KPMG FIPS Survey 2016

FIPS

Financial Institutions Performance Survey

Review of 2016

February 2017

kpmg.com/nz Contents

2 The Survey 88 Non-banks industry overview 4 A KPMG view from the editor 90 Non-banks – Industry overview 8 Banking industry overview 98 Looking back at the non-bank sector 10 Registered banks – Industry overview 100 Non-banks – Timeline of events 22 Registered banks – Timeline of events 102 Financial Services Federation 26 Registered banks – Sector performance 104 Non-banks – Sector performance 38 Registered banks – Analysis of annual results 112 Where is P2P lending at today? 46 Major banks – Quarterly analysis 114 Non-banks – Analysis of annual results 50 Review of bank directors’ attestation regime 118 Cyber security: It’s not just about technology 52 Sustainable performance requires good conduct 124 Registered banks – ownership and credit ratings 54 More legislation? Success is all about 125 Non-banks – Credit ratings customer-centricity 126 Non-banks – Ownership 58 Transforming the agri‑food industry 127 Descriptions of the credit rating grades 62 Customers drive banking innovation 128 Definitions 64 Get ready to embrace digital disruption 129 Endnotes 66 Blockchain – time to understand the value 132 KPMG’s Financial Services Team 70 IFRS 9 – Rising to the challenge 134 Contact us 74 Generating a leading house price index 78 Productivity is a strategic imperative for New Zealand banks 80 What FATCA, GATCA and other tax changes will mean 82 Banking industry forecasts KPMG’s Financial Services team provides focused and practical audit, tax and advisory services to the insurance, retail banking, corporate and investment banking, and investment management sectors. Our professionals have an in-depth understanding of the key issues facing financial institutions. Our team is led by senior partners with a wealth of client experience and relationships with many of the market players, regulators and leading industry bodies. 2 | KPMG | FIPS 2016 The Survey

The KPMG Financial TABLE 1: MOVEMENTS Institutions Performance Who’s out Who’s in Survey (FIPS) report of 2016 Banks: 251 —— Nil —— Nil th represents the 30 year —— GE Capital —— EFN (New Zealand) Limited KPMG has provided in-depth Non-banks: 23 —— The Warehouse Financial —— LeasePlan (New Zealand) insights into New Zealand’s Services Limited banking and finance sector. In this 30th edition publication Bank of China) are still in the early (New Zealand), formerly part of GE we will be presenting industry stages of their development, we may Capital’s Equipment Finance and commentary and analysis continue to see further accelerated Fleet Solutions Division, is one of the on the performance of the growth and it may be some time entities that acquired a portion of GE before this begins to normalise. Capital’s loan book and because of New Zealand registered Of particular future interest for these that, we welcome EFN (New Zealand) banks and non-bank financial entities will be the impact of the dual to this year’s publication as they branch, subsidiary registration recently have met the $75 million threshold institutions, together with a announced by the RBNZ. for inclusion. The remainder of GE range of topical articles from Capital’s loan book was acquired Follow the announcement of its by two large entities, whom we other key stakeholders such withdrawal from New Zealand, hope to welcome into the survey Deutsche Bank has relinquished its as industry experts, regulators from next year onwards when banking license to the RBNZ in August and our own business they will by virtue of being large for of this year. However, this year will two years be required to file their line leaders. be the last year of its inclusion as part financial statements. of our banking sector analysis, with 31 December 2015 being the last The Warehouse Group Limited’s The survey covers registered bank annual financial statements available acquisition of The Warehouse Financial and non-bank entities with balance for Deutsche Bank. Services Limited from Westpac, has meant that the financial performance dates between 1 October 2015 and For the non-bank sector participants, of Warehouse Financial Services 30 September 2016. As a result, the threshold for inclusion in this will now be consolidated under The entities with the balance date survey has remained unchanged Warehouse Group’s 31 July 2016 yearof 31 December will have their from the prior year at total assets end financial statements. Hence, The 31 December 2015 financial results of $75 million. In total, the non- Warehouse Financial Services Limited included in this year’s survey as bank sector comprises of 23 survey will no longer be included in the survey their most recent results. Those participants that are involved in an due to the absence of publicly available affected include Bank of China, China array of activities, including equipment standalone financial statements. Construction Bank, Citibank, Deutsche financing, vehicle financing, consumer Bank, Industrial and Commercial loans, working capital loans, and The sale of Fisher & Paykel Finance Bank of China, JP Morgan Chase residential mortgages. to FlexiGroup (New Zealand) Limited Bank, Kookmin Bank, Rabobank has not affected the way Fisher & Following developments from and The Hongkong and Shanghai Paykel is presented in the survey this the previous year, we see the Banking Corporation. year, however it will have an impact departure of GE Capital and The next year. As this year marks the first full year of Warehouse Financial Services from financial reporting from Bank of China this year’s survey. Having sold off In addition, we also welcome and China Construction Bank, we hope its New Zealand operations in 2015, LeasePlan New Zealand Limited the comparative figures presented GE Capital has since transferred the to this year’s publication. We have will help develop a better sense of the majority of its loan books to its new included all prior year comparatives potential size of these two growing owners, and as such do not have for LeasePlan to ensure consistency banks. However, as the Chinese banks any loans to report on at its most and comparability between (including Industrial and Commercial recent year end fiscal date. EFN reporting periods.

As with all previous FIPS Surveys, the information used in compiling our analysis is extracted from publicly available annual reports and disclosure statements for each organisation, with the exception of certain information provided by the survey participants. A limited number of participants provide us with audited financial statements that might not otherwise be publicly available. We wish to thank the survey participants for their valued contribution, both for the additional information provided and for the time made available to meet and discuss the industry issues with us. Without these valuable meetings with Executives the document would lack a lot of the colour and deep insights that it does. Massey University continues to be a key contributor to the compilation of this publication, assisting with the data collection, as well as drafting the banks’ profit forecasting section of this survey. We thank them for their continued contribution. External contributors continue to play a vital role in our publication, providing insight on key issues and developments that we might not otherwise have. We would like acknowledge the contributors from The Reserve Bank of New Zealand (RBNZ), the Financial Markets Authority (FMA), New Zealand Bankers’ Association (NZBA), The Financial Services Federation and the Real Estate Institute of New Zealand (REINZ), for their exceptional contribution towards the compilation of this publication. We have supplemented their external thought leadership commentary on the industry with some of KPMG’s own business line thought leadership. We trust you find the content of this survey of interest.

As I sit down to write the At the beginning of the year, funding channels started to tighten and become editor’s letter, I look back over more expensive. This was followed by 2016 and what has truly been a series of successive slumps in dairy a year of volatility and change prices at the Global Dairy Trade auction. Fortunately, later in the year, global dairy that perhaps offers a window prices have rebounded. into a future where increased On the geo-political front, there was volatility and pace of change turmoil all over the world as ruling will be the norm. governments received clear messages from citizens that they were not being listened to. First there was Brexit and then late in the year, the election as US president of a billionaire businessman, talk show/reality TV host who prefers rhetoric over facts and John Kensington uses Instagram and Twitter to espouse Partner – Audit his policy. In New Zealand our own Head of Banking and Finance Prime Minister resigned, a new KPMG Prime Minister was appointed and subsequently an election date was set for 20 September 2017. John has been with KPMG’s Financial While all of this was going on, funding Services audit team for 30‑plus years, was becoming more difficult and more 21 of these as a partner working with expensive to obtain and the fourth a wide range of financial services industrial revolution was impacting audit clients, specialising in banks and us faster than ever. finance companies. Despite all of this, the New Zealand John has a wealth of experience in economy has remained strong. auditing and accounting for banking Immigration, tourism, and the non-dairy products and services including primary sector have all performed well. treasury, retail offerings, corporate Unemployment is at an all-time low and loans and loan provisioning. He is New Zealanders are feeling reasonably currently Head of KPMG’s Banking confident about their future. and Finance team, Head of Financial Services Audit and editor of this Some of the concerns expressed in publication. John is also a Trustee 2015 about an Asian (Chinese) market of the Kidscan Charitable Trust, and collapse have proven unfounded. Deputy Chairman of the New Zealand Despite that 2016 was the year Audit and Assurance Standards Board of volatility and change. (NZAuASB) and a member of the External Reporting Board (XRB). John is also a member of CAANZ and the Institute of Directors.

The key takeaways from the 2016 year —— One factor we have seen near This was not seen as sustainable that are highlighted by the survey are the end of the 2016 and early and was in part behind banks’ as follows: 2017 is the beginning of what actions to slow lending. This in some wrongly refer to as ’credit turn led to an increased focus —— One thing that continues to rationing’. There has been a clear on local deposits and increased underpin the banking sector’s message from the major banks competition in that part of performance is the strength of its that New Zealanders cannot the market. balance sheet. expect lending rates to continue —— One area that always provides —— This year is the first year for to fall nor to borrow at the same animated discussion is regulation. seven years that we have seen exuberant levels. A combination of The current period has been no a reduction in sector profitability increased funding costs, regulation exception. At present the single compared to the prior year. This limiting the amount of funding an biggest area of concern in the was caused by a reduction in non- Australian parent can provide to regulatory space is in relation to interest income combined with a New Zealand subsidiary, and the RBNZ’s revised outsourcing increases in the impaired asset concern around the overheated policy. It would be fair to say that expense and operating costs. The property market has caused the Bank Executives are still nervous decrease in non-interest income banking industry to start to prepare about where this might ultimately is understandable as this is a New Zealanders for rising interest end up. A fortnight ago the RBNZ very volatile line in the sector’s rates and publicly warn that further issued its final outsourcing policy income statement. The increases Official Cash Rate reductions are proposal. There are very clear in impaired asset expense is also unlikely to be passed on. At the sides to the argument around understandable given where heart of all this, is a realisation outsourcing with the banks saying we are in the economic cycle that returns on assets and equity “we have outsourced services to and the fact that a lot of that in the sector have slipped to an centres of excellence and in doing growth was driven by collective unsustainable level. so have improved the quality of provisioning increasing in line with —— Probably one of the most control and the service, and have balance sheet growth combined outstanding illustrations of this taken significant costs out of the with industry specific overlays, was illustrated when within New Zealand financial system”. particularly in the agri-sector. The 48 hours of the Reserve Bank of “If we are made to bring these increase in operating expenditure New Zealand (RBNZ) publishing centres back on shore, we will is a combination of the regulatory a consultation paper on the unfortunately duplicate and bring impost and the need to innovate 19 July, the four major banks and back to the New Zealand economy for the customer. Kiwibank immediately announced those costs previously removed —— This year the sector margin a voluntary adoption of the new and there is no guarantee that decreased 13 basis points (bps) 60% loan-to-value ratio (LVR) the quality of service from the from 2.28 to 2.15%. This was restriction. This was further backed on-shored centre will match the primarily caused by less relief on up by a number of banks deciding off-shore centre”. the funding side of the balance that in the future foreign income —— The RBNZ’s position, which sheet and intense competition would not be included in the has largely prevailed in the final on the lending side. affordability calculations. policy is that they have a desire —— Asset quality has continued to be —— This all came at a time when the to see locally incorporated banks strong with the total provision to structural relationship between being able to be managed totally average gross loans and advances deposits and loans had become onshore. In the event that is ratio showing a slight improvement seriously out of balance. During required, they would not want of 3 basis points from 0.58% to the period June, July and August, a situation where they were reliant 0.55%. However, over the same the major banks saw a significant on an offshore centre under the period the impaired asset expense increase in lending and at the jurisdiction of another regulator. has increased. same time a significant decrease in deposits such that a significant system deficit was needed to be funded from offshore lending.

Looking to the future, the banking It will be interesting to see if the This was surprising because the sector is facing a time of increased same happens in our election New Zealand financial sector has challenges, volatility and uncertainty. in September of this year. had its share of questions raised albeit none of them as significant —— In the near term, securing of —— The constant threat of disruption as have occurred overseas. funding at favourable prices will and the growth of digitalisation Conduct risk is an ever changing be exercising all Executives’ minds. in the banking sector will only picture with things that are seen as build in pace. All Executives —— The global market is more volatile acceptable business practice today have said that they will further due to the various geopolitical being considered inappropriate digitise their offerings and they issues that it is facing. Nothing in the near future and their will look to partner with Fintech makes markets more expensive identification and public shaming entities to do so. They readily than a degree of uncertainty as is not only swift if via social media, acknowledge that a Fintech to what might happen. but near impossible to control. partnership is the way forward as One factor that is very clear in —— In addition, locally the regulatory they do not have the resources relation to conduct risk is there space has some water to go under or the time to develop many needs to be a definite move from the bridge, whether it be in relation propositions required on their own ‘customer service’ to ‘customer to the implementation of the new and partnership is the best way experience’. Customer service is outsourcing policy, the review of to ensure that they stay abreast about the customer getting service the Financial Advisor’s Act, or the of the latest developments. quicker. Customer experience is RBNZ’s capital and liquidity review. Executives agree that the most ensuring that customer needs —— One exciting piece of regulation likely disruption will come in the are being fully understood before released in late December was payment space. anything is suggested as a solution the ability for non-systemically —— With disruption, the risk of cyber and, that the customer is not important foreign banks to have crime increases. Customers only sold a product quickly, at the a dual registration. For some of expect entities to have their data appropriate price, but it is still a those players, this is an exciting and other sensitive information product that serves their best business opportunity and it will needs and provides them with be interesting to see how it protected against cyber intrusion. what they want. This is a subtle, translates into competition within As more channels and apps are but important change. the banking sector. opened and different services are offered, all of these channels and When you sit back and look at what has —— On the global stage, there are services require appropriate cyber happened in 2016 and what potentially a number of significant matters protection. One thing is certain; lies ahead in 2017, the clear messages that will impact the sector. Firstly, those on the other end of the cyber are – expect volatility, expect change, the geopolitical turmoil that has crime line are only increasing their and expect the unexpected. All of these been caused by the likes of efforts to hack into, steal private are circumstances that both threaten Brexit and the US elections will data, and create embarrassment. over the next year or two start to and provide tremendous opportunity play out. In addition, as elections —— The other major area where we will to the banking sector. 2017 could be occur in other countries, it will be see a significant impact in the future a very interesting year. interesting to see what happens. is line the area of conduct risk. It is clear from recent election Surprisingly throughout this survey results that there is a significant the Executives we spoke to thought section of the global population that their entities were well placed that are not happy with their lot and in relation to conduct risk. While possibly have lost interest in the they acknowledged that many of facts of the situation and rely more their parent entities had issues on Facebook, Twitter, and Instagram in this area, they did not see the to find out what is going on and are New Zealand landscape as being quite prepared to protest vote to one that was fraught of examples send a message to the leadership. of inappropriate conduct risk.

Banking industry overview

Decrease in profitability as the 1 MOVEMENT IN NET PROFIT AFTER TAX result of a reduction in non- interest income and increases $MILLION in the impaired asset expense 6,000 and operating costs. 5,000

4,000 The New Zealand banking sector experienced a contraction in 3,000 profitability as net profit after tax (NPAT) declined by $334.38 million 2,000 (6.46%) to $4.84 billion (see Figure 1). Four of the five major banks (ANZ, 1,000 BNZ, Kiwibank and Westpac) contributed a total decrease of 0 $400 million, while Commonwealth 2015 NET NET NON- OPERATING IMPAIRED TAX 2016 NET Bank of Australia New Zealand (CBA) PROFIT INTEREST INTEREST EXPENSES ASSET EXPENSE PROFIT reported a 4.25% ($37 million) growth AFTERTAX INCOME INCOME EXPENSES AFTERTAX in NPAT for the year. The other (non- major) banks also produced some This does not come as a surprise, However, many Executives we notable movements in profitability with given the extent of volatility that spoke to felt that funding pressures The Bank of Tokyo-Mitsubishi, HSBC was experienced in the global from rising interest costs offshore and TSB Bank contributing an increase financial markets this year. Increased and a more competitive local of $81.20 million to NPAT, while operating expenditure also had a deposit market, as well as the other Deutsche Bank and Rabobank saw notable effect on NPAT levels this measures such as LVR limits and NPAT levels decline by $18 million and year, as operating expenses (including restriction on foreign income in $36.56 million, respectively. amortisation) climbed $223.42 million, affordability calculations, could slow The single largest factor in this or 4.56%, to $5.12 billion. Of the lending growth in the upcoming year. year’s performance was a reduction 21 survey participants, 16 reported Asset quality remained strong, with in non-interest income of 11.19% higher operating expense (including total provisions over average gross ($350.20 million). ANZ and BNZ amortisation) in the current year due loans and advances showing a slight reported a decrease of $510 million to larger personnel expenses and the improvement of 3 basis points (bps), in non-interest income, which was continued investment in technology from 0.58% to 0.55%. However, partially offset by a $160 million and digital capabilities. impaired asset expense experienced increase from CBA and Deutsche Sector margins were also impacted. an increase of 4.93%, or $21.59 million Bank. Of the $160 million increase, Interest margins for the year were to $459.60 million in the last year, CBA contributed $76 million. However, down 13 bps, from 2.28% to 2.15%. which is in line with lending growth. due to a reclassification of income Net interest income was lifted by between net interest income and non- 1.36% (or $127.41 million), as a interest income in the 2016 financial result of interest expense declining The cost pressure of growing year by CBA, using restated 2015 by $1.48 billion (10.55%), offset by regulatory compliance, increased financial year figures would result in a a $1.36 billion (5.79%) decrease in competition, volatility in markets smaller increase of $47 million for non- interest income. Lending growth for and the costs associated with interest income. The fall in non-interest the banking sector was at its fastest staying digitally competitive are income for ANZ and BNZ stemmed pace in the last eight years, with loan examples of the current challenges from a decline in trading income and books this year growing by 8.10%, the industry is facing. unfavourable movements of financial from $366.04 billion to $395.71 billion. instruments (mainly cash flow and fair value hedging derivative instruments).

TABLE 2: REGISTERED BANKS – PERFORMANCE TRENDS

Impaired asset Operating Net profit after expense/ Increase in Increase in net expenses/ Year tax/Average Interest margin Average gross total assets profit after tax Operating total assets loans and income advances

2016 7.03% -6.46% 1.00% 2.15% 39.39% 0.12% 2015 10.20% 6.94% 1.16% 2.28% 37.32% 0.12% 2014 5.28% 20.41% 1.17% 2.24% 39.44% 0.08% 2013 1.15% 8.53% 1.00% 2.26% 42.05% 0.16% 2012 0.78% 14.12% 0.93% 2.26% 44.40% 0.22% 2 011 4.51% 10.04% 0.84% 2.23% 43.62% 0.30%

As competition in the banking industry In some cases, Executives were left Executives noted that they have continues to build and margins are to wonder if any profit was being made already encountered instances of fraud squeezed, return on equity (ROE) and on such deals, and if such deals were in this respect. However, at the same return on assets (ROA) levels have only being made in the interest of time, a smaller group of Executives fallen over the past year. The banking retaining market share, retaining a key wondered if this was an opportunity sector saw its ROE and ROA decline customer or for some other reason. for them, particularly if through their by 200 bps and 16 bps, to 13.96% and They also wondered how long they global network, they were able to 1.00%, respectively. The decreases could be realistically maintained. verify the income. in ROE and ROA played a large role in why banks have scaled back lending However, as the banking industry Executives of smaller banks were growth in recent months, as they look entered into the second half of 2016, eager to comment on new LVR for deals that are appropriately priced things took an interesting turn with restrictions for residential property as opposed to primarily looking for developments that were not fully investors and owner occupiers and loan book growth. These decreases anticipated. It began in June with what they see as a distinctive change are also a reflection of an increasingly announcements from each of the in the behaviour and attitude of the big challenging environment where banks big four New Zealand banks that four banks in the local market. There are finding it more difficult to maintain they would impose restrictions and is a general consensus amongst those current levels of earnings. The cost exclude foreign income for affordability Executives that the big four banks are pressures of growing regulatory calculations on home loans to foreign showing less interest in competing compliance, increased competition, buyers following the steps that were for some deals in certain areas of the volatility in markets and the costs taken by their respective parent lending market. One of these areas associated with staying digitally companies in the Australian market as is the mortgage market, where fewer competitive are examples of the current early as April. cash offers and incentives have been challenges the industry is facing. offered or where they are, they are not Many Executives spoken to across occurring to the same extent as at the a range of large and smaller banks beginning of the year. The industry remains highly commented that the inclusion of competitive foreign income in an affordability Commercial property investment is The first half of the year showed the calculation was difficult to verify another area that banks are seeing banks continuing to demonstrate – in particular, the level of foreign less ferocious competition. The RBNZ’s a continued desire for loan growth. income being declared, the validity of November 2016 Financial Stability This was embodied by what some supporting documents being provided, Report notes that bank credit to the of the Executives described as overly- and its source (for the purpose of anti- commercial property sector grew at generous offers around interest rates money laundering regulations). around 10%2 in the year to September and other incentives, in order to secure 2016 and it is forecast that this type a deal. of lending will continue to increase.

