ECONOMICS : Are Banks In For More Scrutiny?

These are extraordinary times, when our Prime Minister thinks it prudent to personally visit the heads of our major banks and – presumably – try to persuade them to do something they might not otherwise do. But the recently elected John Key was doing exactly that, early in February (with Labour leader Phil Goff hard on his heels).
Key later described his visits as “a bit of health check”, in essence to see if the banks were still able to borrow and lend enough, but also to tell the bankers the Government expected them to act “honourably” and pass on lower interest rates. He hastened to insist he was “not arguing that they are not”. He also had discussed fees charged to break fixed-term mortgages.
“The banks are the lubricant that will keep the economy going,” he said – remark that should lead us to suppose he wants to be sure there is plenty of it and that interest rates are lowered enough to tempt commercial borrowers to borrow more and invest in the greater production. This will generate greater employment and pump up our sagging GDP growth.
But Key was also interested in the welfare of home owners stuck with fixed mortgages negotiated year or so ago, when property values were surging, who are finding the going tough as property values fall (and who envy neighbours who opted for floating mortgage deals). The paradox is that those who preferred fixed rates when the OCR was rising saved themselves bundle of money, compared with those who took floating rates. Now they are yelping as they learn what it costs to break their contracts.
The politicians’ focus on banks and bank practices raised concerns in some quarters that we were headed back towards Muldoonism, the precursor to the mid-1980s era of financial deregulation. In those days the government told banks what they could and could not lend and at what price.
Goff was also anxious to seek assurances the banks will go easy, when dealing with those who face losing their homes during the global recession. He recognised that banks are commercial enterprises, and when contracts for fixed-term loans or deposits are entered into they have to be honoured by both sides. But “in exceptional circumstances I would expect banks to show flexibility…”. He urged the Government to clamp down on any who charge “exorbitant” fees to people wanting to break their mortgages due to hardship.
We are heading towards an era of greater government influence on the banks, if not tighter regulation. “That’s absolutely for sure,” says Infometrics economist Andrew Gawith. There’s good reason. The Government has given its guarantee to retail and wholesale bank deposits. The quid pro quo will be keeping closer eye on them; more extremely it might put them under government pressure to lend.
The regulatory impetus comes from overseas. The banks in Britain and the US were subject to much more extreme government interventions than here, either through the investment of huge sums in them or the provision of billions of dollars in bailout money.
The banks here – in effect – more modestly have been offered the chance to buy state insurance policy. When they pay their premiums, they might hope to be left alone.
But in the short term, at least, the Government will argue its obligation to support the banks allows it to nudge them to drop interest rates and crank up their lending, because we need people to borrow to get the economy back on its feet. When the credit squeeze is over and the economy is growing again, however, the Government won’t necessarily be willing to restore the deregulated regime, enabling the banks to borrow from and lend to whomever they see fit.
Or will the Government say this has been nasty experience, which we do not want to repeat, and from here on it wants to take greater interest in what banks do?
Now that overseas investors will be putting money into banks with government guarantee, of course, they will be keen to check New Zealand’s sovereign risk and prospects. That’s why posse of central bankers and officials was doing the rounds of overseas financiers, at the same time Key was talking with the bankers. They would be assuring the investors about New Zealand’s economic health and that if our banks should seek funding from them, we are in good heart.
Here’s hoping they didn’t talk to the same people they were talking to two years ago. At that time, the surge of overseas funds into New Zealand was driving up the exchange rate, and the government line (accompanied by warning about exchange rate risk) was to discourage investment here.

Bob Edlin is leading economic commentator and NZ Management’s regular economics columnist.

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