings and banking don't tend to be areas thought of when people think about what to do to make NZ a better place economically in regard to taking risk and driving productivity growth, Bagrie says.

"We sort of overlook what's a fundamentally essential one and that's that flow, that process of credit intermediation, [it] is absolutely essential. The Prime Minister has been talking a lot about encouraging the taking of risk...Well, yeah, in order for firms to take risk, you need the financial system to be prepared to take risk."

In the podcast Bagrie also talks about NZ businesses having a bankability problem and how to rectify this, the role of the Reserve Bank's regulatory capital settings, banks' becoming more vanilla, the rise and rise of bank profits over the past 30 years or so, the low level of banks' non-performing loans, the need for better competition policy across the economy, how housing lending has grown as a percentage of total NZ bank lending over the past 20-odd years, and especially over the past five years, Australian influence at the big four banks, open banking, his thoughts on the idea of a Business Growth Fund, and more.

*You can find all episodes of the Of Interest podcast here.