TABLE 3: REGISTERED BANKS – NON-PERFORMING LOANS 2013 2014 2015 2016

Past due assets to gross loans and advances 0.27% 0.19% 0.19% 0.13%

Gross impaired assets to gross loans and advances 0.87% 0.66% 0.48% 0.37%

Total 1.14% 0.85% 0.67% 0.50%

However, Executives noted that they Recent tightening of the lending Despite no indication of strong are looking more closely at the deals criteria by certain banks was also competitive pressures easing in the that they are prepared to lend on made in consideration of several near future, the RBNZ and the banks and ensuring that those deals that factors, including a significant have signalled the market to expect are being funded are ones that will reduction in the availability of cheap interest rate hikes in the upcoming provide an appropriate return at an funds, increasing geopolitical and year. They have cited upward appropriate risk. global economic uncertainty, and a pressures from funding costs and severely overheated housing market. funding imbalances in New Zealand The Executives also commented While some may label these recent as the biggest driving factors behind that lending practices/policies were developments (restriction on foreign the increase. due for a much-needed change income, early implementation of new as they had started to see certain loan-to-value ratio (LVR) rules, and the lending deals that were pushing Higher funding costs pulling back of the bank’s presence in ROE, ROA and return on investment expected due to increased certain areas of the lending market) (ROI) triggers. This prompted banks global uncertainty as credit rationing, Executives have to start taking a closer look at the While the highlights of last year’s clarified that it is about being smarter ROA, ROI and the capital impacts survey were cheaper funding, tougher in terms of using their capital when of the deals that they were starting competition and tight margins, the deciding who they are lending to, as to see and to consider whether it banking industry news in the latter they are still very much willing to lend was appropriate and sustainable to half of this year has been filled with to customers if the deal is right and be doing such lending. It appears headlines about funding pressures it makes business sense. This means banks are no longer ‘falling over each and how they were affecting the focusing lending growth strategies other’ to do every deal. Furthermore, way banks were having to compete. on existing key customers, and on the Executives pointed out that this This year, the banking industry had to potential customers with strong recent change in behaviour could notably scale back on lending growth opportunities and a solid credit rating. also be better characterised as a during the second half of the year, Executives have stressed that the shift in their strategic focus, from an amidst concerns of funding constraints key to effective resource allocation approach that meant competing at leading to issues with capital levels, lies in pricing loans correctly (in terms all costs for additional businesses to and with ROA and ROI triggers of interest rates), to ensure that being more mindful of maintaining/ being met as a result of low margin they have sufficient funds to lend to building capital levels, and the return deals and an increase in the outflow the people that they really want to on capital being achieved on new of funds that was not matched by lend to, principally those who have a businesses. This focus, in many cases, deposit growth, thus forcing banks to bankable proposition. has been driven by a general desire fund offshore. All this occurred at a to strengthen capital measures and As the larger banks continue to adjust time when there was also the desire by some parent country regulatory their operations to be in alignment to bolster capital and local deposits, initiatives that will limit the Australian with their new growth strategies there especially for the subsidiaries of the parent bank lending to its subsidiaries. might be a slight easing of competitive Australian banks. pressures from these banks on certain types of lending. However, we can still expect significant competition in the 2 SEE FIGURE 2 – PAGE 20 banking sector in areas where good margins can be found, and the risk levels are appropriate. •

Many of the developments that we Many of the small foreign banks In the event that there are further OCR saw in the second half of the year, have expressed interest in applying cuts, the banks have already intimated as discussed in the competition for a branch licence, particularly the publicly that they will be unlikely section, can be explained by funding three Chinese banks. Executives to pass on the cuts to borrowers constraints that began impacting the of small foreign banks have stated for reasons explained above. The New Zealand financial market late that their interest in a branch license Executives reiterated that contrary to last year. The first of these were the is the result of current funding publicly-held beliefs, the movements in new Australian Prudential Regulation limitations imposed by their parent home loan rates should be considered Authority (APRA) capital requirements companies, via directives, conditions in the context of a myriad of factors, that restricted Australian banks from of registration and/or the RBNZ’s and not solely on the OCR movement. lending more than 5% of level 1 Orders in Council which restrict the Factors to consider also include, but tier 1 capital to their subsidiaries level of related party borrowing and are not limited to, the banks’ current in New Zealand. This meant that, lending that can occur, and capital funding mix (i.e. the combination of cumulatively, the big four banks in adequacy requirements. All these onshore and offshore funding), the New Zealand will have to return billions factors have prevented them from availability of funds for immediate of dollars in funding to their Australian doing all the deals that they wanted disbursement, and strategic goals (e.g. parents over the next few years. These to, especially those in the area of attracting only quality loans with the banks will have to then turn to the local corporate lending, construction and use of interest rate pricing). deposit market or offshore wholesale infrastructure projects. markets to replace those funds. This explains some of the competition 5 SEE FIGURE 5 – PAGE 21 that we are seeing in the retail 4 SEE FIGURE 4 – PAGE 20 market. In addition, increased global uncertainty as a result of geopolitical • issues around the globe this year • Executives from the banking industry have meant that access to cheap In relation to the local retail deposit have, in recent months, signalled the offshore funds began to dissipate markets, the banking system noted financial market to expect slower loan as investors had to be compensated that between the months of July growth for the foreseeable future, and with higher-risk premiums for to August it had witnessed a large a rise in home loan rates, as increased access to their funds. At the same outflow in deposits as investors were funding costs persist through the time New Zealanders’ appetite for liquidating their deposit holdings in upcoming year. While new loans will borrowing was increasing. favour of other investment classes, be funded by more expensive funds, whether they were investment it might be some time before the On the other hand, increased property purchases, funds or shares. effect of the interest rate repricing competition with other competitors for At the same time, the appetite for comes through to the financials due local deposits is also putting pressure lending increased significantly, creating to the current funding mix of existing on funding costs as the banks a gap that had to be funded offshore. interest-bearing liabilities (i.e. fixed compete to attract adequate funds vs. variable interest rate terms One other area that the banks identified from the local retail market. on borrowings). as an issue this year is the spate of successive OCR cuts. Executives have commented that the OCR cuts Digitisation and disruptors 3 SEE FIGURE 3 – PAGE 20 placed them in a tough predicament One area that we see digitisation in the public eye. They were unable having a profound effect on within • to reduce deposit rates due to a the industry is in the use of branches. In addition, the new dual registration decline in the volume of deposits, A banking expert from Massey for small foreign banks, which has because of already low rates, and at University estimates that over a been in force since 21 December the same time they could not reduce period of five years, approximately 2016, could lead to more competition, home loan rates any further as they 150 branches of New Zealand’s major as foreign banks that are currently not were already under margin pressure banks have been closed.3 The report systematically important will have the and starting to hit ROE and ROI limits. does not mention if this was driven opportunity to enter the local market. by the expansion of digitisation or digitisation replacing these services (which is a common theme).

As foot traffic into branches is on the The Executive of the local bank does Nearly all Executives see partnering decline, Executives are beginning admit that their success in this area as the way forward. In doing so, they to question the relevance of having can be attributable to the fact that their have said that the biggest challenge branches, particularly in their current main target market tends to be part so far has been to find the right form. They have gone on to give of the older generation who may not Fintech company to partner with. an example of how today’s typical be as technologically savvy, and their What is happening is that they are customers are only visiting their focus is on providing better customer noticing a significant number of branches one or two times year, as service as opposed to profitability. Fintech companies that are developing they move on to online banking to fulfil and selling applications to other When asked about the topic of their daily banking needs. With that companies, only to find out later that disruptors and how they see them in mind, Executives have recognised they do not necessarily interact well developing in New Zealand, Executives that there is a need to transform their with their in-house systems as they are in agreement in saying that branding into one that stresses the lacked the understanding of how their disruptors will likely emerge in the use of online banking, via a device systems work. While it is easy to such as a mobile phone or a tablet, payment space. This is an area where say that the banks need to establish as the focus of their new brand image. they see the greatest potential for partnerships with Fintech companies For most people, at the moment the a Fintech disruptor to enter their in order to survive impending first thing that comes to mind when industry, and to supplement it with disruption, it is also important that they they think of a bank is often a bricks tools and platforms that will enhance are partnering with Fintech companies and mortar branch, and this is what the user’s purchasing experience with that have the right skills and Executives are hoping to change. a more elegant form of interaction knowledge to develop applications/ and shorter response times, with However, one local New Zealand tools that will seamlessly blend into a reduction of the current costs. bank argues that operating a branch their core IT systems. As New Zealand has one of the more is not necessarily a disadvantage efficient and advanced economies Technology innovation will continue to and is keeping its branches open. in the world, some Executives have change how banks operate. A KPMG The local bank is using branches to questioned if there is sufficient margin report predicts that by 2030, digital its advantage, after having listened available to entice Fintech companies transformation will drive an even to its customers about the kind of to make a genuine effort in building an deeper fundamental shift in banking products/services that they value information technology (IT) application – moving it from being hidden to the most from their bank. What they that will achieve the list of things that completely invisible. However, it have heard is that their customers are we have mentioned above. While most will be more intertwined in the lives placing tremendous value in having a Executives think that New Zealand of consumers than ever before. branch in their local community, and may not be a target in the first wave, The KPMG report ‘Meet EVA, the in developing long-term and close they acknowledge they must look into future face of the Invisible Bank’ relationships with their personal and invest in similar technologies as says that ‘this Invisible Bank will be banker by getting to know the branch the impact of these technologies will buried within a broader, more digital, staff, and dealing with the same staff connected way of life. Consumers be global. on a consistent basis (as opposed to will interact with a personal digital being served by a new staff member As the world around them changes assistant’. According to this vision, every couple of months due to high due to new Fintech technologies, large parts of the traditional bank employee turnover). What it has been the Executives are not sitting idly by could disappear. Customer service call trying to achieve with the use of waiting for a disruptor to take away centres, branches and sales teams, branches is to increase the level of their margins or indeed their business. for large parts of the market, could personal contact with its customers, Many are in talks with Fintech be a thing of the past. The transition enhance the customer experience companies to find common areas will not be easy. The winners will be with a personal touch to every service where they can work together and those that are able to utilise their delivered, and ultimately create build an application/tool that will give data, drive down costs, build effective customer loyalty. them a competitive advantage against partnerships with a broad range of other banks. third parties, and of course, those with robust cyber security.4

As the banking industry begins The RBNZ’s apprehension in this area While Executives understand the to prioritise the adoption of new is understandable, given its role is to issue that the RBNZ is trying to Fintech technologies and transition ensure the continued integrity of the address with its proposal, they argue its business operations to online banking industry by keeping exposures that it will result in the duplication of platforms, Executives see privacy to internal risks to a minimum. administration services/costs that exist and security as a key consideration at the group level in the New Zealand On 19 July the RBNZ published a for them. The topic of cyber security sector, and are not convinced that consultation paper, proposing to is continually discussed throughout bringing back-offices, which represent increase LVR limits nationwide for the digital transformation process, well-staffed centres of excellence, both residential property investors even after the completion of its back onshore and that they will either and owner-occupiers. Within 48 hours implementation. The issue of cyber result in benefits or actually be able of the release of the consultation security is focused on ensuring that to be replicated. Following strong paper, all of the major banks, including all necessary and appropriate security feedback from the banking industry Kiwibank, responded by issuing policies and procedures are in place to the original proposal issued in statements announcing the immediate and are working effectively. While August 2015, the RBNZ released and voluntary adoption of the 60% safeguarding customer privacy/data a revised proposal in May 2016 to LVR restriction on all new mortgage from potential cyber criminals is a alleviate some of the concerns raised. lending deals to property investors, crucial element of cyber security, In the revised May 2016 proposal, the as proposed by the RBNZ. With equally important is ensuring that the RBNZ has since recognised the need support from the major banks, the new digital systems and channels to allow the outsourcing of certain RBNZ confirmed the implementation being added are able to interact non-essential functions, provided the of the proposed LVR restrictions, seamlessly with core IT systems. bank has backup capabilities and is with the effective date of 1 October In a fast-changing technological world, able to demonstrate direct control and cyber security risk has increased 2016. Many of the non-major banks, the ability to operate the outsourced exponentially due to the complexity especially Executives of small function (independent of related and the unpredictably of a cyber event, foreign banks, have mentioned that parties and/or its parent). and as such, it remains on the top of the new LVR restrictions have not the agenda for financial institutions. affected them operationally as they As an update to this issue, in February had only been doing loans at 60% 2017, the RBNZ released a final policy Regulation in a continually LVRs or less. For small overseas paper concerning the revision of its banks, this restriction (i.e. 60% LVRs) current outsourcing policy. Although, changing risk landscape has long been driven by directives no specific dates have been given as It has certainly been another busy from their offshore parents, as a to when this would start. The RBNZ year for regulators as the RBNZ has measure to control credit risks from plans to hold another consultation introduced several policy initiatives foreign operations. on an exposure draft for a new and pieces of legislation. These include BS11 (of The Banking Supervision The proposal for a revised outsourcing the dual registration policy for small Handbook). For a high level summary policy has become what is arguably foreign banks, the revision of LVR comparing the key features of the the most debated issue facing the rules, updates to AML/CFT guidelines revised and original outsourcing banking industry at the moment. for banks and the publication of policy, see appendix one of the This is largely due to the cost of its several consultation/discussion ‘Summary of submissions on the implementation, which the banks papers, including the stress-testing Consultation Paper’.6 methodology for New Zealand have initially estimated to be in the 5 incorporated banks, a proposal on range of $10 million to $400 million. Apart from the outsourcing review, the the dashboard approach to quarterly However, Executives have emphasised banks have expressed some interest in disclosures for banks, and the review that the full extent and scope of the the capital and liquidity review that the of the outsourcing policy for registered proposal is still not entirely clear at this RBNZ has planned for the upcoming banks. Executives perceive that point in time. year. The RBNZ has decided to the RBNZ is becoming increasingly regularly review its policy frameworks cautious about the banking system’s and make the necessary revisions to liquidity and credit quality. them, so as to remain relevant and appropriate in light of changes to the international regulatory standards and the industry environment.

The RBNZ said that it would consider The bank is first required to provide Recent regulatory developments whether there are benefits in a convincing argument as to why it are seen as efforts by the RBNZ harmonising New Zealand’s approach requires a branch license (i.e. what to fine-tune the current legislative with the liquidity standards developed activities does it plan to undertake frameworks, and many survey by the Basel Committee on Banking under a branch license that it participants are of the opinion that all Supervision. Another major change in otherwise cannot or would have key/necessary regulations have now this respect is the implementation of significant difficulty in doing so either been put into place. new Basel III requirements that are set as a subsidiary or through its parent). Key developments that the registered to phase in during a six-year phase- Additionally, it would also have to banks can look forward to in the in period, from 2013 to 2019. The demonstrate an ability to identify the upcoming year are as follows: RBNZ’s review will also touch upon risks involved in operating a branch the new requirements to determine if and construct a clear and effective plan 1. Following the International adjustments to its liquidity policy will on how it intends to either mitigate or Monetary Fund’s (IMF’s) visit be required so that the standards of address those risks. in August and November 2016, its policy frameworks are kept aligned as part of its Financial Sector The RBNZ did initially have some with international standards. Assessment Program (FSAP), reservations about the dual registration a formal report of key findings With the upcoming capital and system. The RBNZ believes that is expected to be published by liquidity review, Executives are allowing a dual registration system the IMF in the first half of 2017. hopeful that the RBNZ will review could drive increased volatility New Zealand was last reviewed the methodology by which the banks in capital inflows and outflows, under the FSAP in 2004. are required to calculate their capital compromising New Zealand’s financial ratios. The Executives explained that stability. However, the RBNZ also 2. As discussed above, the RBNZ New Zealand’s policy framework sees the benefits of the use of a will begin a review of its policy for capital requirements applies a dual registration system, with better framework in the upcoming year. more fundamentally conservative access to funding the key benefit The review will be focused on approach that those of APRA and with a branch structure is the ability capital and liquidity requirements Basel. Executives argue that if they to directly access capital markets that apply to locally incorporated had performed their capital ratio more cheaply and easily than a local banks in New Zealand. calculations based on methodologies subsidiary, given a branch shares the under APRA and Basel, then they parent’s (typically higher) credit rating. Banks continue to look at would have achieved a higher Also, it may promote further efficiency and improve their approach capital ratio due to the different and innovation, and better manage to culture and conduct risk calculation methodology. regulatory costs. Due to the lack of measurable outputs Most recently, in December 2016, Survey participants are not fond of the and its exclusion from balanced the RBNZ issued a policy paper fact that there is an increasing amount scorecards, it is easy to see why confirming its decision to allow the of regulation over the banking industry, conduct risk may sometimes fail implementation of a dual registration due to the costs of compliance and to get the right level of attention in system for small non-systemic foreign resources required, at a time when corporations. Unfortunately, more banks. Non-systemic banks are banks they are seeking to innovate and often than not, conduct risk only gets that have not been identified as being where there are multiple pressures the attention of Executives when systemically important to the overall on resources, and they see regulatory inappropriate behaviours, whether by financial stability of New Zealand. compliance consuming a lot of these employees or industry competitors, However, it is also important to point resources. The banks have accepted are brought to the public’s attention, out that any bank wanting to avail that this is part of doing business and in today’s environment, it itself of dual registration will have to in an industry that represents a key can spread very quickly via the meet certain stringent requirements supporting pillar to the financial uncontrolled forum of social media. before it can be approved for a branch stability of New Zealand’s economy, Even as conduct risk goes onto an registration license. and as such further regulation is to executive’s agenda, it is important be expected, however, they are not that the focus on conduct risk is not anticipating any major legislative quickly lost amidst the prominence works or overhauls to come through of strategic goals that relate RBNZ’s pipeline. to profitability.

Dealing with conduct risk does not The rationale for this is that in knowing Outlook of the New Zealand have to be an onerous undertaking if more about a customer, the bank economy banks are able to embed it as a key should be in a better position to spot A review of New Zealand’s economy pillar of their core business objectives. unusual transactions (i.e. money can often be a good indicator of the To translate this to business terms, laundering) and escalate them for general health of the banking industry this means having business goals further examination in a timely manner. as it remains closely intertwined with that are first and foremost driven by Managing conduct risk is a complex several key industries, particularly the the need to focus on understanding job that involves a multi-layer approach dairy and housing markets. the customer’s needs, and then developing suitable strategies and as it involves a range of stakeholders. products to meet them. It is when They include shareholders/owners, the following is done out of order (i.e. customers, suppliers, surrounding 6 SEE FIGURE 6 – PAGE 21 developing products/services before communities, and even other getting a clear grasp of the customer’s industry competitors. It also shows needs) that a banks runs the risk of that the concept of conduct risk is • encompassing a wider definition, as Executives have noted that currently either products/services that do not the New Zealand economy, while not a align with the needs of the customers. recent developments show that it is no longer just about the conduct of ‘rock star’ economy, is in good a shape Part of understanding the customer’s a firm and its employees, but also and there are no current indications to wants/needs also involves recognising if the individuals/corporations that say that a recession will come from that the average person’s notion they associate with share the same inside New Zealand. New Zealand of what customer service is today values and beliefs that the community continues to have low unemployment has changed. It has evolved to a around them deems appropriate. levels, low interest rates, steady GDP point where the ‘overall customer The challenge going forward will be for growth of 3.0% for the year ended 10 experience’ has become the product banks to actively anticipate new issues September 2016, and its exporting that banks are trying to sell to their that might arise from conduct risk and tourism industries are performing customers, and where the act of that they might not have otherwise well. The one aspect that could providing a service (i.e. customer thought of, and ensure controls are impact locally is a fall in immigration, service) is just a small component in place to mitigate the risk. Other as this is bringing people (workforce) of the overall customer experience. issues that conduct risk typically and investment into New Zealand. It is also becoming apparent that encompasses include collusion, anti- This is not something the industry banks not only have to worry about competitiveness, information privacy, will need to worry about just yet the repercussions of their activities and how effective the banks are in as New Zealand continues to see but also about with whom they are escalating and resolving conduct risk record-breaking net migration figures 11 being associated. In August, the funds issues when they do appear. for 2016, and even possibly for 2017. industry (which includes some banks) In reinforcing what we have heard was brought into the media spotlight One trend we did notice from from non-bank Executives, the banks when an investigation revealed that talking to Executives was that they also believe that should economic its default KiwiSaver schemes were were surprisingly confident that disruption impact New Zealand, it will either directly or indirectly investing in their organisation was on top of likely come from global events that will unethical companies that are involved in conduct risk and felt it unlikely they have a flow-on effect in New Zealand. weapons manufacturing, tobacco, and would suffer the same issues other However, what they cannot definitively nuclear energy.7 Shortly afterwards, all organisations, or indeed their parent anticipate is what that event might of the banks investigated announced had offshore. When one looks back at be or when it would arrive in that they would review or divest from the list of issues in the industry over New Zealand. What we have seen in all such investments.8, 9 the past year, this confidence was the interviews is a wariness and the surprising, as while New Zealand is return to a very risk-based view of the Additionally, Executives have also yet to see a serious issue come to the world and New Zealand economy by given the example of how the AML/ market, there have been a number of CFT Act has expanded upon the Executives and, if anything, together matters that would fall into the conduct concept of conduct risk by placing have a slightly cautious approach. risk category. The question that a burden of expectation upon the we would ask is: is this confidence banking industry to know who their well placed? customers are (i.e. employment, family and financial background).

