Time for banking to embrace a little risk
The Reserve Bank served up a long-weekend treat for finance geeks last Friday, announcing a new depositor insurance protection scheme to protect Kiwis’ first $100,000 of deposits at each bank.
While it’s certainly a comfort for the average person, I couldn’t help but feel a little flat about this announcement. We have so much opportunity to reinvigorate our finance sector to make it work harder and better for all New Zealanders, a deposit protection scheme isn’t really the most urgent item on the list.
What it does is bring New Zealand into line with other major economies. However, in a country where our local and Australian-owned banks don’t typically make the same level of hugely risky behaviours that led to the Global Financial Crisis, we can afford to think much bigger right now.
So, I spent my long weekend thinking about how we could make the best use of our capacity to change and improve our financial system. Resisting an urge to exercise my stable of hobby horses, I focused instead on what the ‘around the barbecue’ problems are within New Zealand banking.
What we all hear is: New Zealanders are not adequately supported by our banks to buy our first homes, there is a cultural bias in our lending practices, and, to the detriment of NZ Inc, our banks do not adequately back our small and medium sized businesses.
And basically, it boils down to our system’s overly cautious approach to risk.
Banks consider the risk of lending based primarily upon the perceived probability of default (PD) and the perceived risk of loss given default (LGD).
Keeping an eye on the levels of loss should a default occur seems to be common sense. But, like in all things, everything in moderation, and indeed, in my opinion, it is high time to moderate our risk settings.
When LGD is ‘optimised’, it looks like the banks care too much about the size of the first home-owner’s deposit, and not enough about the quality of the home buyer’s character, job and their practical ability to repay the loan and interest given their other expenses.
Our heavy focus on taking mortgage security is also a source of cultural bias in New Zealand’s banking system. Communally-owned Māori land is considered poor security from a traditional LGD analysis, as it is difficult to sell to reduce losses in the event of a default. Without the “right” kind of security, however, banks will not lend, leaving land underutilised and its owners and guardians without a valuable means of improving their income or helping their community. The effect of this is to keep many Māori alienated from their land, unable to play much of an active role in looking after it. At the very least, it’s not customer-centric.
Beyond first home-buyers and Māori, small and medium businesses are also being impacted by our collective focus on LGDs. New Zealand is an economy dominated by SMEs, of which I proudly lead one. Investment in productive businesses rather than home renos is what gives us the bigger multiplier effect on growth, jobs and ultimately better outcomes for New Zealand.
But small business owners will tell you again and again how getting bank funding to support business growth and job creation is ultimately dependent on them risking their family home to reduce the bank’s LGD.
It is inequitable for banks to only support small businesses where the owner already has a family home and is willing to risk it. Home ownership should not be a practical pre-requisite to being an entrepreneur. This is doubly true when you consider that whilst young Kiwis are unlikely to be owners of homes, they are the likely to be owners of amazing ideas.
Finance should be a social enabler that provides you the ability to borrow from your future self rather than an unfair advantage provided only to those who have previously earned or inherited wealth and assets.
To really make a difference in the lives of average New Zealanders, it would be great to see our government and regulators lead a debate on the social and economic benefits of increasing cashflow-centric, not risk-centric lending in New Zealand. For example, we could require banks to disregard LGD for a proportion, say 20%, of their lending decisions. We change these settings all the time for residential property buyers, so there’s no reason why it can’t be done for other things as well.
The government has shown it recognises the dangers of our national property obsession and is focused on lifting wellbeing and equality for Māori and spurring our economic rebuild. Why not embrace a tiny bit of increased risk to help grow and strengthen the SME engine room of our economy, reduce cultural bias and support first home-buyers at the same time?
The reward for society is far higher than the risk – and more interesting, I suspect, than how our deposits are insured.
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