In analysing some of the internal Similarly, leading economists at the When asked about the implementation matters facing New Zealand, it is big four banks have also increased of debt to income (DTI) tools, noted that the latest statistics reveal their forecast milk payout for the Executives are in unanimous unemployment rates to be at 4.9% current 2016/2017 season to the range agreement that the RBNZ’s for the September 2016 quarter,12 the of $5.80 to $6.25/kgMS.19 Economists consideration of DTI measures are lowest since 2008. At that level, those at Rabobank expect a further recovery taking place a bit late in the cycle, listed as unemployed are likely people of global milk prices in 2017 due to as current DTI ratios have already who are not equipped with the right supply constraints, as opposed to exceeded levels that would have skills that the economy requires at demand factors.20 On another note, been considered ideal. According to this time. Fonterra’s success in the international Executives, an ideal DTI level would market has led to the introduction of be in the range of 5 to 7. However, GDP growth this year was supported winter milk premiums from the winter they say that most borrowers are by a rebound in exports earnings that of 2017 onwards, so as to encourage already at levels of 9 to 12. In addition came mainly from wine, beef, lamb, additional milk production for a to this, the banks do sympathise with fisheries, forestry, stone fruits, kiwifruit market that needs to be catered for young families as the implementation and dairy. throughout the year. of DTI restrictions could effectively Moving onto the topic of dairy, despite prevent them from buying a house In the last couple of years, we having lost its spot as the largest of their own, and this could be an have seen significant changes earnings exporter to the tourism sector unintended social consequence that in the housing market with the just over a year ago,13 the dairy sector the Executives feel that the effect implementation of tighter LVRs, the continues to be a key cornerstone of might not have been adequately introduction of a capital gains tax on New Zealand’s economy, with a direct researched. The other issue raised investment properties sold within two contribution of 5-6% towards total with the enforcement of DTI years (including the requirement for an GDP.14 Since our last update in the measures is that it would require a IRD number and a local New Zealand June 2016 FIPS quarterly publication, clear, fair and explicit definition of bank account), the exclusion/restriction the global dairy milk prices continued what constitutes income and what of foreign income in calculations, to deliver strong gains in the last constitutes debt, and this is likely and the big four banks shifting their quarter of 2016, with the Global Dairy something that the banking industry strategic focus from loan growth to Trade (GDT) index recovering by and regulators could find themselves maintaining/building capital levels. 21.58%15 for the three-month period at odds over. Meanwhile, the RBNZ The most recent changes might have between October and December is still waiting on its formal request to started to have an impact, as auction 2016. The GDT index rebounded by the government to be granted, that sale rates across the country have a staggering 54.60% between June would give them statutory powers that fallen notably in the last quarter of 2016 and December 2016, compared would enable them to implement DTI the 2016. to a 4.66% contraction during the first restrictions, should they deem them half of the year.16 In its Global Dairy Despite the drop-off in sales, the to be necessary.22 Quarterly Q4 2016 report, Rabobank median sale price of houses sold With New Zealand being in a good attributes the return of milk prices in December 2016 was $516,000, position relative to the rest of the during the second half of 2016 to the up 11% from December 2015.21 world, and largely uninterrupted fall in milk supply by key European and It is anyone’s guess how long the by global events at the moment, Oceania markets.17 slowdown will last, if it was indeed Executives have indicated that this caused by the latest round of cooling might be a good opportunity for the measures put in place, or if it will government to channel more of its ‘stick’ this time round. However, we 7 SEE FIGURE 7 – PAGE 21 resources into developing its ageing will not really know the answers to infrastructure. Executives have raised these questions until New Zealand is the issue of traffic congestion in • back from holiday and the economy Auckland and Wellington as a good Fonterra has since increased its is back in full gear. forecast milk payout in November example of drag upon our economic by 75 cents, to $6.50 to $6.60/kgMS growth. Inadequate infrastructure in (including dividends of 50-60 cents).18 such cases would reduce economic productivity and could cause capacity constraints that might hinder future GDP growth.

MAJOR BANKS: YIELD VS. % 2 COST OF FUNDING 7.0

6.0 COST OF FUNDS

SPREAD 5.0 YIELD (OR RETURN ON INTEREST BEARING ASSETS) 4.0

3.0

2.0

1.0

0.0 SEP 12 MAR 13 SEP 13 MAR 14 SEP 14 MAR 15 SEP 15 MAR 16 SEP 16

SIX MONTH TERM DEPOSIT % 3 VS. FIXED AND FLOATING 7. 0 MORTGAGE RATES 6.0 EFFECTIVE FLOATING MORTGAGE RATE

EFFECTIVE FIXED MORTGAGE RATE 5.0

OCR 4.0 SIX-MONTHTERM DEPOSIT RATE 3.0

2.0

1.0

0.0 SOURCE: RESERVE BANK OF NEW ZEALAND STATISTICS (B3) NOV 14 FEB 15 MAY 15 AUG 15 NOV 15 FEB 16 MAY 16 AUG 16 NOV 16

REGISTERED BANKS: % 4 LENDING GROWTH BY 25.0 SECTOR 20.0 BUSINESS

HOUSING 15.0

CONSUMER 10.0 AGRICULTURE 5.0

0.0

-5.0

-10.0 SOURCE: RESERVE BANK OF NEW ZEALAND STATISTICS (C5) NOV 07 NOV 08 NOV 09 NOV 10 NOV 11 NOV 12 NOV 13 NOV 14 NOV 15 NOV 16

MAJOR BANKS: COST OF % 5 FUNDS VS. OCR 4.5

4.0 ANZ

BNZ 3.5 CBA +ASB

KIWIBANK 3.0 WESTPAC

AVERAGE OVERNIGHT INTERBANK 2.5 CASH RATE

2.0

1.5 SOURCE: RESERVE BANK OF NEW ZEALAND STATISTICS (B2) SEP 12 MAR 13 SEP 13 MAR 14 SEP 14 MAR 15 SEP 15 MAR 16 SEP 16

REGISTERED BANKS: 6 SECTORAL ANALYSIS OF CREDIT EXPOSURES AS AT 30 NOVEMBER 2016

AGRICULTURE, FORESTRY, FISHING AND MINING 15% (2015: 15%) MANUFACTURING 3% (2015: 3%) ULTILITIES 1% (2015: 2%)

CONSTRUCTION 1% (2015: 1%) OTHER COMMERCIAL LENDING 18% (2015: 17%) FINANCE, INVESTMENT AND INSURANCE 4% (2015: 5%) GOVERNMENT AND PUBLIC AUTHORITIES 3% (2015: 2%) MORTGAGES 53% (2015: 52%) PERSONAL LOANS 3% (2015: 3%)

SOURCE: RESERVE BANK OF NEW ZEALAND STATISTICS (S7)

REGISTERED BANKS: $MILLIONS % 7 DAIRY EXPOSURES 65,000 68 AS AT 30 JUNE 2016

DAIRY LENDING (LHS) 55,000 64

AGRICULTURAL LENDING (LHS) DAIRY LENDING AS A PERCENTAGE OF TOTAL AGRICULTURAL LENDING (RHS) 45,000 60

35,000 56

25,000 52

15,000 48 SOURCE: RESERVE BANK OF NEW ZEALAND STATISTICS (C27) 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

• 4th • 23rd • Jan. 2016 Moody’s affirms the ‘A1’ long-term The RBNZ releases a 2nd consultation • 27th rating of all three New Zealand’s paper on its outsourcing policy, with Fitch Ratings downgrades the outlook Chinese banks, but downgrades their a revision to the initial proposal made of New Zealand’s issuer default respective outlook from ‘stable’ to on August 2015. ratings from ‘positive’ to ‘stable’, but ‘negative’. This reflects the change to maintains its ‘AA’, sovereign rating. their parents’ outlook and the China’s Simultaneously, Fitch Ratings revises current sovereign rating. • Jun. 2016 New Zealand’s banking sector outlook 7th 10th • to ‘negative’. • The Co-operative Bank announces its The RBNZ cuts the OCR by 25 bps partnership with Unisys, a global IT • 28th to 2.25%. company that provides leading-edge The RBNZ leaves the OCR unchanged IT security to help modernise its core 16th at 2.50%. • IT infrastructure and capabilities. The RBNZ publishes a final report, detailing the result of the dairy stress • 9th • Feb. 2016 test that began in late 2015. Westpac and ANZ stops lending • 11th to foreign property buyers with BNZ acquires a 17% stake in Figured • Apr. 2016 overseas income. Overseas income Limited, a cloud-based accounting by New Zealand citizens and residents software provider that caters primarily • 27th will still be considered, but with a tighter lending criteria. to agri-businesses. The RBNZ announces that a visit by the IMF in August and November The RBNZ leaves the OCR unchanged • 16th this year can be expected, as part at 2.25%. Westpac reaches an agreement of the ‘Financial Sector Assessment with the Commerce Commission to Programme’. The results of this • 10th refund over $4 million for overcharged assessment is expected to be BNZ is the third major bank in overseas ATM card fees. published in a formal report by the New Zealand to halt lending to IMF in early 2017. foreign borrowers. • Mar. 2016 • 28th • 13th The RBNZ leaves the OCR unchanged ASB will no longer lend to borrowers • 1st at 2.25%. with foreign income, unless the The Commerce Commission individual is a New Zealand citizen completes its review on the level of or resident. competition within the dairy industry, • May 2016 The banking sector in New Zealand and concludes that any deregulation 5th is recognised as being one of the of the Dairy Industry Restructuring • most digitally innovative in the world, Former BNZ employees, Ryan Act 2001 (DIRA) would give Fonterra according to Forrester, a top global William Writ and Scott Alan McRobie too much power in setting domestic market research company. agrees to a settlement of $250k farmgate milk prices. with law enforcement, after having been uncovered for approving a loan for a personal investment property development. No criminal charges were filed.

• 27th • 29th • Jul. 2016 Westpac’s Australian parent, Deutsche Bank AG relinquishes its • 19th Westpac Banking Corporation, New Zealand banking licence with The RBNZ releases a consultation express its offer to borrow at least the RBNZ, completing the wind- paper, proposing to increase NZ$250 million from retail investors up of its New Zealand operations LVR limits nationwide on all new in New Zealand in exchange for (which Deutsche Bank AG announced mortgage lending. unsecured subordinated fixed last year). rate notes, subjected to unlimited • 20th oversubscriptions. The funds raised ANZ, ASB and Westpac publicly will be used to meet its APRA • Sep. 2016 announce that they will voluntarily not capital requirements. accept new loan applications from • 1st property investors that do not meet Westpac launches CashNav app, the 60% LVR restriction. However, • Aug. 2016 the product of a collaboration all pre-approvals will still be honoured, • 2nd with a New York Fintech company unless expired. Heartland Bank establishes a Share called ‘Moven’. Sale Plan for shareholders with 21st 5th • holdings of less than 10,000 shares. • BNZ and Kiwibank are the last of The Co-operative Bank sees their the major banks to voluntarily adopt • 11th long-term issuer default rating by Fitch stiffer restrictions for new lending to The RBNZ cuts the OCR by 25 bps Ratings, upgraded by a notch to ‘BBB’. property investors, requiring at least to 2.00%. a 40% deposit. • 11th • 19th Kiwibank increases its phone banking • 22nd Moody’s changes the long-term fees in a bid to encourage customers China Construction Bank receives credit rating outlook of the big 4 to use its online banking services for an additional $140 million in funding New Zealand banks from ‘stable’ to minor inquiries/matters. from its Chinese parent in exchange ‘negative’, bringing it in-line to that of for 100 million capital shares, their Australian parents. • 22nd raising its capital balance to roughly The RBNZ leaves the OCR unchanged $200 million. • 23rd at 2.00%. ANZ intends to offer 5 and 7 year 26th The RBNZ publishes a policy • unsubordinated unsecured bonds, In relation to an announcement paper, summarising the feedback with unlimited subscription, in a made on June 3, The Co-operative received from its consultation on the bid to raise at least $100 million for Bank raised $15 million through the ‘Publication of Submissions’. each term. offer of unsecured debt securities. The amount is half of what it initially 25th • 23rd • The RBNZ releases its sought to raised (i.e. $30 million). The S&P’s expresses concern over subordinated notes will be issued on consultation paper on its proposed the growing use of interest-only 28th July 2016. dashboard approach to quarterly mortgage loans in New Zealand, citing financial disclosures by locally that a fall in house prices could be incorporated banks. ‘particularly problematic’.

• 12th • Oct. 2016 BNZ confirms that it is currently • Nov. 2016 • 1st considering plans to restructure parts • 2nd New LVR rules comes into effect, of its business. New Zealand’s unemployment rate restricting mortgage lending to falls to 4.9% for the three months 13th residential property investors across • ended 30 September 2016, a first ANZ becomes the first bank in New Zealand with LVR’s greater than since 2008. 60% to no more than 5%, and no New Zealand to offer Apple Pay more than 10% to owner-occupiers for customers with a Visa Debit or • 3rd with LVR’s greater than 80%. personal ANZ Visa credit card. Following its expression of intent 17th on 18 October 2016, ASB confirms 5th • the offering size of ‘ASB Notes 2’ • Kiwibank partners with ‘i2c’, a The class action lawsuit brought to be $375 million. ASB has issued global provider of personalised against ANZ New Zealand by ‘Fair Play a warning that ‘ASB Notes 2’ payment and integrated commerce on Fees’, citing unreasonable late credit is a relatively complex financial solutions, to develop prepaid gift card payment fees and unarranged product that is not suited for the and travel card programmes that overdraft fees, has been settled out-of- average investor. court settlement, with ANZ not having provide features that enhances the to admit to any fault. payment experience. • 7th 25th The Co-operative Bank launches its 7th • new ‘fair rate’ credit card, charging • The RBNZ announces the release In a partnership with Xero, Callaghan an interest rate of 12.95% for both of formal OCR projections from Innocation and Creative HQ, Kiwibank purchases and cash advances, all for November onwards. These projections launches New Zealand’s first Fintech an annual fee of $20. The Co-operative will be incorporated as part of its Accelerator, called the ‘Kiwibank Bank claims it to be the lowest Monetary Policy Statement releases. Fintech Accelerator’. It is a programme interest rate of any other credit cards that aims to fund and support the • 28th offered by New Zealand banks. growth of Kiwi Fintech start-ups. ANZ announces a reduction in several 10th 9th of its fees, but claims that it is not • • related to the class action lawsuit by ASB partners with Paymark to launch ANZ announces that from November ‘Fair Play on Fees’ that was settled online EFTPOS. onwards, customers will be given out-of-court earlier this month. the option to ‘opt-out’ of unarranged The RBNZ cuts the OCR by 25 bps overdrafts. ASB and BNZ are the only 31st to 1.75%. two other major banks in New Zealand • NZ Post announces the completion of 15th that offers its customers such the partial sale of Kiwi Group Holdings • BNZ changes the manner in which it an option. Limited (Kiwibank’s holding company) calculates interest on late credit card to NZ Super Fund and Accident • 11th Compensation Corporation (ACC). payments. The changes brings them Heartland Bank’s ‘BBB’ long-term The sale was initially proposed on in-line with how interest is calculated issuer credit rating, with a stable 6 April 2016. at ANZ and Westpac. outlook, is affirmed by Fitch Ratings.

• 18th • 12th ASB increases its ‘ASB Notes 2’ Heartland Bank announces its • Jan. 2017 offering size to $400 million, the intention to raise up to $30 million in • 11th maximum amount as stipulated by new capital to support growth and Industrial Commercial Bank of China its disclosure statement. The ‘ASB digital strategy. $20 million will be joins the New Zealand Bankers’ Notes 2’ will be issued as scheduled raised through a placement, while the Association as its 16th member. on 30 November 2016. remaining $10 million will be raised through its Share Purchase Plan. • 20th • 28th S&P’s affirms New Zealand’s RBNZ formally warns TSB Bank for • 13th ‘AA’ sovereign foreign currency failing to review and to keep its anti- Heartland Bank completes its long‑term rating. money laundering risk assessment $20 million equity placement, for up to date, between the period $1.46 per share. • 31st of 30 June 2013 and 9 June 2016. Heartland Bank partners with 15th TSB agrees to take immediate steps • Spotcap, an online lender for SMEs, Fonterra establishes a 1.5 billion Yuan to remedy the issue. providing it with a funding facility (approx. NZD$216 million) facility (undisclosed) to support its growth agreement with Bank of China, strategy in Australia. • Dec. 2016 diversifying the funding sources • 1st of its Chinese operations. • Feb. 2017 BNZ is the first bank in New Zealand Statistics New Zealand reports annual to offer Google’s Android Pay service. GDP growth of 3.0% for the year • 1st ended 30 June 2016. Westpac announces a reduction • 8th in fees for several of its products The Co-operative Bank issues an • 21st and services. additional $30 million in subordinated Following a consultation held in June, notes to retail investors, in a bid to the RBNZ has published a policy • 2nd shore-up its capital position. paper confirming its stance to allow RBNZ publishes the finalised dual registration for small foreign policy paper concerning its review 9th • banks that are not systemically of the outsourcing policy for RBNZ orders an independent review important to New Zealand’s registered banks. of Westpac’s capital model, after financial stability. the release of its latest quarterly disclosure revealed that it had • 23rd breached its conditions of registration. Fonterra introduces a new price premium for winter milk contracts beginning for the winter of 2017.

Profits down driven by challenging market 8 MOVEMENT IN NET PROFIT AFTER TAX conditions $MILLION This past year has proven to be a 6,000 challenging one for the banking sector as net profit after tax (NPAT) 5,000 for the year was down on last year, decreasing by $334.38 million (6.46%) to $4.84 billion (see Figure 8). 4,000 The current year’s result highlights that record profits seen in previous 3,000 years have come under pressure due to competitive pressures, resulting in 2,000 margins being squeezed, and volatility in global markets making funding both 1,000 more difficult and more expensive to raise, all at a time when both loan 0 impairments and operating expenses 2015 NET NET NON- OPERATING IMPAIRED TAX 2016 NET PROFIT INTEREST INTEREST EXPENSES ASSET EXPENSE PROFIT are rising. AFTERTAX INCOME INCOME EXPENSES AFTERTAX The decrease in profitability is largely attributable to a $350.20 million focus on providing exceptional amortisation), offset by a $22 million reduction in non-interest income customer experience, citing an increase in net interest income and a and an increase of $223.42 million increase in sales made through digital reduction of impaired asset expense in operating expenses (including channels as an example of this. These and tax expense of $8 million and amortisation), which was offset by sales have more than doubled over the $54 million, respectively. Although modest growth in net interest income past two years as a result of improving Westpac did see a decrease of of $127.41 million. mobile and digital experiences. $43 million in NPAT, this was mainly The 11.19% reduction in non-interest due to a $26 million increase in Operating expenses increased by income, as a result of a decline in impairment charges and an increase $223.42 which also had a noticeable trading income and unfavourable in operating expenses (including impact on profitably. An increase fair value/hedging movements over amortisation) of $10 million. in amortisation of goodwill and financial instruments, had the largest other intangibles accounted for Of the non-major banks, TSB Bank impact on profitability. This income $60.81 million of the growth in had the largest NPAT increase statement line is volatile, and with operating expenses. of $36.05 million (141.26%). TSB the exception of CBA, the other four attributed its strong financial major banks (ANZ, BNZ, Kiwibank and Between the major banks, ANZ and performance this year to the growth Westpac) saw a $520 million decrease BNZ stood out with decreases in strategy of the bank supporting the in non-interest income. NPAT of $229 million (12.93%) and launch of a new suite of transactional, $125 million (12.04%), respectively. On a more positive note, 10 out savings and investment products ANZ’s reduction of NPAT can be of 21 survey participants reported to align their product offerings attributed to a $325 million decline improved profitability for the year, with perceived customer needs.25 in non-interest income coupled with which contributed an additional A reduction of impairment expenses a $71 million increase in impaired $134.03 million to this year’s NPAT. also had an impact on the positive asset expense, against net interest Among these 10 survey participants, results, which saw TSB reporting a income growth of $149 million and CBA was the only major bank that saw credit impairment gain of $8.72 million a $105 million reduction in taxes. higher NPAT levels for this year with in the current year, including a Similarly, BNZ’s $125 million decrease 4.25% ($37 million) NPAT growth to $13.71 million write-back of a Solid in NPAT is mainly the result of a $908 million. CBA noted in its press Energy provision as the result of a $185 million decrease in non-interest release,24 that the positive results revaluation of this debt. income and a $26 million growth were a product of sustained growth in in operating expenses (excluding key market segments and a continued

TABLE 4: MOVEMENT IN INTEREST MARGINS 2016 2015 Movement Entity % % (bps)

Australia and New Zealand Banking Group Limited – New Zealand Banking Group 2.22% 2.26% -4

Bank of Baroda (New Zealand) Limited 3.48% 3.73% -25 Bank of China (New Zealand) Limited 2.21% n/a n/a Bank of India (New Zealand) Limited 3.67% 4.21% -54 Bank of New Zealand 2.19% 2.30% -11 China Construction Bank (New Zealand) Limited 1.48% n/a n/a Citibank, N.A. New Zealand Branch 1.69% 1.93% -24 Commonwealth Bank of Australia New Zealand Banking Group 2.14% 2.30% -16

Deutsche Bank AG, New Zealand Group -3.03% 1.66% -469 Heartland Bank Limited 4.79% 4.89% -10 Industrial and Commercial Bank of China (New Zealand) Limited 0.89% 0.82% 7

JPMorgan Chase Bank, N.A. New Zealand Branch 0.85% 0.77% 8 Kiwibank Limited 2.07% 2.12% -5 Kookmin Bank Auckland Branch 1.24% 1.66% -42 Rabobank Nederland New Zealand Banking Group 2.30% 2.62% -32 Southland Building Society 2.72% 2.91% -19 The Bank of Tokyo-Mitsubishi UFJ Limited, Auckland Branch 0.37% 0.47% -10

The Co-operative Bank Limited 2.71% 2.88% -17 The Hongkong and Shanghai Banking Corporation Limited, New Zealand Branch 1.85% 1.82% 3

TSB Bank Limited 2.09% 2.19% -10 Westpac Banking Corporation – New Zealand Division 2.12% 2.29% -17 Sector Average 2.15% 2.28% -13

n/a = not available

A summary of the financial —— impaired asset expense and calculation of ratios correspond performance of the survey participants deteriorated by $21.59 million to the original prior year balances was as follows: (or 4.93%); and reported in the prior year financial statements of the survey participants —— net interest income grew by a —— tax expense was down by affected. Had the restated prior year further $127.41 million (or 1.36%), $133.42 million (6.75%), balances reported in the current year’s to reach $9.49 billion; to $1.84 billion. financial statements been utilised in —— non-interest income saw a It is noted that certain prior year this survey, some of the calculations reduction of $350.20 million or figures reported by some survey of ratios and movements would have 11.19%, declining to $2.78 billion; participants have been restated in the differed from the ones reported in —— operating expenses (including current year’s financial statements. this analysis. See endnotes 37 to amortisation) were up Unless otherwise stated within the 42 for more information about the $223.42 million (4.56%), commentary, all prior year figures entities affected. to $5.12 billion; utilised for the purpose of our analysis

TABLE 5: REGISTERED BANKS – DERIVATIVE CONTRACTS Interest rate contracts Exchange rate contracts Entity Year Forwards Swaps Futures Options Total Forwards Swaps Options Total

2016 41,507 1,170,478 78,988 3,969 1,294,942 63,473 144,501 4,627 212,601 ANZ 2015 24,633 1,130,414 45,407 2,045 1,202,499 75,930 130,093 3,690 209,713 2016 14,351 395,083 224,541 322 634,297 64,487 49,047 6,004 119,538 BNZ 2015 3,560 442,045 242,715 183 688,503 81,395 47,818 6,456 135,669 2016 4,850 46,388 2,828 499 54,565 6,797 0 243 7,040 CBA + ASB 2015 14,477 33,574 1,250 82 49,383 7,365 2,713 315 10,393 2016 1,400 35,281 325 0 37,006 945 41 34 1,020 Kiwibank 2015 1,800 37,506 1,075 0 40,381 978 36 37 1,051 2016 1,225 257,354 15,273 1,181 275,033 17,295 51,204 0 68,499 Westpac 2015 112 350,798 8,821 215 359,946 27,540 46,538 0 74,078 2016 61,933 1,869,303 321,630 5,971 2,295,843 152,052 244,752 10,874 408,698 Total 2015 44,582 1,994,337 299,268 2,525 2,340,712 193,208 227,198 10,498 430,904

Margins continue to contract All of the five major banks also saw However, it is important to point out The banking sector saw net interest reductions to their NIMs for the year, that the NIM of 4.79% includes a 2015 margins (NIM) fall by 13 bps, from with Westpac seeing the largest pre-amalgamated interest earning 2.28% to 2.15% in 2016, despite decrease of 17 bps, followed by assets figures within the calculation. an increase in net interest income CBA, BNZ, ANZ and Kiwibank, with Using 2015 restated amalgamated of 1.36% ($127.41 million) for the decreases in the range of 16 bps figures, Heartland Bank would have year (see Table 4). The decline in to 4 bps. This range, however, is achieved normalised NIM of 4.41%, NIM for the banking sector was the reduced to 12 bps to 4 bps if restated which is still the strongest in the result of a prevailing low interest prior year figures were used for banking sector. BNZ and CBA. Using restated 2015 rate environment and strong levels The yield on lending continued to comparatives, CBA’s NIM had only of competition, which continue to tighten due to the intense competition contracted by 12 bps, decreasing put downward pressure on lending in lending assets, particularly in the from 2.26% (prior year restated NIM) margins. Out of the 19 survey area of residential mortgages, in to 2.14% in the current year. Despite participants, 16 reported a decline addition to customers’ preferences declining NIMs, four major banks had in NIMs for the year, and a further for lower margin fixed rate loans at a a combined increase of $210 million two entities – Bank of China and time when it is perceived that interest in net interest income, with Westpac China Construction Bank – did not rates are at a low point in the cycle. being the exception with a decrease have comparatives. The proportion of floating to fixed rate of $7 million. The largest increase in loans has continued to decrease in This year, Deutsche Bank had the net interest income came from ANZ, the past year by an additional 167 bps, largest NIM drop of 468 bps to which was the result of a $796 million to 22.76% as at November 2016.26 -3.03%, followed by Bank of India (17.54%) reduction in interest expense and Kookmin Bank with reductions offset against a $647 million (8.72%) of 54 bps and 42 bps, respectively. decrease in interest income. NIMs for The decrease in NIM for Deutsche the major banks remain clustered in 9 SEE FIGURE 9 – PAGE 32 Bank can be associated with the the range of 2.07% to 2.22%. winding up of its operations in New Zealand which led to a $96 million Heartland Bank continues to have the • strongest NIM at 4.79% due to the There is a clear preference for one decrease in net interest income, and two-year fixed rate loans, as they resulting in a total net interest income niche market in which they operate, particularly in the areas of reverse comprise almost two-thirds of total loss of $63 million. 27 mortgages, asset financing and mortgage lending (66.79%). working capital markets.

As a result, the increase in interest- Of the 21 survey participants, nine In relation to the other banks, earning assets of 6.85% did not reported lower non-interest income Rabobank had the largest reduction translate into higher interest income for this year when compared to in non-interest income of 45.84% as interest income decreased by our previous survey, with three ($16.56 million) when compared to 5.79% to a total of $22.07 billion. participants reporting a net loss from the rest of the survey participants, non-interest income activities. The derived from higher hedge accounting The five major banks saw a decrease decrease in non-interest income was losses which were $29.5 million more in interest income that amounted primarily driven by the major banks, than last year, resulting in a net loss to $1.46 billion. The most significant with four of them contributing a of $52.69 million for non-interest decreases came from ANZ and BNZ, decrease in non-interest income of income. This was due to a change in with a decline of $647 million and $520 million. CBA was the exception, the measurement of hedging items $393 million, respectively. Surprisingly, delivering an additional $76 million for Rabobank for the financial year for 12 of the 21 banks surveyed reported (this reduces to $47 million if restated 2016. Using restated the financial year positive growth in interest income of 2015 comparatives are used). CBA’s comparatives for 2015 would have $146.68 million collectively. This was, growth in non-interest income is meant that Rabobank had a larger however, undone by the significant largely attributed to a $15 million decrease in non-interest income of reductions from the major banks. reduction in losses from hedging $18.54 million (54.30%). TSB Bank’s Despite lower interest income, the instruments, a $11 million increase in reduction in non-interest income of reduction in interest expense of funds management income, and an 24.14% ($5.09 million) was due to 10.55% has positively impacted net additional $16 million increase in other income from ’investment in associate interest income levels, which have operating income. – held for sale‘ being no longer increased by 1.36% to $9.49 billion. included in TSB Bank’s financials, Volatility in global markets, together as it has since been transferred to Margins will continue to be under with changes to a valuation a new group structure under the pressure in this low-interest rate methodology of financial instruments, TSB Community Trust. Excluding the environment as lending continues had a significant impact on the non- income effect from ’investment in to grow. Additional downward interest income for ANZ as it reported associate’, non-interest income for margin pressures will be felt from a decrease of $325 million (28.09%). TSB increased from $15.45 million increases in wholesale funding The reduction in non-interest income to $16.01 million. costs and competition for deposits by ANZ was primarily resulting (see the Funding mix section for from a $250 million decrease in further analysis). Banks, borrowers net trading gains and a $102 million Funding mix and depositors alike will face some decrease in income from hedging Funding costs (interest expense/ interesting times as we move into instruments. ANZ noted in its average interest bearing liabilities) 2017, with there being little likelihood press release that changes to the for the banking sector faced a of any OCR cuts being passed on, and methodology for credit valuation contraction of 62 bps, decreasing from further pressure on funding availability adjustments (CVA) in determining 3.87% to 3.25%. Of the 21 banks, and rates. Banks are already warning the fair value of derivatives, in order 12 reported a decrease in funding of increasing interest rates for 2017. to align itself with evolving market costs. The decrease in funding practice, has negatively impacted its costs for the banking sector is the Decrease in non-interest results this year.28 BNZ’s financials result of a 10.55% ($1.48 billion) income impacted by told a similar story, reporting a reduction in interest expense, despite market volatility weaker market performance which an increase in interest-bearing resulted in a reduction of $185 million liabilities of $24.27 billion (6.46%) to Unfavourable valuation adjustments (26.54%) in its non-interest income, $399.82 billion. and lower treasury earnings have driven by a $90 million decrease negatively impacted profitability for in trading income from interest the banking sector, contributing to a rate derivatives, additional losses 5 SEE FIGURE 5 – PAGE 21 $350.20 million (11.19%) reduction from hedge accounting and trading in non-interest income. derivatives that were $47 million higher, and a $92 million loss from fair • value movements.

While the results of these figures Lending asset continues to may initially seem to contradict recent SEE FIGURE 10 – PAGE 32 gain momentum remarks made by the Executives about 10 Over the past year, total assets for rising funding costs, it is important the banking sector have increased by to point out that these figures do • $32.85 billion (or 7.03%), reaching a not necessarily reflect the current The report also notes that the increase total of $500.32 billion for the sector. situation within the funding market in funding costs, which has been With lending growth for the year at due to the disparity of the survey passed on to borrowers through $29.66 billion (or 8.10%), this was participants’ year-end balance dates. higher lending rates, may dampen observed to be the fastest pace in This is particularly true for disclosure credit growth and, therefore, narrow growth during the last eight years and statements of non-major banks that the gap between deposit and credit it took total loans to $395.71 billion. have a year-end date that falls between growth. However, if the gap between 31 December 2015 and 30 June 2016, credit and household deposit growth when funding costs were lower than continues to persist, banks will be they are now. Comments made by required to increase market funding, 11 SEE FIGURE 11 – PAGE 32 Executives in relation to rising interest adding to the estimated $40 billion costs relate more to the second half of market funding to be rolled over in the medium term (according the • of 2016, and into 2017. Strong lending growth was made November 2016 RBNZ Financial possible by a rising housing market It is noted that the decrease in funding Stability Report).29 costs was primarily driven by the major as the total value of New Zealand’s banks that saw decreases in the range Competition within the local deposit housing stocks climbed to a value of of 50 bps to 90 bps. Citibank and The market will continue to intensify just over $1 trillion for the year ended Bank of Tokyo-Mitsubishi were the as banks look to strengthen their 30 September 2016, an increase of 30 only other participants that disclosed funding mix and source their funding 16.17% during the year. lower interest expense levels, with from more stable sources, such as All five major banks reported increases decreases of $3.44 million and household deposits and long-term to their loan books in the range of $18.38 million, respectively. market funding. However, given the 5.46% and 9.33%. In total, the major small size of the domestic funding The decrease in funding (as a banks account for over 88.01% of market, it is expected that a large the $29.66 billion in new lending percentage) for the major banks was proportion of the funds required will the result of the combined effect of for the year. With $6.47 billion in be raised from offshore markets. additional lending, CBA had the largest lower interest expense levels and With increased volatility in the global larger interest-bearing liabilities. It is dollar increase in gross loans and financial market for the foreseeable advances, which were attributable noted that the increase in interest future, further increases in funding bearing liabilities among four of the to strong lending growth across all costs can also be expected. One of key portfolios, including business, major banks was substantially driven the questions raised with Executives by higher levels of customer deposits commercial, rural, personal and was whether the decrease in deposits home lending. and other borrowings. experienced by some banks was The November 2016 RBNZ Financial the beginning of a structural change Loan growth between the big four Stability Report highlighted that since or more of a blip. Some Executives banks appears to be equitably 2015, credit growth has increased, but speculated that it was the beginning distributed, as ANZ, BNZ and household deposit growth has slowed, of a move away from deposits, Westpac achieved lending growth which has caused the gap between caused in part by a greater flow of of $6.28 billion, $6.24 billion and credit and household deposit growth money into KiwiSaver and other $6.03 billion, respectively. BNZ’s levels to widen. In an attempt to close investments, which was caused re‑entry to the broker market meant the gap between credit and household partly by the low deposit rates and that they had an additional $1.8 billion deposit growth, banks have begun to partly by consumer preference in the in home loans written through brokers 31 increase lending and deposit rates, younger demographic. this year. which have resulted in higher deposit rates towards the end of 2016.

With the exception of Bank of Despite the dairy downturn earlier China (due to an absence of prior in the year, growth in dairy lending SEE FIGURE 12 – PAGE 33 year comparatives), the Chinese remains largely in-line with total 12 banks had the largest percentage lending growth in the agricultural increases in loan growth as they sector as the proportion of dairy • continued to establish their foothold lending to total agricultural lending The overall improvement in asset in the New Zealand market. China remains consistent at 66.77% quality for the banking sector is Construction Bank and ICBC saw (66.69% in 2015). attributable to specific provisioning loan book growth of 7,919.15% levels decreasing by 36.11% to ($303.15 million) and 342.27% $441.55 million, partially offset by ($294.96 million), respectively. increases to collective provisioning SEE FIGURE 7 – PAGE 21 7 that have only marginally increased Of the 21 survey participants, only by 13.84% or $199.01 million. The three banks reported decreases in • Bank of Tokyo-Mitsubishi recorded the gross loans and advances this year, Across the board, the majority of the largest decline in specific provisions as including Deutsche Bank, Kookmin banks have enjoyed strong lending a direct result of the disposal of all its Bank and HSBC. growth this past year despite the impaired loans, with specific provisions In terms of gross loans and advances, threat of increasing competition from declining from $63.70 million to nil. ANZ continues to dominate the new market entrants and non-bank Rabobank and HSBC had the next lending space with a market share of lenders. Going into 2017, lending largest improvement towards specific 30.65%, down by 77 bps from 31.42% growth will be challenged due to provisioning levels, with decreases last year. Westpac’s market share pressures on the funding side of the of $49.28 million and $19.86 million, remained fairly stable with an increase balance sheet. This means that the respectively. Despite the dairy sector of 9 bps to 19.21%, while BNZ and funding gap between local deposits downturn, Rabobank achieved strong CBA saw the largest increases of the raised and loans lent will have to loan provision recoveries which major banks of 17 bps and 22 bps, be filled by funding from overseas outweighed new provisions taken to 18.93% and 19.16%, respectively. sources, which is typically more during the year, resulting in a decrease expensive. The focus for lending in provisioning for the current year. The composition of lending exposures growth will be on deals that provide The big four banks had a combined remains largely unchanged from an appropriate return. In addition, lower increase of $179 million (representing last year, with mortgage exposures lending growth is to be expected in 89.94% of the banking sector’s total being the single most dominant the near future, due to increased LVR increase) in collective provisioning to component of the banking sector’s restrictions by the RBNZ, restrictions allow for additional risk in a growing loan book. According to RBNZ data, of lending activities involving foreign lending book and the dairy downturn mortgage lending represents 53.05% borrowers and the voluntary exclusion in the first half of the year. or $227.74 billion of total lending in of overseas income when performing the sector. debt servicing calculations by the In spite of a growing loan book, major banks and some others. There gross impaired assets and past due will also be an increased emphasis on assets have fallen significantly by 16.73% ($294.10 million) and 23.38% 6 SEE FIGURE 6 – PAGE 21 deals that provide good margins at risk levels that are appropriate, particularly ($159.73 million), to $1.46 billion and as the banks’ funding tightens. $523.37 million, respectively. With this, • the ratio of past due assets to gross Based on the most recent RBNZ data, Asset quality remains strong loans and advances have dropped from dairy lending by the banking sector 0.19% to 0.14%. Similarly, the ratio of continues to grow, but at a slower Asset quality indicators show that total gross impaired assets to average gross pace of 6.18% ($2.33 billion) for the provision (i.e. collective and specific loans and advances has improved by year ended 30 June 2016, compared provision), as a percentage of average 12 bps to 0.38%. to last year’s growth of 9.25% gross loans and advances, is currently ($3.20 billion). sitting at 0.55%, a 3 bps improvement from the previous year. •13 SEE FIGURE 13 – PAGE 33

RESIDENTIAL MORTGAGE $MILLION 9 LOANS MATURITY PROFILE 250,000

FLOATING 200,000

< 1YEAR

1>2YEARS 150,000

2>3YEARS

3>4YEARS 100,000

4>5YEARS

5YEARS + 50,000

0 SOURCE: RESERVE BANK OF NEW ZEALAND STATISTICS (S8) NOV 12 MAY 13 NOV 13 MAY 14 NOV 14 MAY 15 NOV 15 MAY 16 NOV 16

BASIS POINTS BANK FUNDING COSTS 10 (SPREAD TO SWAP RATES) 350

300 OFFSHORE WHOLESALE

DOMESTIC WHOLESALE 250

RETAIL 200

150

100

SOURCE: RESERVE BANK OF NEW ZEALAND STATISTICS 0 (NOVEMBER 2016 FINANCIAL STABILITY REPORT) SEP 11 SEP 12 SEP 13 SEP 14 SEP 15 SEP 16

REGISTERED BANKS: $MILLIONS % 11 TOTAL ASSETS VS. 600,000 2.40 INTEREST MARGIN

500,000 2.30 TOTAL ASSETS (LHS)

INTEREST MARGIN (RHS) 400,000 2.20

300,000 2.10

200,000 2.00

100,000 1.90

0 1.80 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

REGISTERED BANKS: % 12 IMPAIRED ASSET EXPENSE TO 1.2 GROSS LOANS AND ADVANCES

1.0 NET LOAN WRITE OFFS/AVERAGE GROSS LOANS AND ADVANCES IMPAIRED ASSET EXPENSE/ 0.8 AVERAGE GROSS LOANS AND ADVANCES TOTAL PROVISIONS FOR DOUBTFUL DEBT/ GROSS LOANS AND ADVANCES 0.6

0.4

0.2

0.0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

MAJOR BANKS: PAST DUE AND % % 13 GROSS IMPAIRED ASSETS VS. 1.0 250 GROSS LOANS AND ADVANCES

GROSS IMPAIRED/GROSS LOANS AND 0.8 200 ADVANCES (LHS) PAST DUE/GROSS LOANS AND ADVANCES (LHS) 0.6 150 TOTAL PROVISIONS/PAST DUE AND GROSS IMPAIRED ASSETS (RHS) 0.4 100

0.2 50

0.0 0

30 SEP 14

30 SEP 16

30 SEP 15

31 MAR 16

31 MAR 15

31 MAR 15 ANZ BNZ CBA +ASB KIWIBANK WESTPAC

REGISTERED BANKS: $MILLIONS % 14 GROSS IMPAIRED AND PAST 7, 000 280 DUE ASSETS 6,000 240 PAST DUE ASSETS (LHS)

GROSS IMPAIRED ASSETS (LHS) 5,000 200 SPECIFIC PROVISION/GROSS IMPAIRED AND PAST DUE ASSETS (RHS) 4,000 160 TOTAL PROVISION/GROSS IMPAIRED AND PAST DUE ASSETS (RHS) 3,000 120

2,000 80

1,000 40

0 0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

TABLE 6: MAJOR BANKS – PERSONNEL COST Entity 2016 2015 Cost/ Cost/ Personnel Personnel Employee average Employee average cost cost numbers employees numbers employees $Million $Million $000's $000's ANZ 7,655 894 116 8,104 874 108 BNZ 5,019 476 97 4,841 449 93 CBA + ASB 4,770 502 107 4,469 487 109 Kiwibank 1,410 122 94 1,188 123 104 Westpac 4,267 465 106 4,497 468 104

However, the impaired asset TSB saw their impaired asset expense The increase was caused by the expense for the year rose by 4.93% levels change from a $56.05 million combined effect of lower operating ($21.59 million) to $459.60 million. charge in the previous year to an income levels and higher operating The increase in impairment expense $8.72 million recovery in the current expenses (excluding amortisation). is in line with an 8.10% growth in year; however, this movement was not Operating income for the banking total gross loans. The impaired asset reflected within its specific/collective sector fell by 1.78% ($222.16 million) expense over the average gross provisioning balance as it was directly to $12.26 billion, and this could be loans ratio for the banking sector netted against its ’Investment attributed to a $350.20 million decline has remained unchanged from the securities‘ balance. The impaired asset in non-interest income for the year. previous year at 0.12%. recovery includes a $13.71 million On the other hand, operating expenses write back of a Solid Energy provision. (excluding amortisation) grew by 3.66% ($170.61 million), to reach total There is a general consensus that operating expenditures (excluding 14 SEE FIGURE 14 – PAGE 33 while asset quality remains strong, amortisation) of $4.83 billion. An caution will need to be taken due to additional $87.32 million in personnel key areas of risk, stemming from dairy, • costs recognised this year would property and global uncertainties, all of ANZ saw the greatest individual account for nearly half of the increase which will have a significant impact on increase in impaired asset expense in operating costs (see Table 6). of 93.42% to $147 million, through the local economy. new and increased provisions and a Of the 21 survey participants, 13 saw reduction in write backs. The result Deterioration of the higher operating expense/operating for ANZ is attributable to the ongoing operating expense ratio due income ratios. Among the major normalisation of provision levels in to lower operating income banks, BNZ registered the largest their portfolios, combined with lower and higher costs increase in its operating expense levels of write-backs and recoveries ratio, with an increase of 357 bps. The focus on innovation initiatives than have been experienced in Higher operating costs for BNZ were and investment in new technologies, previous years. CBA and Westpac due to the continued investment in increased costs from regulatory were similar, with an increase of their key segments such as digital, compliance programmes, and $28 million to $129 million, and small medium enterprises (SMEs), personnel costs continue to be $26 million to $73 million, respectively. brokers and the Auckland housing significant factors driving the higher The increase in impaired asset market. On the other hand, CBA operating expense to income ratios. expense for CBA and Westpac was reported an 88 bps improvement to Operating expenses (excluding due to movements in collective its operating expense ratio, decreasing amortisation) relative to operating provisioning. On the other hand, from 36.56% to 35.68%, as a result income (i.e. operating expense ratio) BNZ and Kiwibank managed to reduce of disciplined cost management and increased from 37.32% to 39.39%, their impaired asset expense by efficiency improvements despite the an increase of 207 bps in the last year. 6.25% to $120 million and 15.38% continued investments in technology to $11 million, respectively. and specialist frontline capabilities.

(excluding amortisation), while The CBA’s 100 bps increase in ROE is Bank of Tokyo-Mitsubishi’s decrease attributable to a 4.25% ($37 million) SEE FIGURE 15 – PAGE 37 15 was achieved through a decrease increase in NPAT, despite its in general administration costs and total equity growing by 3.33% • other expenses. ($177 million). ANZ, BNZ, Kiwibank It is worth noting that the big four and Westpac all saw reductions to Investment in technology and banks continued to have one of the their ROE in the range of 100 bps digital capabilities in a fast-changing lowest operating ratios in the industry, to 324 bps. ranging from 35.68% to 38.44%. The technological environment will remain Bank of Tokyo-Mitsubishi is the only a critical area of investment for survey When looking at the ROA performance other bank that had a better operating participants in order to improve for the banking sector, we noted ratio of 12.59%. As The Bank of customers experience and counteract a similar story where only seven Tokyo-Mitsubishi primarily caters to the threat of market disruptors. participants ended the year with higher corporate customers, the average size ROA levels. This is largely attributable of its loans are typically much larger Return on equity/Return to higher NPAT levels that were able in nature, allowing the bank to receive on assets to increase at a faster rate than asset growth. Where banks reported lower more in the way of interest income The banking sector is experiencing ROA ratios for the year, this was while sustaining a smaller workforce increasing difficulty in maintaining the generally the result of a reduction to and footprint. current level of returns in the present their NPAT. Higher operating expenses (excluding market environment, as decreasing amortisation) were seen across all the margins, higher operating expenses Going forward, Executives have major banks, ranging from 0.41% to and rising bad debts continue to put commented that a big emphasis will 5.30%. Of the major banks, Kiwibank downward pressure on the return be placed on improving and monitoring reported the greatest percentage on average equity (ROE) level. These these levels of returns rather than just increase of 5.30% as a result of challenges have resulted in the ROE focusing on loan book growth. As a significant investments in banking level for the sector declining by result of continuing pressures coming infrastructure and services in the 200 bps, from 15.96% to 13.96%. from competition, higher costs of integration of its new core IT operating Only nine survey participants reported funds and global volatility (affecting system. Kiwibank noted in its press improvements in ROE levels, ranging non-interest income), it is likely that release that there have also been from 12 bps to 2,421 bps. CBA is the ROA and ROE will continue to be major changes to its retail network only major bank that showed higher under pressure from these areas. with branch upgrades and the opening ROE levels this year, with a 100 bps of the first stand-alone Kiwibank increase on ROE levels of 15.79% Capital adequacy ratio from the previous year. The banking branch in central Hamilton.32 When looking at the banking sector’s performance of its return on sector, only 15 survey participants In terms of dollar value, Westpac average total tangible assets (ROA) (subsidiaries/locally incorporated reported the greatest increase in ratio was also impacted negatively, banks) have disclosed their risk operating expenses (excluding as ROA levels for the sector as whole weighted asset exposures, and as amortisation) of $41 million as a result fell from 1.16% to 1.00%. The results such, we are unable to comment on of increased investment in service reported so far, help us to understand the capital adequacy position of the transformation as part of a new the recent focus on maintaining/ survey participants as a whole. service strategy in place to enhance building current capital levels. customer service.33 This year it was noted that 11 survey participants have had a decrease in their Bank of Baroda and The Bank of total capital and tier 1 capital ratios. Tokyo-Mitsubishi were the only 16 SEE FIGURE 16 – PAGE 37 However, despite that, their ratios still two banks who enjoyed a decrease remain well above regulatory minimum in operating expenses (excluding requirements. As the Chinese and amortisation) compared to last year, • The decline in ROE and ROA levels is Indian banks have recently entered into with a reduction of 5.26% ($167k) largely the result of NPAT declining by the sector, it will take some time for and 0.69% ($30k), respectively. Bank 6.46% ($334.38 million), while total them to build leverage as they grow of Baroda’s reduction was attributed equity and total tangible assets have their loan books and increase their to a decrease in employee benefits grown by 5.04% ($1.71 billion) and funding bases (i.e. liabilities). and other operating expenses 7.03% ($32.85 billion), respectively.

Kiwibank again reported another TABLE 7: MAJOR BANKS – FUNDS MANAGEMENT ACTIVITIES reduction of $210 million (5.62%) 2015–2016 in FUM, on top of a $150 million 2016 2015 Entity Movement decrease from the previous year. $Million $Million % Current FUM of $3.53 billion relates to funds held by a subsidiary, which ANZ 26,485 16.47% 22,740 operates Kiwibank PIE Unit Trusts, BNZ 4,722 21.08% 3,900 and is solely invested in term and call CBA + ASB 8,917 18.53% 7,523 deposit investments with Kiwibank. As at 1 July 2016, Kiwibank no longer Kiwibank 3,525 -5.62% 3,735 operates a KiwiSaver fund balance Westpac 10,766 13.95% 9,448 as it has transferred all of its assets Total 54,415 14.93% 47,346 and members to the ’Kiwi Wealth KiwiSaver Scheme‘, managed by Kiwi Wealth Limited (not a subsidiary For example, as a result of having a of Kiwibank). lower leverage position, the Chinese 17 SEE FIGURE 17 – PAGE 37 Continuing a similar trend to last banks started the year with capital year, the big four banks reported ratios of 424.78%, 133.43%, 36.33%. double digit-growth, with BNZ and During the year these have declined in • CBA reporting the largest growth of Over the past year, we have seen the range of 2,364 bps to 38,891 bps, 21.08% ($822 million) and 18.53% a significant amount of funds to conclude the year at 34.87%, ($1.39 billion), respectively. BNZ’s entering the banking sector through 14.00% and 12.69%, respectively. strong growth came on the back of the use of capital raising efforts. an $872 million increase in portfolios Apart from the Chinese banks, Bank Most notably, ANZ and ASB had managed on behalf of its customers. of Baroda and Bank of India (other seek to raise over $200 million and FUM growth for CBA came from recent registrations) saw significant $400 million in additional funds wholly-owned subsidiaries, such as reductions in their total capital ratio of through debt issuances, respectively. ASB Group Investments Limited, 1,780 bps (to 94.20%) and 1,100 bps The Co-operative Bank raised up to an investment administration and (to 70.00%), respectively. Despite the $45 million in subordinated notes management company. decrease, Bank of Baroda and Bank from the two capital raise held this of India continue to have the highest year, and with Heartland Bank most ANZ remains the biggest provider in total capital adequacy ratio. Between recently completing a $20 million the FUM sector, with a $3.75 billion the major banks, BNZ, Kiwibank and capital placement last December (16.47%) growth in FUM to Westpac had decreases of 63 bps and with another $10 million $26.49 billion. The growth in FUM is (to 12.04%), 50 bps (to 12.90%), and currently underworks. attributable to increases across the 20 bps (to 13.10%), respectively. On board, but an increase relating to the other hand, ANZ and CBA showed Funds under management KiwiSaver and other managed funds improvements of 100 bps (14.30%) contributed an additional $2.07 billion, and 160 bps (to 14.30%), respectively. Despite unwanted media attention over its KiwiSaver schemes earlier in while growth from investment The tier 1 capital ratios follow a similar the year in relation to the nature of portfolios managed on behalf of trend, with 11 survey participants certain investments held, the funds customers amounted to $987 million. having had a decrease in their management businesses of the banks Westpac also reported commendable respective tier 1 capital ratios. have seen strong growth in their funds growth of 13.95% growth Despite all this, New Zealand banks under management (FUM) operations. ($1.32 billion) to FUM. Much of the are still well capitalised. RBNZ data as FUM levels have increased by a further increase came primarily from an at 30 September 2016 shows that the 14.93% ($7.07 billion), reaching a year- $828 million increase in retirement locally incorporated banks’ common end FUM balance of $54.42 billion (see plan funds, along with moderate equity tier 1 (CET 1) capital ratio was Table 7). increase of $235 million and 10.4% and the tier 1 capital ratio was $148 million in PIE funds and retail unit 11.9 %, well above the minimum trusts, respectively. requirements of 4.5% for CET 1 and 6% for tier 1.34

REGISTERED BANKS: $MILLIONS % 15 OPERATING EXPENSES VS. 5,000 50 OPERATING EXPENSES TO OPERATING INCOME 4,800 40 SUM OF OPERATING EXPENSES (EXCLUDES ABNORMAL) SUM OF OPERATING EXPENSES/ OPERATING INCOME 4,600 30

4,400 20

4,200 10

4,000 0 2012 2013 2014 2015 2016

GROWTH IN GROSS LOANS & % % 16 ADVANCES VS. RETURN ON 18 1.8 ASSETS & RETURN ON EQUITY 16 1.6 GROWTH IN GROSS LOANS &ADVANCES (LHS) 14 1.4 RETURN ON EQUITY (LHS) 12 1.2 RETURN ON ASSETS (RHS) 10 1.0

8 0.8

6 0.6

4 0.4

2 0.2

0 0.0 2010 2011 2012 2013 2014 2015 2016

INCORPORATED BANKS: % 17 CAPITAL ADEQUACY RATIOS35 14

13 TOTAL CAPITAL RATIO

TIER 1 CAPITAL RATIO 12 COMMON EQUITYTIER 1 CAPITAL RATIO

8 SOURCE: RESERVE BANK OF NEW ZEALAND STATISTICS (G3) SEP 11 MAR 12 SEP 12 MAR 13 SEP 13 MAR 14 SEP 14 MAR 15 SEP 15 MAR 16 SEP 16

Analysis of financial statements Size & strength measures Growth measures Total capital Tier 1 capital Increase in Increase in Location Rank Total Net loans and Customer Increase in Balance Survey Net assets adequacy adequacy Number of Number of Number of net profit underlying Entity of head by total assets* advances deposits total assets date year $Million ratio ratio employees branches owned ATMS after tax profit office assets $Million $Million $Million % % % % % Australia and New Zealand Banking Group 30-Sep-2016 2016 1 163,358 7,819 14.30 11.80 121,129 89,768 7,655 215 666 -12.93 -10.19 7.35 Wellington Limited – New Zealand Banking Group36 30-Sep-2015 2015 1 152,177 7,507 13.30 11.30 114,843 83,134 7,724 225 684 3.51 8.62 12.58 31-Mar-2016 2016 21 92 45 94.20 94.20 64 44 19 3 3 68.89 94.96 18.56 Bank of Baroda (New Zealand) Limited Auckland 31-Mar-2015 2015 20 77 44 112.00 112.00 49 32 20 3 3 -34.60 -20.93 10.94 31-Dec-2015 2016 19 208 56 34.87 34.87 145 35 n/a n/a n/a -655.08 -755.08 205.76 Bank of China (New Zealand) Limited Auckland 31-Dec-2014 2015 21 68 62 424.78 424.78 0 0 n/a n/a n/a 0.00 0.00 0.00 31-Mar-2016 2016 20 101 52 70.00 70.00 74 19 12 3 0 20.06 20.00 18.23 Bank of India (New Zealand) Limited Auckland 31-Mar-2015 2015 19 86 52 81.00 81.00 62 12 11 3 0 32.62 31.06 24.12 30-Sep-2016 2016 3 92,325 6,789 12.04 10.05 74,823 51,481 5,019 171 479 -12.04 -12.20 6.58 Bank of New Zealand37 Auckland 30-Sep-2015 2015 3 86,629 6,884 12.67 11.69 68,590 46,729 4,841 173 474 22.12 19.39 8.94 China Construction Bank (New Zealand) 31-Dec-2015 2016 18 402 53 14.00 14.00 307 97 32 n/a n/a -571.00 -572.97 335.24 Auckland Limited 31-Dec-2014 2015 18 92 58 133.43 133.43 4 1 17 n/a n/a 0.00 0.00 0.00 31-Dec-2015 2016 14 1,974 195 15.44 14.17 755 1,064 29 1 0 -5.44 -3.91 -0.30 Citibank, N.A. New Zealand Branch38 Auckland 31-Dec-2014 2015 13 1,980 196 14.81 13.65 572 923 27 1 0 53.58 45.69 -9.61 Commonwealth Bank of Australia 30-Jun-2016 2016 4 85,804 5,174 14.30 12.30 75,757 50,892 4,770 134 431 4.25 4.57 6.90 Auckland New Zealand Banking Group39 30-Jun-2015 2015 4 80,262 4,997 12.70 11.20 69,288 49,138 4,630 134 462 3.08 0.73 11. 18 31-Dec-2015 2016 11 3,184 121 15.40 12.30 248 150 0 0 0 -75.00 -66.67 49.34 Deutsche Bank AG, New Zealand Group Auckland 31-Dec-2014 2015 12 2,132 152 16.00 12.90 273 83 29 0 0 500.00 650.00 -17.20 30-Jun-2015 2016 9 3,502 453 13.78 13.79 3,130 2,283 363 7 0 32.25 32.35 26.05 Heartland Bank Limited40 Auckland 30-Jun-2014 2015 11 2,778 353 12.86 12.79 2,323 2,085 352 7 0 12.99 17.84 17.20 Industrial and Commercial Bank of China 31-Dec-2015 2016 16 742 54 12.69 12.69 381 127 37 1 n/a 0.64 -0.82 10.63 Auckland (New Zealand) Limited 31-Dec-2014 2015 16 670 57 36.33 36.33 86 9 23 1 n/a -4,777.05 -4,701.64 999.21 JPMorgan Chase Bank, N.A. New Zealand 31-Dec-2015 2016 15 883 0 14.12 13.54 93 193 11 0 0 -37.50 -34.65 -13.04 Wellington Branch 31-Dec-2014 2015 15 1,016 0 12.53 11.82 47 169 13 0 0 400.09 403.37 4.83 30-Jun-2016 2016 5 19,357 1,129 12.90 10.70 16,733 14,743 1,410 258 241 -2.36 -4.08 5.52 Kiwibank Limited Wellington 30-Jun-2015 2015 5 18,344 1,033 13.40 11. 0 0 15,639 13,724 1,188 265 243 27.00 24.05 10.00 31-Dec-2015 2016 17 450 3 16.01 13.74 122 207 13 1 0 -24.36 -24.78 20.19 Kookmin Bank Auckland Branch Auckland 31-Dec-2014 2015 17 374 4 15.97 13.38 126 151 14 1 0 -25.27 -23.74 -10.60 Rabobank Nederland New Zealand Banking 31-Dec-2015 2016 6 14,485 1,480 23.20 16.40 10,642 4,767 319 33 0 -24.77 -23.87 6.86 Wellington Group41 31-Dec-2014 2015 6 13,555 1,340 21.30 16.00 10,001 4,696 305 32 0 -14.45 -12.64 11. 18 31-Mar-2016 2016 10 3,408 235 13.76 12.50 2,889 2,703 447 16 0 2.76 0.32 19.13 Southland Building Society Invercargill 31-Mar-2015 2015 10 2,860 241 15.61 13.85 2,407 2,436 428 17 0 24.29 25.64 2.64 The Bank of Tokyo-Mitsubishi UFJ Limited, 31-Mar-2016 2016 12 3,169 125 15.66 12.71 2,818 484 17 1 0 5,398.68 777.25 4.96 Auckland Auckland Branch 31-Mar-2015 2015 9 3,019 98 15.61 12.33 2,625 201 17 1 0 96.93 82.44 -12.50 31-Mar-2016 2016 13 2,041 157 15.80 15.70 1,807 1,788 311 34 0 15.52 20.83 13.01 The Co-operative Bank Limited Wellington 31-Mar-2015 2015 14 1,806 150 16.50 16.40 1,565 1,575 305 34 0 24.41 26.97 11.24 The Hongkong and Shanghai Banking 31-Dec-2015 2016 8 5,575 39 18.60 16.60 3,589 3,252 217 1 0 27.36 26.80 5.35 Auckland Corporation Limited, New Zealand Branch 31-Dec-2014 2015 8 5,292 28 15.70 14.40 3,780 3,181 213 1 0 165.11 156.73 5.08 New 31-Mar-2016 2016 7 6,427 554 14.52 14.52 3,848 5,813 388 27 45 141.26 152.81 8.71 TSB Bank Limited42 Plymouth 31-Mar-2015 2015 7 5,912 498 13.85 13.53 3,290 5,366 328 27 47 -48.92 -50.08 4.05 Westpac Banking Corporation – New Zealand 30-Sep-2016 2016 2 92,833 6,512 13.10 11.20 75,912 57,541 4,267 189 620 -4.27 -5.15 5.09 Auckland Division 30-Sep-2015 2015 2 88,336 5,668 13.30 11.40 69,873 51,916 4,497 189 639 -1.28 9.82 8.85 2016 500,320 31,046 n/a n/a 395,268 287,453 25,336 1,095 2,485 -6.46 -0.06 0.07 Bank Sector Total 2015 467,467 29,421 n/a n/a 365,444 265,561 24,982 1,114 2,552 0.07 0.10 0.10 * Total Assets = Total Assets - Goodwill - Other Intangibles n/a = not available

Analysis of financial statements Credit quality measures Profitability measures Efficiency measures Individual Total Impaired provision provision Net Non- Collective asset Net profit Underlying Operating for for interest interest Net profit Operating Impaired Gross provision/ expense/ Total after tax/ profit/ expenses*/ Past due doubtful doubtful income/ Interest Interest income/ Net profit after tax/ Underlying expenses/ Survey asset impaired Net loans Average operating Average Average Average Entity assets debts/ debts/ Average margin spread Average after tax Average profit Operating year expense assets and gross income total total total $Million Gross Gross total % % total $Million equity $Million income $Million $Million advances loans and $Million assets assets assets impaired loans and assets assets % % % advances % % % assets advances % % % % % Australia and New Zealand Banking Group 2016 147 152 433 35.57 0.39 0.52 0.12 3,861 1.92 2.22 1.85 0.53 1,542 14.00 0.98 2,230 1.41 0.94 38.44 Limited – New Zealand Banking Group36 2015 76 222 404 40.10 0.41 0.55 0.07 4,037 2.00 2.26 1.83 0.81 1,771 16.91 1.23 2,483 1.73 1.03 36.61 2016 0 0 0 100.00 0.41 0.58 0.11 4 3.35 3.48 1.32 1.89 1 3.14 1.65 1 1.60 3.56 67.91 Bank of Baroda (New Zealand) Limited 2015 0 0 0 100.00 0.41 0.63 0.11 4 3.51 3.73 1.99 1.81 1 1.91 1. 12 1 0.95 4.31 81.00 2016 0 0 0 0.00 0.30 0.30 0.60 3 2.18 2.21 1.87 -0.36 -6 -10.38 -4.46 -7 -5.05 6.55 361.27 Bank of China (New Zealand) Limited 2015 0 0 0 0.00 0.00 0.00 0.00 1 0.00 0.00 0.00 0.00 -1 0.00 0.00 -1 0.00 0.00 236.17 2016 0 0 0 0.00 0.41 0.41 0.07 4 3.60 3.67 1. 18 0.52 1 1.43 0.79 1 1. 11 2.96 71.78 Bank of India (New Zealand) Limited 2015 0 0 0 0.00 0.41 0.41 0.04 4 4.12 4.21 1.57 0.46 1 1.21 0.80 1 1. 12 3.43 74.94 2016 120 173 253 39.53 0.59 0.73 0.17 2,269 1.96 2.19 1.79 0.57 913 13.00 1.02 1,303 1.46 0.95 37.29 Bank of New Zealand37 2015 128 196 215 42.79 0.55 0.68 0.19 2,432 2.09 2.30 1.85 0.84 1,038 16.24 1.25 1,484 1.79 0.99 33.72 China Construction Bank (New Zealand) 2016 0 0 0 0.00 0.10 0.10 0.20 3 1.46 1.48 1.03 -0.19 -5 -8.54 -1.92 -5 -1.91 3.06 241.57 Limited 2015 0 0 0 0.00 0.08 0.08 0.00 1 0.00 0.00 0.00 0.00 -1 0.00 0.00 -1 0.00 0.00 149.33 2016 0 0 0 0.00 0.00 0.00 0.00 47 1.67 1.69 1.44 0.71 20 10.22 1. 01 28 1.41 0.98 40.91 Citibank, N.A. New Zealand Branch38 2015 0 0 0 0.00 0.00 0.00 0.00 45 1.91 1.93 1.71 0.23 21 11.02 1. 01 29 1.39 0.75 35.14 Commonwealth Bank of Australia 2016 129 77 430 13.02 0.35 0.42 0.18 2,228 2.07 2.14 1. 76 0.61 908 16.79 1.09 1,304 1.57 0.96 35.68 New Zealand Banking Group39 2015 101 100 365 14.79 0.29 0.37 0.15 2,125 2.22 2.30 1.85 0.57 871 15.79 1. 14 1,247 1.64 1.02 36.56 2016 0 0 0 0.00 0.00 0.00 0.00 44 -2.37 -3.03 -2.17 4.03 6 4.38 0.23 10 0.38 1.28 77.27 Deutsche Bank AG, New Zealand Group 2015 0 0 0 0.00 0.00 0.00 0.00 56 1.40 1.66 1. 76 0.98 24 1 7. 1 4 1.02 30 1.27 1. 10 46.43 2016 14 22 37 13.23 0.52 0.67 0.49 155 4.67 4.79 4.26 0.26 54 12.44 1.72 73 2.31 2.19 44.41 Heartland Bank Limited40 2015 11 35 30 51.56 0.40 1.05 0.52 128 4.73 4.89 4.34 0.25 41 11.11 1.59 55 2.13 2.41 48.47 Industrial and Commercial Bank of China 2016 1 0 0 0.00 0.33 0.33 0.33 7 0.86 0.89 0.76 0.09 -3 -5.30 -0.42 -3 -0.42 1.26 132.47 (New Zealand) Limited 2015 0 0 0 0.00 0.56 0.56 1. 12 4 0.81 0.82 0.78 0.17 -3 -5.07 -0.81 -3 -0.80 1.65 168.02 JPMorgan Chase Bank, N.A. New Zealand 2016 0 0 0 0.00 0.00 0.00 0.00 17 0.57 0.85 0.72 1.23 4 0.00 0.42 6 0.62 1. 18 65.62 Branch 2015 0 0 0 0.00 0.00 0.00 0.00 19 0.58 0.77 0.71 1.36 6 0.00 0.64 9 0.91 1.03 53.25 2016 11 7 15 60.00 0.26 0.32 0.07 477 1.98 2.07 1.62 0.55 124 11.47 0.66 188 1. 0 0 1.47 58.28 Kiwibank Limited 2015 13 11 23 52.17 0.26 0.34 0.09 473 2.06 2.12 1.60 0.64 127 12.48 0.73 196 1. 12 1.51 55.81 2016 0 0 0 0.00 0.43 0.43 -0.03 7 1.24 1.24 1.23 0.52 3 80.08 0.70 4 0.98 0.78 44.35 Kookmin Bank Auckland Branch 2015 0 0 0 0.00 0.44 0.44 -0.06 8 1.65 1.66 1.64 0.47 4 74.25 0.96 5 1.36 0.78 36.89 Rabobank Nederland New Zealand 2016 -6 25 49 14.01 0.14 0.21 -0.06 266 2.27 2.30 1.96 -0.38 111 7.88 0.79 161 1. 14 0.79 41.92 Banking Group41 2015 -19 22 239 23.50 0.12 0.68 -0.19 295 2.57 2.62 2.28 -0.28 148 11.66 1. 15 211 1.64 0.81 35.18 2016 13 3 9 30.35 0.57 0.66 0.50 114 2.68 2.72 2.40 0.97 20 8.26 0.64 28 0.90 2.33 63.70 Southland Building Society 2015 12 5 13 45.09 0.51 0.75 0.52 107 2.87 2.91 2.57 0.90 19 8.13 0.69 28 1. 0 0 2.34 62.09 The Bank of Tokyo-Mitsubishi UFJ Limited, 2016 0 0 0 0.00 0.00 0.00 0.00 34 0.36 0.37 0.31 0.74 26 23.70 0.86 30 0.96 0.14 12.59 Auckland Branch 2015 30 0 64 100.00 0.00 2.37 1.04 29 0.46 0.47 0.40 0.45 0 -0.51 -0.02 -4 -0.14 0.13 14.61 2016 1 6 2 30.27 0.18 0.21 0.08 71 2.68 2.71 2.22 1. 01 10 6.68 0.53 16 0.84 2.77 75.22 The Co-operative Bank Limited 2015 1 7 1 61.74 0.20 0.26 0.07 66 2.85 2.88 2.35 1.02 9 6.06 0.52 13 0.78 3.02 78.23 The Hongkong and Shanghai Banking 2016 -35 0 4 24.69 0.08 0.11 -0.95 146 1.75 1.85 1.70 0.94 85 172.20 1.56 119 2.20 1. 14 42.42 Corporation Limited, New Zealand Branch 2015 -18 0 122 1 7. 0 0 0.14 0.68 -0.50 133 1. 74 1.82 1.71 0.84 66 300.37 1.29 94 1.82 1. 11 42.89 2016 -9 3 10 14.36 0.47 0.50 -0.24 144 2.07 2.09 1.63 0.26 62 11.70 1. 0 0 86 1.39 1.08 46.25 TSB Bank Limited42 2015 56 2 1 61.42 0.45 0.46 1.75 147 2.17 2.19 1. 74 0.36 26 5.23 0.44 34 0.59 0.98 38.62 Westpac Banking Corporation – 2016 73 56 222 47.30 0.43 0.57 0.10 2,362 1.96 2.12 1.64 0.65 963 14.56 1.06 1,400 1.55 0.98 37.64 New Zealand Division 2015 47 83 282 41.84 0.43 0.59 0.07 2,371 2.10 2.29 1.79 0.70 1,006 17.21 1. 19 1,476 1. 74 1. 0 0 35.77 2016 460 523 1,464 30.16 0.41 0.53 0.12 12,263 1.96 2.15 1.76 0.57 4,839 13.96 1.00 6,973 1.44 1.00 39.39 Bank Sector Total 2015 438 683 1,758 34.18 0.39 0.56 0.12 12,485 2.10 2.28 1.84 0.70 5,174 15.96 1.16 7,388 1.66 1.05 37.32 * Operating Expenses = Total Expenses - Interest Expense - Loan Write Offs and Bad Debts - Abnormal Expenses.

Balance sheet breakdown Assets ($Million) Liabilities ($Million) Equity ($Million)

Entity shares shares reserves reserves provisions) Intangibles Total equity Total Total assets Total instruments instruments instruments instruments Fixed assets Fixed Other assets Balance date Total liabilities Total Debt securities Debt securities Other liabilities Retained earnings Retained earnings Subordinated debt Subordinated Customer deposits Customer Derivative financial Derivative Derivative financial Derivative Head office account Head office Share capital – ordinary capital – ordinary Share Convertible debentures/ Convertible Loans and advances (less Loans and advances balances with other banks and investment properties and investment Balances with other banks investments in subsidiaries in subsidiaries investments Perpetual preference shares shares preference Perpetual and money market deposits market and money Balances with related parties parties Balances with related Balances with related parties parties Balances with related Other equity/Cash flow hedge hedge Other equity/Cash flow Trading, investment securities, securities, investment Trading, Cash on hand, money at call and money Cash on hand, 2016 Australia and New Zealand Banking Group Limited 30-Sep 4,527 14,957 16,634 120,651 4,903 387 3,424 1,223 166,706 89,768 2,053 29,207 17,096 13,614 2,336 1,465 155,539 8,044 11 0 62 3,050 11,167 – New Zealand Banking Group Bank of Baroda (New Zealand) Limited 31-Mar 22 0 0 64 3 0 0 1 92 44 0 0 0 2 0 0 47 40 0 0 0 5 45 Bank of China (New Zealand) Limited 31-Dec 61 0 0 145 0 1 0 1 208 35 25 0 1 88 0 3 152 63 0 0 0 -7 56 Bank of India (New Zealand) Limited 31-Mar 22 0 0 74 4 1 0 0 101 19 0 0 0 29 0 1 49 50 0 0 0 2 52 Bank of New Zealand 30-Sep 4,098 4,703 7,319 74,378 934 165 216 728 92,541 51,481 1,244 22,753 7,786 814 542 916 85,536 2,351 0 200 115 4,339 7,005 China Construction Bank (New Zealand) Limited 31-Dec 85 0 1 307 7 2 0 0 402 97 15 125 2 110 0 1 349 59 0 0 0 -5 53 Citibank, N.A. New Zealand Branch 31-Dec 524 0 0 755 117 1 0 578 1,974 1,064 23 0 0 684 0 7 1,779 29 34 0 0 133 195 Commonwealth Bank of Australia New Zealand 30-Jun 2,110 5,529 1,275 75,492 667 187 449 408 86,127 50,892 452 18,527 1,741 3,265 5,134 619 80,630 704 462 1,034 448 2,849 5,497 Banking Group Deutsche Bank AG, New Zealand Group 31-Dec 119 808 0 248 2,002 0 0 7 3,184 150 460 494 0 1,946 0 13 3,063 20 0 0 3 99 122 Heartland Bank Limited 30-Jun 84 236 0 3,114 0 9 58 46 3,547 2,283 0 717 6 0 0 43 3,049 421 0 0 -2 79 498 Industrial and Commercial Bank of China 31-Dec 353 5 1 380 0 1 0 2 742 127 0 85 9 461 0 5 687 60 0 0 -6 0 54 (New Zealand) Limited JPMorgan Chase Bank, N.A. New Zealand Branch 31-Dec 118 258 0 93 177 0 1 237 884 193 0 224 0 54 0 412 884 0 0 0 0 0 0 Kiwibank Limited 30-Jun 756 955 658 16,689 77 23 158 41 19,357 14,743 135 2,207 725 43 258 117 18,228 400 0 0 113 616 1,129 Kookmin Bank Auckland Branch 31-Dec 22 0 0 121 306 0 0 0 450 207 117 0 0 122 0 1 447 0 3 0 0 0 3 Rabobank Nederland New Zealand Banking Group 31-Dec 293 645 22 10,627 2,839 5 0 53 14,485 4,767 0 3,120 27 5,023 0 68 13,005 551 204 0 0 725 1,480 Southland Building Society 31-Mar 77 401 4 2,873 2 24 5 28 3,412 2,703 150 199 42 0 39 39 3,172 0 0 0 -13 253 240 The Bank of Tokyo-Mitsubishi UFJ Limited, 31-Mar 227 27 11 2,818 66 0 0 19 3,169 484 0 0 9 2,549 0 1 3,044 0 83 0 1 41 125 Auckland Branch The Co-operative Bank Limited 31-Mar 198 9 4 1,804 0 8 13 6 2,041 1,788 0 65 15 0 0 16 1,884 0 0 0 -5 162 157 The Hongkong and Shanghai Banking Corporation 31-Dec 353 447 208 3,586 961 1 16 18 5,591 3,252 186 844 105 1,106 0 44 5,537 0 54 0 1 0 54 Limited, New Zealand Branch TSB Bank Limited 31-Mar 118 2,449 0 3,830 0 19 4 7 6,427 5,813 0 0 11 0 0 49 5,873 10 0 0 15 530 554 Westpac Banking Corporation – 30-Sep 2,316 7,834 4,838 75,582 1,218 161 650 759 93,358 57,541 616 15,977 6,236 3,525 1,091 1,335 86,321 143 1,913 0 -105 5,086 7,037 New Zealand Division Bank Sector Total 16,483 39,264 30,975 393,631 14,292 997 4,993 4,163 504,798 287,453 5,476 94,543 33,811 33,436 9,400 5,155 469,274 12,945 2,763 1,234 626 17,956 35,525

Balance sheet breakdown Assets ($Million) Liabilities ($Million) Equity ($Million)

Entity shares shares reserves reserves provisions) Intangibles Total equity Total Total assets Total instruments instruments instruments instruments Fixed assets Fixed Other assets Balance date Total liabilities Total Debt securities Debt securities Other liabilities Retained earnings Retained earnings Subordinated debt Subordinated Customer deposits Customer Derivative financial Derivative Derivative financial Derivative Head office account Head office Share capital – ordinary capital – ordinary Share Convertible debentures/ Convertible Loans and advances (less Loans and advances balances with other banks and investment properties and investment Balances with other banks investments in subsidiaries in subsidiaries investments Perpetual preference shares shares preference Perpetual and money market deposits market and money Balances with related parties parties Balances with related Balances with related parties parties Balances with related Other equity/Cash flow hedge hedge Other equity/Cash flow Trading, investment securities, securities, investment Trading, Cash on hand, money at call and money Cash on hand, 2015 Australia and New Zealand Banking Group Limited 30-Sep 4,532 13,718 13,650 114,376 4,179 388 3,492 1,195 155,530 83,134 2,417 26,848 13,926 14,093 2,381 1,871 144,670 8,047 11 0 -10 2,812 10,860 – New Zealand Banking Group Bank of Baroda (New Zealand) Limited 31-Mar 23 0 0 49 3 1 0 1 77 32 0 0 0 1 0 0 34 40 0 0 0 4 44 Bank of China (New Zealand) Limited 31-Dec 67 0 0 0 0 1 0 0 68 0 0 0 0 5 0 0 6 63 0 0 0 -1 62 Bank of India (New Zealand) Limited 31-Mar 18 0 0 62 4 1 0 0 86 12 0 0 0 21 0 0 34 50 0 0 0 2 52 Bank of New Zealand 30-Sep 3,643 4,918 7,895 68,216 1,259 176 158 522 86,787 46,729 1,439 21,183 8,310 1,095 0 989 79,745 2,351 0 650 96 3,945 7,042 China Construction Bank (New Zealand) Limited 31-Dec 76 0 0 4 12 1 0 0 92 1 33 0 0 1 0 0 34 59 0 0 0 -1 58 Citibank, N.A. New Zealand Branch 31-Dec 450 751 0 572 143 1 0 62 1,980 923 15 0 0 837 0 9 1,785 29 34 0 0 134 196 Commonwealth Bank of Australia New Zealand 30-Jun 3,174 4,675 1,759 69,087 641 189 438 622 80,585 49,138 1,003 13,759 1,193 5,774 3,784 614 75,265 704 462 1,480 496 2,178 5,320 Banking Group Deutsche Bank AG, New Zealand Group 31-Dec 48 353 0 273 1,444 1 0 13 2,132 83 210 71 0 1,608 0 8 1,980 20 0 0 3 129 152 Heartland Bank Limited 30-Jun 32 323 0 2,314 29 5 26 70 2,799 2,085 0 262 3 32 0 44 2,426 341 0 0 0 32 373 Industrial and Commercial Bank of China 31-Dec 582 0 0 86 0 2 0 1 670 9 4 50 0 547 0 3 613 60 0 0 -3 0 57 (New Zealand) Limited JPMorgan Chase Bank, N.A. New Zealand Branch 31-Dec 321 448 0 47 19 0 1 180 1,016 169 0 397 0 259 0 192 1,016 0 0 0 0 0 0 Kiwibank Limited 30-Jun 686 1,318 480 15,598 77 20 116 49 18,344 13,724 325 2,397 475 22 255 113 17,311 400 0 0 101 532 1,033 Kookmin Bank Auckland Branch 31-Dec 3 0 0 125 246 0 0 0 374 151 189 0 0 30 0 1 370 0 4 0 0 0 4 Rabobank Nederland New Zealand Banking Group 31-Dec 320 687 16 9,989 2,472 6 0 65 13,555 4,696 0 2,787 35 4,624 0 72 12,215 551 169 0 0 620 1,340 Southland Building Society 31-Mar 128 306 2 2,395 2 19 5 6 2,863 2,436 0 65 10 39 41 28 2,619 0 0 0 5 238 244 The Bank of Tokyo-Mitsubishi UFJ Limited, 31-Mar 77 223 5 2,625 68 1 0 21 3,019 201 0 0 8 2,710 0 1 2,921 0 83 0 1 15 98 Auckland Branch The Co-operative Bank Limited 31-Mar 209 10 2 1,562 0 8 11 5 1,806 1,575 0 61 6 0 0 15 1,656 0 0 0 -1 151 150 The Hongkong and Shanghai Banking Corporation 31-Dec 426 495 116 3,775 448 1 18 30 5,309 3,181 182 740 72 1,040 0 50 5,265 0 42 0 2 0 44 Limited, New Zealand Branch TSB Bank Limited 31-Mar 107 2,450 1 3,275 0 16 4 59 5,912 5,366 0 0 1 0 0 47 5,414 10 0 0 0 488 498 Westpac Banking Corporation – 30-Sep 1,107 7,636 5,459 69,576 3,451 164 658 810 88,861 51,916 837 15,755 6,717 4,288 1,984 1,171 82,668 143 1,824 0 -102 4,328 6,193 New Zealand Division Bank Sector Total 16,028 38,311 29,384 364,006 14,498 1,000 4,927 3,712 471,866 265,561 6,654 84,374 30,756 37,026 8,445 5,229 438,046 12,868 2,629 2,130 587 15,606 33,820

Balance sheet breakdown Assets ($Million) Liabilities ($Million) Equity ($Million)

Entity shares shares reserves reserves provisions) Intangibles Total equity Total Total assets Total instruments instruments instruments instruments Fixed assets Fixed Other assets Balance date Total liabilities Total Debt securities Debt securities Other liabilities Retained earnings Retained earnings Subordinated debt Subordinated Customer deposits Customer Derivative financial Derivative Derivative financial Derivative Head office account Head office Share capital – ordinary capital – ordinary Share Convertible debentures/ Convertible Loans and advances (less Loans and advances balances with other banks and investment properties and investment Balances with other banks investments in subsidiaries in subsidiaries investments Perpetual preference shares shares preference Perpetual and money market deposits market and money Balances with related parties parties Balances with related Balances with related parties parties Balances with related Other equity/Cash flow hedge hedge Other equity/Cash flow Trading, investment securities, securities, investment Trading, Cash on hand, money at call and money Cash on hand, 2015 Australia and New Zealand Banking Group Limited 30-Sep 4,532 13,718 13,650 114,376 4,179 388 3,492 1,195 155,530 83,134 2,417 26,848 13,926 14,093 2,381 1,871 144,670 8,047 11 0 -10 2,812 10,860 – New Zealand Banking Group Bank of Baroda (New Zealand) Limited 31-Mar 23 0 0 49 3 1 0 1 77 32 0 0 0 1 0 0 34 40 0 0 0 4 44 Bank of China (New Zealand) Limited 31-Dec 67 0 0 0 0 1 0 0 68 0 0 0 0 5 0 0 6 63 0 0 0 -1 62 Bank of India (New Zealand) Limited 31-Mar 18 0 0 62 4 1 0 0 86 12 0 0 0 21 0 0 34 50 0 0 0 2 52 Bank of New Zealand 30-Sep 3,643 4,918 7,895 68,216 1,259 176 158 522 86,787 46,729 1,439 21,183 8,310 1,095 0 989 79,745 2,351 0 650 96 3,945 7,042 China Construction Bank (New Zealand) Limited 31-Dec 76 0 0 4 12 1 0 0 92 1 33 0 0 1 0 0 34 59 0 0 0 -1 58 Citibank, N.A. New Zealand Branch 31-Dec 450 751 0 572 143 1 0 62 1,980 923 15 0 0 837 0 9 1,785 29 34 0 0 134 196 Commonwealth Bank of Australia New Zealand 30-Jun 3,174 4,675 1,759 69,087 641 189 438 622 80,585 49,138 1,003 13,759 1,193 5,774 3,784 614 75,265 704 462 1,480 496 2,178 5,320 Banking Group Deutsche Bank AG, New Zealand Group 31-Dec 48 353 0 273 1,444 1 0 13 2,132 83 210 71 0 1,608 0 8 1,980 20 0 0 3 129 152 Heartland Bank Limited 30-Jun 32 323 0 2,314 29 5 26 70 2,799 2,085 0 262 3 32 0 44 2,426 341 0 0 0 32 373 Industrial and Commercial Bank of China 31-Dec 582 0 0 86 0 2 0 1 670 9 4 50 0 547 0 3 613 60 0 0 -3 0 57 (New Zealand) Limited JPMorgan Chase Bank, N.A. New Zealand Branch 31-Dec 321 448 0 47 19 0 1 180 1,016 169 0 397 0 259 0 192 1,016 0 0 0 0 0 0 Kiwibank Limited 30-Jun 686 1,318 480 15,598 77 20 116 49 18,344 13,724 325 2,397 475 22 255 113 17,311 400 0 0 101 532 1,033 Kookmin Bank Auckland Branch 31-Dec 3 0 0 125 246 0 0 0 374 151 189 0 0 30 0 1 370 0 4 0 0 0 4 Rabobank Nederland New Zealand Banking Group 31-Dec 320 687 16 9,989 2,472 6 0 65 13,555 4,696 0 2,787 35 4,624 0 72 12,215 551 169 0 0 620 1,340 Southland Building Society 31-Mar 128 306 2 2,395 2 19 5 6 2,863 2,436 0 65 10 39 41 28 2,619 0 0 0 5 238 244 The Bank of Tokyo-Mitsubishi UFJ Limited, 31-Mar 77 223 5 2,625 68 1 0 21 3,019 201 0 0 8 2,710 0 1 2,921 0 83 0 1 15 98 Auckland Branch The Co-operative Bank Limited 31-Mar 209 10 2 1,562 0 8 11 5 1,806 1,575 0 61 6 0 0 15 1,656 0 0 0 -1 151 150 The Hongkong and Shanghai Banking Corporation 31-Dec 426 495 116 3,775 448 1 18 30 5,309 3,181 182 740 72 1,040 0 50 5,265 0 42 0 2 0 44 Limited, New Zealand Branch TSB Bank Limited 31-Mar 107 2,450 1 3,275 0 16 4 59 5,912 5,366 0 0 1 0 0 47 5,414 10 0 0 0 488 498 Westpac Banking Corporation – 30-Sep 1,107 7,636 5,459 69,576 3,451 164 658 810 88,861 51,916 837 15,755 6,717 4,288 1,984 1,171 82,668 143 1,824 0 -102 4,328 6,193 New Zealand Division Bank Sector Total 16,028 38,311 29,384 364,006 14,498 1,000 4,927 3,712 471,866 265,561 6,654 84,374 30,756 37,026 8,445 5,229 438,046 12,868 2,629 2,130 587 15,606 33,820

Size & strength measures Profitability measures Entity Entity 31 Dec 14 31 Mar 15 30 Jun 15 30 Sep 15 31 Dec 15 31 Mar 16 30 Jun 16 30 Sep 16 31 Dec 14 31 Mar 15 30 Jun 15 30 Sep 15 31 Dec 15 31 Mar 16 30 Jun 16 30 Sep 16

Total assets49 ($Million) Interest margin (%) ANZ43 135,290 140,253 150,664 152,038 152,289 160,801 163,538 163,282 ANZ43 2.33 2.23 2.21 2.23 2.22 2.18 2.24 2.17 BNZ44 79,658 81,926 85,657 86,629 86,819 89,913 91,906 92,325 BNZ44 2.28 2.34 2.36 2.30 2.21 2.21 2.15 2.12 CBA + ASB45 74,149 76,994 80,147 81,321 81,785 86,012 85,678 88,764 CBA + ASB45 2.40 2.13 2.20 2.13 2.12 2.09 2.22 2.04 Heartland Bank46 2,543 2,623 2,772 2,825 3,290 3,334 3,489 3,595 Heartland Bank46 5.06 4.91 4.83 4.81 5.18 4.58 4.53 4.46 Kiwibank 17,064 17,948 18,228 18,686 18,858 19,227 19,199 19,372 Kiwibank 2.17 2.12 2.07 2.13 2.07 1.98 2.02 1.96 Southland Building Society 2,826 2,858 3,094 3,163 3,286 3,408 3,506 3,543 Southland Building Society 2.97 2.93 2.86 2.67 2.63 2.61 2.57 2.63 The Co-operative Bank Limited 1,770 1,795 1,838 1,896 1,971 2,029 2,109 2,179 The Co-operative Bank Limited 2.90 2.80 2.81 2.77 2.71 2.61 2.51 2.46 TSB Bank Limited47 5,908 5,908 5,991 6,208 6,299 6,424 6,475 6,522 TSB Bank Limited47 2.15 2.15 2.12 2.14 2.08 2.03 2.02 2.12 Westpac 82,442 82,087 87,455 88,203 88,416 90,309 91,518 92,708 Westpac 2.28 2.26 2.32 2.28 2.17 2.11 2.12 2.08 Total 401,649 412,392 435,846 440,968 443,014 461,455 467,418 472,291 Average 2.34 2.26 2.28 2.25 2.21 2.17 2.20 2.13 Increase in gross loans and advances (%) Non-interest income/Total tangible assets (%) ANZ43 1.53 1.75 3.60 0.86 1.51 1.47 1.94 0.43 ANZ43 0.79 0.90 0.76 0.80 0.33 0.77 0.62 0.37 BNZ44 1. 16 1.57 1. 01 1.72 2.35 2.24 1.80 2.46 BNZ44 0.63 0.94 0.97 0.83 0.42 0.71 0.59 0.56 CBA + ASB45 1. 19 2.75 2.04 2.29 2.53 1.87 2.38 3.43 CBA + ASB45 0.63 0.70 0.53 0.66 0.77 0.57 0.47 0.62 Heartland Bank46 4.50 4.10 4.11 3.21 22.19 3.02 3.29 4.01 Heartland Bank46 0.41 0.41 0.36 0.39 0.89 0.45 0.45 0.26 Kiwibank 2.20 2.04 1.50 2.24 2.51 0.53 1.55 1. 74 Kiwibank 0.73 0.57 0.57 0.59 0.62 0.55 0.46 0.56 Southland Building Society 2.88 2.50 11.34 2.71 2.04 2.67 3.19 3.15 Southland Building Society 0.96 1.03 0.98 0.95 1.03 0.97 1. 0 0 1. 0 0 The Co-operative Bank Limited 2.93 2.19 3.24 4.28 4.23 2.87 4.01 4.97 The Co-operative Bank Limited 1. 13 0.24 1. 0 0 0.99 1.02 0.64 0.94 0.98 TSB Bank Limited47 3.04 1.73 5.27 3.39 4.57 2.80 3.26 5.32 TSB Bank Limited47 0.35 0.40 0.24 0.38 0.20 0.21 0.21 0.35 Westpac 1.67 1.51 1.57 1.99 1.38 2.22 2.88 1.86 Westpac 0.73 0.66 0.73 0.69 0.63 0.62 0.65 0.71 Average 1.50 1.90 2.34 1.65 1.85 1.85 2.22 1.90 Average 0.71 0.80 0.74 0.74 0.51 0.67 0.58 0.53 Capital adequacy (%) Impaired asset expense/Average gross loans and advances (%) ANZ43, 48 11.80 12.60 12.50 13.30 13.30 13.70 14.40 14.30 ANZ43 0.05 0.07 0.10 0.06 0.09 0.08 0.18 0.14 BNZ44 12.28 12.90 12.59 12.67 13.26 12.58 12.48 12.06 BNZ44 0.02 0.26 0.10 0.38 0.22 0.23 0.15 0.08 CBA + ASB45 12.70 12.10 12.70 13.30 14.10 13.70 14.30 12.70 CBA + ASB45 0.29 0.14 0.08 0.09 0.14 0.17 0.31 0.12 Heartland Bank46 13.76 13.36 12.86 12.85 14.46 14.01 13.78 12.71 Heartland Bank46 0.52 0.44 0.74 0.56 0.34 0.41 0.63 0.49 Kiwibank 13.30 12.40 13.40 12.80 12.80 12.90 12.90 12.80 Kiwibank 0.16 0.08 0.03 0.08 0.07 0.10 0.02 0.00 Southland Building Society 16.07 15.61 14.59 14.21 14.27 13.76 13.50 13.63 Southland Building Society 0.43 0.79 0.31 0.62 0.33 0.67 0.21 0.44 The Co-operative Bank Limited 16.50 16.50 16.30 16.20 15.80 15.80 15.50 16.10 The Co-operative Bank Limited 0.07 0.05 0.16 0.04 0.08 0.05 0.08 0.16 TSB Bank Limited47 13.48 13.85 13.71 15.77 14.86 14.52 14.62 14.59 TSB Bank Limited47 6.06 0.04 0.07 -1.47 0.08 0.31 0.07 0.12 Westpac48 11.60 12.10 12.40 13.30 13.90 14.00 14.00 13.10 Westpac 0.12 0.07 0.08 0.01 -0.01 0.06 0.02 0.32 Average 0.17 0.13 0.09 0.11 0.11 0.13 0.16 0.16 Net profit ($Million) Operating expenses/Operating income (%) ANZ43 425 452 427 467 347 416 430 349 ANZ43 39.02 36.61 38.03 36.34 43.30 42.41 36.61 43.98 BNZ44 232 270 295 241 192 259 229 233 BNZ44 39.67 32.91 34.47 35.81 42.26 34.94 39.69 40.28 CBA + ASB45 214 218 212 234 243 220 211 245 CBA + ASB45 37.04 37.60 41.19 37.73 36.76 37.98 37.66 36.03 Heartland Bank46 10 11 10 10 15 14 15 14 Heartland Bank46 48.13 47.14 48.45 49.94 49.59 43.96 42.55 43.51 Kiwibank 36 29 27 33 38 29 24 28 Kiwibank 54.10 62.07 67.52 59.84 59.35 62.39 71.30 67.80 Southland Building Society 5 4 6 4 5 6 7 7 Southland Building Society 66.27 62.82 60.39 67.73 70.22 57.43 60.30 59.65 The Co-operative Bank Limited 3 2 2 3 3 2 2 3 The Co-operative Bank Limited 77.95 78.63 80.40 77.65 73.38 81.41 80.27 75.07 TSB Bank Limited47 -18 16 13 25 13 10 14 14 TSB Bank Limited47 37.95 43.59 44.68 42.50 47.83 51.65 45.26 47.36 Westpac 244 247 266 249 251 239 249 224 Westpac 38.97 37.89 38.95 43.11 40.48 40.80 41.25 38.92 Total 1,151 1,249 1,259 1,266 1,107 1,195 1,181 1,117 Average 39.98 37.90 39.80 39.52 42.52 41.07 40.33 42.02

$MILLION 18 MAJOR BANKS: NET PROFIT 500

450

ANZ 400

BNZ 350

CBA +ASB 300

KIWIBANK 250 WESTPAC 200

150

100

0 DEC 14 MAR 15 JUN 15 SEP 15 DEC 15 MAR 16 JUN 16 SEP 16

MAJOR BANKS: INTEREST % 19 MARGIN 2.50

2.40 ANZ 2.30 BNZ

CBA +ASB 2.20

KIWIBANK 2.10 WESTPAC 2.00

1.90

1.80

1.70 DEC 14 MAR 15 JUN 15 SEP 15 DEC 15 MAR 16 JUN 16 SEP 16

MAJOR BANKS: INCREASE % 20 IN GROSS LOANS AND 4.00 ADVANCES 3.50 ANZ 3.00 BNZ

CBA +ASB 2.50

KIWIBANK 2.00 WESTPAC 1.50

1.00

0.50

0.00 DEC 14 MAR 15 JUN 15 SEP 15 DEC 15 MAR 16 JUN 16 SEP 16

MAJOR BANKS: % 21 NON-INTEREST INCOME/ 1.20 TOTAL ASSETS

1.00 ANZ

BNZ 0.80 CBA +ASB

KIWIBANK 0.60 WESTPAC

0.40

0.20

0.00 DEC 14 MAR 15 JUN 15 SEP 15 DEC 15 MAR 16 JUN 16 SEP 16

MAJOR BANKS: % 22 OPERATING EXPENSES/ 75 OPERATING INCOME 70 ANZ 65 BNZ 60 CBA +ASB 55 KIWIBANK

WESTPAC 50

30 DEC 14 MAR 15 JUN 15 SEP 15 DEC 15 MAR 16 JUN 16 SEP 16

MAJOR BANKS: IMPAIRED % 23 ASSET EXPENSE/AVERAGE 0.50 GROSS LOANS AND ADVANCES

0.40 ANZ

BNZ 0.30 CBA +ASB

KIWIBANK 0.20 WESTPAC

0.10

0.00

-0.10 DEC 14 MAR 15 JUN 15 SEP 15 DEC 15 MAR 16 JUN 16 SEP 16

The bank directors’ attestation The Reserve Bank uses thematic reviews to conduct in-depth reviews of regime has been a cornerstone areas of particular supervisory interest, of the Reserve Bank of including current or emerging risks New Zealand’s approach to within the banking sector. We do not presuppose that a thematic review prudential supervision for two will identify material compliance decades. Overall, we believe breaches or supervisory concerns. that it has stood the test of Recent thematic reviews have focused on problem loan identification and time well. Our discussions with loss provisioning for the dairy sector, directors indicate that directors banks’ Internal Capital Adequacy Assessment Processes (ICAAP), take their responsibilities outsourcing arrangements, and credit very seriously. origination policies and practices for housing and rural lending. For 2017, the Reserve Bank will undertake a Grant Spencer thematic review to gain insights on Deputy Governor and The Reserve Bank’s approach attestation approaches and governance Head of Financial Stability to banking sector regulation and arrangements for New Zealand Reserve Bank of New Zealand supervision is heavily focused on incorporated banks. ensuring that bank directors and senior managers have the right The requirements for directors to sign incentives to manage their bank’s off on their banks’ quarterly disclosure risks (self-discipline), and ensuring statements enhance the effectiveness that market participants have the of self-discipline and market discipline, appropriate information, incentives by strengthening the accountability and mechanisms to influence the of bank directors and increasing the behaviour of banks in a way that also market’s ability to assess the soundness contributes to a sound and efficient and performance of banks. Currently, banking sector (market discipline). directors are required to attest in the Grant Spencer is the Deputy Governor Where material market failures exist, quarterly disclosure statements that and Head of Financial Stability with the Reserve Bank relies on formal after due enquiry, they believe that: the Reserve Bank of New Zealand, rules and requirements to incentivise and is Chair of the OECD’s Financial —— the disclosure statement contains financial institutions to act in ways Markets Committee. all the required information, and is that align with the public interest not false or misleading; The Financial Stability function of (regulatory discipline). the Reserve Bank encompasses —— all of the bank’s conditions of We see the attestation regime as the three departments: Prudential registration have been complied key mechanism that supports and Supervision; Financial Markets and with over the accounting period of enhances self-discipline and, given Macro Prudential. Together, they the disclosure statement; how long it has been in place and the are responsible for formulating differing approaches adopted by banks, —— credit exposures to connected and implementing public policy to it is therefore timely to review how persons were not contrary to the promote and maintain a sound and it is working in practice. We will be interests of the bank over that efficient financial system. undertaking a thematic review of the period; and Grant has held executive positions regime in 2017, which is intended to —— the bank had systems in place to with the ANZ Banking Group in assess the effectiveness and scope of monitor and control adequately New Zealand and Australia, and the the attestation approaches adopted by the material risks of the banking International Monetary Fund (IMF) in New Zealand incorporated registered group, including credit risk, interest Washington DC. He has also been banks, and the processes that bank rate risk, currency risk, equity Head of both the Economics and directors use to fulfil their obligations risk, liquidity risk, operational risk, Financial Markets Departments within under sections 81 to 82 of the Reserve and other business risks over the the Reserve Bank. Bank of New Zealand Act 1989 (the accounting period, and that those Reserve Bank Act). systems are being properly applied.

The Reserve Bank has always been —— a desk-based review of clear that it places a heavy emphasis information provided by banks that on the role of self-discipline and supports and enables directors the critical nature of the directors’ to reach conclusions on the attestations in the quarterly quarterly attestations. disclosures, given that the Reserve The confidentiality of all information Bank does not either conduct onsite obtained will be protected under supervision or regularly require the provisions of section 105 of the independent verification of information Reserve Bank Act. provided by banks.50 This was a theme that received considerable attention It is expected that the review will from the International Monetary Fund provide a comprehensive view of best (IMF) during their recent New Zealand industry practice with regards to the Financial Sector Assessment role of bank directors, and the scope Programme (FSAP).51 and nature of their involvement in the attestation process. In particular, The thematic review of the bank the findings of the review could directors’ attestation regime will help contribute to future Reserve Bank us assess the effectiveness of this guidance for bank directors regarding distinct New Zealand approach. As their attestation obligations, and may such, its purpose is to: contribute to future refinements to a. assess the effectiveness of the Banking Supervision policy on 52 the director attestation regime Corporate Governance. established by the Reserve Bank of As with previous thematic reviews, the New Zealand Act 1989; and Reserve Bank will provide feedback b. improve the Reserve Bank’s to all banks on the general findings understanding of banks’ general from the review, including anonymised approaches to governance. examples of best practice across the banking sector. The review may The review will involve consultants also give rise to specific supervisory with expertise on bank corporate follow-ups where areas of concern governance, who will work alongside are identified. Reserve Bank staff. Between 8 and 12 New Zealand incorporated banks will be included in the review, which has a target completion date of 30 June 2017. A range of information-gathering tools is likely to be used, including some of the following: —— a confidential survey of bank directors; —— face-to-face interviews with a cross-section of directors and relevant senior management involved in the attestation process; —— discussion of bank-specific case studies where attestation obligations would be expected to be a material consideration; and

The transition to the Financial The conduct guide sets out that the FMA will take a risk-based approach Markets Conduct Act (FMC to conduct regulation. We do this by Act) is complete, 190 financial assessing which financial services services firms are licensed, providers, and what types of conduct, are most likely to pose risks to fair, and the FMA is now a fully- efficient and transparent markets – and fledged conduct regulator. For also harm investors and consumers. financial services providers, Then we’ll direct our regulatory attention and effort accordingly. from 2017 onward, conduct As we assess risk, our focus will be regulation is the new normal. on whether the financial services providers we regulate have the interest of their customers at heart. Because conduct is at the core of In particular, it will be on how they the Act, it gives weight to the FMA’s demonstrate a commitment to good Liam Mason existing statutory mandate to monitor customer outcomes in the delivery of Director of Regulation what financial providers do, and how their products and services. Financial Markets Authority they do it. So, it is important to be clear on how we will view and respond They recognise that sustainable to conduct. That is why we have just success is based first on published the final version of our 53 understanding the customer’s conduct guide, having considered need… then meeting it to the best submissions from a wide range of of their ability. firms from the financial services industry during the consultation period. The FIPS Survey is focussed on It is not just the FMA saying this and Liam leads and oversees the licensing performance, and for the FMA it taking this approach. Regulators in and supervision of all financial is critical to our strategy that we other parts of the world are saying it markets participants, from individual communicate our view that the too, as are the global contemporaries Authorised Financial Advisors conduct of financial services providers of the local industry including, in some through to KiwiSaver providers. He directly affects the consumers of those cases, their parent organisations. They is also responsible for the FMA’s services, and therefore, that affects all recognise that sustainable success compliance frameworks, contacts, New Zealanders. is based first on understanding the customer’s need (including helping and intelligence functions. High standards of conduct support them to determine that need), then fair, efficient, and transparent markets Liam has extensive experience meeting it to the best of their ability. in securities law and corporate and – a good result for all of us – governance matters, advising on the confident participation in those And of course it’s already second securities and financial services law markets of businesses, investors, and nature for many businesses to and policy, Crown entity governance consumers. This benefits our economy recognise the value of good customer and legal compliance. and the vigour and sustainability of service and relationship management financial sector performance. So, the – the overall promise of ‘customer transformation to focus on conduct, experience’. We have engaged with which is at the heart of the FMC Act the industry to help them understand – and in the FMA’s mandate – is also how what it is done for commercial commercially astute for the financial reasons can also, with not much services industry. adjustment, help to build more confident New Zealand investors.

In fact, in many cases, it is the simple These themes may not be new, but act of taking a corporate vision they are developing rapidly both at statement that sits on a plaque or home and internationally. An example poster near the lifts and putting it into is foreign exchange trading services effective practice on the front line. by overseas entities, and other unregulated products that operate Additionally, we are now engaging deliberately outside New Zealand’s with investors to make them aware of jurisdiction yet still manage to entice their entitlements under the FMC Act Kiwi investors or consumers. This and the minimum standards of service impacts our market integrity, and so and behaviour they should expect we will continue to warn investors when engaging with the financial about these non-regulated companies services industry. and take action where we can against We will focus on providers’ conduct any overseas companies that are through our intelligence-led using New Zealand’s good reputation supervision. So then, what does the for their gain. FMA see as potential drivers of risk across the sector? We have reviewed our foundation document, the FMA’s The benefits are worth pursuing Strategic Risk Outlook, and set out as long as the risks are the underlying strategic risks to appropriately managed. achieving our regulatory outcomes, including conduct. Although we recognise that new Strategic Risk Outlook 2017 technologies bring benefits to investors and business – more The FMA has also published its efficiency, lower business costs and updated Strategic Risk Outlook (SRO) better accessibility – the increased this month. The outlook describes the reliance on technology also brings consistency in our key priorities as risks. These include increased we shift from FMC implementation exposure to complex products for into operating as a conduct-based retail investors and data security regulator. While the seven priorities vulnerabilities. The benefits are worth have remained the same, there have pursuing as long as the risks are been developments to the underlying appropriately managed. So we are risks and drivers of risk. supportive of technological innovation We have also identified some in financial services and have developing themes that will remain on regulatory settings that are flexible our radar. These are: and modern in order to promote and accommodate innovation within the —— regulating in an environment of framework of the FMC Act. rapid technological innovation and change; We have introduced to the updated —— retail investor participation in SRO a deeper insight into the complex or risky products; influences we take into account in deciding what risks are present. We —— reviewing the boundary of our hope that this, and understanding how regulatory perimeter; and we will view conduct, helps financial —— helping investor decision-making service providers understand not only in changing market conditions. what we are focusing our resources on, but also the results we are aiming for.

In our last review, we Arguably, financial services have been most impacted by the Credit highlighted the raft of Contracts and Consumer Finance emerging legislation that Amendment Act 2014 (CCCFA) that was heading in the direction came into effect in June 2015. It strengthens consumer protection by of the financial services defining lender responsibility principles industry. That legislation is (Responsible Lending Code) around now in force, so what does affordability, providing customers with clear information and acting it mean for banking and ethically. In addition, the sector has most importantly, how is had to reconsider their fees in light the regulatory environment of new requirements around how fees are calculated and charged changing? We may find and the requirement that these the future could bring less are ‘reasonable’. Adele Wallace ‘black letter’ legislation, Amendments to the Fair Trading Associate Director – Advisory replaced with a shifting Act 1986 (FTA) came into effect in KPMG March 2015. These amendments focus towards overarching represent the implementation of principles based on new unfair contract provisions, customer outcomes with providing new rights for consumers Adele is an Associate Director in and obligations for businesses. KPMG’s Auckland practice specialising a strong ethical culture The requirements have triggered a in conduct risk. Adele brings valuable at the heart of business. number of organisations to launch insight and a rich range of experience extensive reviews of contractual terms in approaches to conduct risk across We discuss how you can and conditions across all products banking and general insurance go beyond the ‘legislative and draft new standardised terms through her extensive work in the and conditions. regulatory practice at KPMG UK and burden’ and instead, by her previous roles in the industry. harnessing the many drivers Additionally, November 2016 signalled the end of the licensing process for improving consumer that began two years ago as part of outcomes, can create wider financial services reforms to innovation and opportunity regulate the industry further. All fund managers, discretionary investment in the market. management service providers and derivatives issuers must meet new governance and capability standards The financial services industry has under the Financial Markets Conduct recently seen a significant increase Act 2014 (FMCA). in both legislation and regulation and Now that we have emerged from the industry is increasingly feeling the this flurry of legislative change, we pressure. Both 2015 and 2016 have can reflect on the drivers behind been busy years for legal, risk and their inception. It isn’t hard to see compliance departments, so we take that this legislative activity signalled a look at some of the changes and a championing of the consumer consider some practical considerations and a concerted effort by regulators for implementation. to improve the behaviours and interactions that companies have with their customers.

But regulatory reflections have Instead, organisations will be asked revealed an interesting contradiction. to demonstrate how their culture and Despite global increases in consumer- conduct consistently deliver good based legislation and regulation aimed customer outcomes. They will need at improving consumer experience, to provide evidence-based positive instances of misconduct continue. assurance that they are achieving Arguably, instances have actually good customer outcomes, rather than increased, which has driven a relying on simple negative assurance. deterioration of trust and customers’ To many organisations and their perception of the value they get from risk advisors, the departure from their financial services provider. the simple interpretation of black- letter legislation and reasonably Moving towards change in fluid regulatory expectations has culture and conduct caused some discomfort and Increasing the extent and coverage uncertainty. How should you go about of legislation and regulation has understanding your organisation’s failed to stem the tide of poor culture and changing it? Who should customer outcomes. The inherent take responsibility and where in the culture in firms and focus on profit business should the change be driven? and shareholder value rather than Are there instances of misconduct that customer outcomes are being seen you simply don’t know about and what as potential root causes. As a result, is driving this? we are seeing regulatory approaches take a more holistic view of the entire Success is all about organisation and a renewed focus on customer-centricity and improving organisational culture and good customer outcomes individual conduct. To succeed during this period, There has been a groundswell of organisations will need to change their discussion and interest around view of ‘compliance’ from a burden ‘conduct and culture’ around the that simply needs to be ticked off or globe with the UK’s Financial Conduct perfunctory adherence to regulation Authority taking the lead. Closer to and instead consider good conduct home, the FMA have recently released and positive customer outcomes a consultation paper on their view of as the ‘way things are done in conduct and how they will consider this business’. conduct in their supervision of providers. The consultation states that “Good conduct is vital to fair, efficient We see the focus on good conduct and transparent markets, and ensures as a key driver of innovation which the confident and informed not only ‘future proofs’ a business participation of businesses, investors … but which also strengthens and consumers.” In Australia, APRA the overall market and increases have released their insights into risk perceptions of integrity, building culture, and Australian Securities and consumer trust and creating Investments Commission’s rhetoric is brand advocates. strongly levelled at firms’ culture and tone from the top. As the international landscape continues to evolve and mature, we can expect further changes to the domestic landscape, but this is unlikely to be driven by the ‘black letter’ legislation that we have seen in recent years.

Organisations that are succeeding They are ensuring that customer- Conduct risk are taking a holistic view and centricity is at their heart of everything really examining their strategies they do, starting at the very top of the Conduct risk is the risk that and business models. The world organisation and embedded into their strategic business decisions is changing fast, and customer business models, training, product negatively impact on the ultimate expectations are increasing, so design and performance management. customer. Usually, these are these businesses are harnessing the At the same time, they are starting decisions that are made quite drive for change and taking a wider programmes which change the overall early in the value chain, for view by focusing on their longer- culture and measuring that customers example, in strategy setting and term strategies and strengthening are getting real value from their core product design. Conduct is all relationships with customers business offerings. about balancing the financial rather than simply on short-term Organisations may be missing interests of the company with the profit increase. a significant opportunity for needs of the customer and driving These are organisations who have improvement by innocently believing trust and sustainable income by realised that being customer-centric that they have a positive culture being more customer-centric. not only makes good business sense, and conduct environment. Clearly, but it is absolutely at the core of their businesses don’t overtly decide business model and the source of that their strategy will be to mislead Culture future growth. They have identified customers; however, our experience Culture is what drives day-to-day that good culture and conduct is a is that sometimes poor customer behaviour. The accumulation differentiator in an industry where outcomes are inadvertent or an of years of corporate history products and pricing are very similar, unintended consequence of a decision and the messages that senior and they are starting to stand out made much higher up the value chain, leadership drive through the for all the best reasons. We see the and usually this is because there business, either through their focus on good conduct as a key driver has failed to be a clear analysis or own behaviours or expectations, of innovation which not only ‘future understanding of the potential risks to that form part of the attitudes and proofs’ a business where new Fintech customers as a result of a decision. players, digital disruptors and peer-to- beliefs around the organisation It is clear that this absolutely starts at peer entities are starting to take market as to what constitutes expected the top and the drive for change has to share by focusing on ethical behaviour performance. Organisations may come from senior leadership and has and delivering to customer needs, but believe that they have a strong to permeate through their decisions, which also strengthens the overall system of controls to prevent behaviours and expectations, market and increases perceptions of inappropriate behaviour, but continually setting an example for the integrity, building consumer trust and culture has a huge influence whole of the organisation. on an employee’s course creating brand advocates. of action when faced with Regulation is certainly one aspect of competing priorities. Change is driven from the pressure to improve customer the top outcomes, but it’s clear that failing to move at pace to harness the myriad Successful businesses are reviewing of other drivers: changing customer and re-evaluating their strategic Risk culture expectations; employee satisfaction; priorities and their core business digital disruption; and increasing Risk culture is the way the firm models to identify the potential competition from Fintech entrants, identifies and deals with those risks to customer outcomes; they could mean that traditional providers risks. It is all about creating an are looking at a broad blend of data get left behind by failing to balance the environment whereby risks can and inputs to give them real insight. divergent interests of the customer, be identified and called out. They are talking to their employees employees, the company and the This includes having the right and their customers, looking at wider market. Now is the time to turn people taking responsibility for complaints and social media to see those risks into opportunities. risk, monitoring and managing where those moments of truth risks that are emerging, are, discovering where they aren’t and dealing with issues that delivering, identifying their root causes have crystallised. and defining what needs to change.

Turn risk into opportunity by harnessing customer centricity and the drivers of change

Digital disruption Social media Competition from new market entrants Level of customer advocacy becomes and Fintech are changing traditional @ more visible. Increased opportunities distribution models. for client interaction.

Customer expectations Regulatory intervention Customers desire transparency and Sustained regular and government

simple products that perform as expected. $ investigation increases the risk of fines Trust in banks is at a low. and unsustainable strategies.

EXTERNAL DRIVERS Innovation

Sustainable business model Pressure for change Customer advocacy Employee Employee satisfaction

DIVERGENT INTERESTS

Company Corporate effectiveness and efficiency

People Employee Client Customers development satisfaction and reward and needs

Society/ Shareholder Regulator Shareholder Contribution returns to society

The relief for many in the primary sector was palpable in the last quarter of 2016 as Global Dairy Trade (GDT) auction after GDT auction delivered sizeable price gains. The GDT index finished the year 67% above its low point on 5 April 2016. This has driven in a welcome increase in farm gate milk prices after a number of tough seasons, Ian Proudfoot but leaves some big questions Partner – Audit hanging over the future Global Head of Agribusiness direction of the dairy industry. KPMG

Ian joined KPMG in London in 1992 For farmers, higher prices mean a transferring to the New Zealand firm return to profitability and stronger in 1996. Ian is the leader of KPMG’s cash flows. For some, this delivers the Agribusiness group in New Zealand, ability to restart their lives, having cut and Global Head of Agribusiness for everything but the bare essentials of the firm. He is author of the KPMG life to the bone to survive the last two Agribusiness Agenda, a publication years. The sense of relief for suppliers that, since 2010, has addressed the to the industry is almost as great, industry opportunities and challenges because banker’s price increases in New Zealand. reduce the emotional and financial challenges of managing distressed Since the publication of the KPMG loans and deliver opportunities to start Agribusiness Agenda, Ian has supporting customers to grow. presented to numerous companies and industry groups on the strategic challenges facing New Zealand’s primary industries. He is currently researching KPMG’s Agribusiness Agenda for 2017.

Building a platform for a The opportunity to grow high value I fear that the momentum for structural stronger industry crops or raise alternative animals change will slow until a time (which on the Canterbury Plains to secure may not be too far into the future) The last three years have been tough premiums available globally for novel that we again see cyclical commodity for dairy farmers, for many they will products gives farmers more choices prices falling and the need for change not recover the equity that has been over land use than they have had comes back into focus. lost until we are well into the 2020s, for decades. but I believe the industry has built The only problem with delaying change the foundations for a stronger future. There has also been some good is that the rest of the world is moving Having come through the last few progress on seeking to monetise the forward regardless of what we choose years bruised, but with a reinvigorated unique attributes of our dairy system. to do or not to do in New Zealand. desire to compete, the right decisions Synlait Milk’s grass fed products We are a small player in a large global now will enable the dairy sector to for Munchkins in the US are a good system that is growing at faster rates capture more of the value it grows in a example of recognising that others will than we are. This makes our traditional rapidly changing global market. place financial value on what we have role in the market less relevant. As historically taken for granted. Lewis new export competitors emerge, new Road Creamery has demonstrated forms of milk are commercialised Many farmers… have been forced to that there is a place in the market for (we expect a cultured milk product to focus on the fundamentals of their innovative, premium products. They be commercialised during 2017, for business. have also showed that these can be example, natural milk grown without successfully commercialised without the environmental and welfare the overhead burden that traditional challenges associated with animals), Inside the farm gate, many farmers stainless steel infrastructure places on governments support their domestic operating today have never had to a business through the use of modern, producers to deliver food security, and face the challenge of such a sustained flexible business models. consumer preferences evolve, we run period of low prices. They have been the risk of being left behind if we do forced to focus on the fundamentals not respond effectively. of their business. In particular, they There has also been some good have learnt which costs have a direct progress on seeking to monetise nexus to growing a better product, and the unique attributes of our It is critical that we recognise a as a consequence, offer the potential dairy system. price recovery driven by an upswing to earn a higher return. Many farming in commodity prices means nothing businesses are run more effectively of substance has changed. today than they were three years ago. These developments suggest that more people clearly understand what I also believe that there is increasing the pathway looks like to develop a It is critical that we recognise a price acceptance that simply growing dynamic, flexible, high performance recovery driven by an upswing in more volume is not the answer to dairy industry that is increasingly commodity prices means nothing of growing value. Many argue that we sheltered from commodity substance has changed. Prices are have, as a consequence, reached price movements. doing what they have always done and probably passed peak milk – responding to demand and supply production. Tightening environmental conditions rather than reflecting regulation and changes in community We should never forget we a material shift in the strategy of expectations will make future dairy are not alone the industry. We cannot afford to farm conversions more difficult. As a However, I am not hopeful that the be complacent to expect this price consequence, discussions are starting industry will continue its progress recovery to be any more permanent on how land, irrigated during the dairy towards capturing its potential as than previous price recoveries, boom, can generate higher returns price pressures reduce. For many, particularly as supply can be dialled up from the access to water in the future. unrelenting low prices highlighted the faster today than was possible in the need to shift away from commodity past to take advantage of peak prices markets to deliver more consistent, (something that is already apparent, sustainable returns. There is a strong with the US milk pool already starting correlation between high prices and to grow in response to the recent comfort with the status quo. price increases).

Commodity price movements must The industry needs to address how Correctly scaled production, open not deflect the industry from taking it invests as a priority to avoid being communications and the best the steps that need to be taken to challenged by the same overcapacity technology will not deliver an cement its future as the world’s issues that have beset the red meat additional dollar to the farm gate if leading artisan producer of nutritious, sector for 20 years. we do not understand our consumers sustainable, grass-fed dairy products. and their dreams, aspirations and Recognition of the need to have open problems properly. It is only through channels of communications with deep connectivity with the people What does that change all stakeholders is critical. Premium that will ultimately consume the food agenda look like? consumers want to understand who that we produce that we can create My view is that everything must is producing their food, what their the products that solve the problems start with the ultimate consumer of values are and how they bring those they face on a day-to-day basis. As our products and the need to design values to life through their business. a consequence, I believe the most and deliver the products that will fit They also seek assurance about how a important investment the industry can within their lifestyles and shape the product’s integrity is maintained across make is in becoming more connected health outcomes that they are looking the supply chain and confidence that with their consumers, by having more to achieve. the product they buy is the product people embedded into the places that we sent. This means the industry This means we need to be growing their consumers live. needs to be open in telling its stories less milk (most probably a lot less milk) and about the opportunities to do to provide processors with a greater better. It also needs to invest in the ability to produce and deliver these The farmers that want to be part platforms that provide consumers value-added products. This is a major of a value chain that rewards them total confidence over the integrity of change for an industry that has used for doing the right things will make the products they purchase. Product volume growth as the key benchmark a difference. assurance is only one aspect of the to measure its success. To achieve an digital transformation facing the optimal supply position, it increasingly primary sector. The fusion revolution feels like the time is approaching There is not a single prescription (where digital, physical and biological for the repeal of the Dairy Industry that will work for every organisation. technologies are being fused to Restructuring Act and its obligations Each organisation will follow its own create disruptive new solutions) is which sustain uneconomic and strategy, appropriately balancing a transforming every aspect of agri-food environmentally marginal supply. desire for return with the risk that it is businesses. From the augmentation prepared to take on. It is clear from our of a farmers intuition through data discussions that there are those that The industry needs to address and analytics, to the mechanisation of aspire to catch significantly more of the how it invests as a priority to avoid tasks utilising robotics and unmanned value they grow and as a consequence being challenged by the same vehicles and the use of blockchain they are looking to shake up the value overcapacity issues that have beset to provide confidence over product chains they are currently part of. the red meat sector for 20 years. integrity, the primary sector faces a significant period of investment; into The farmers that want to be part of both the technology, and the people a value chain that rewards them for doing the right things will make a It also means that there needs to needed to operate them, if it is to difference. The researcher with an a significant reassessment of how capture the opportunities available in innovative consumer solution will the industry deploys capital. It is the market. make a difference. The digital analyst investment into brands, consumer with a game changing algorithm will experience, and world class innovation The fusion revolution… is make a difference. It is these and other that will differentiate our products transforming every aspect of change agents prepared to stand up to in the eyes of a consumer and agri‑food businesses. complacency and do things differently secure stable and sustainable price that will shape the pace of change in premiums, rather than more stainless the industry. They will progressively steel processing plants on the ground. detach the industry from the peaks and troughs of the commodity cycle and accelerate the arrival of a more prosperous future for our country.

“The horse is here to stay Now we take for granted 24/7 access to banking services. While banks have but the automobile is only retained branch networks, the vast a novelty – a fad,” said the majority of banking transactions today Michigan Savings Bank are done through a range of other innovative channels. That includes president in 1903. He was being able to call your bank’s contact advising Henry Ford's lawyer centre from the comfort of your own not to invest in the Ford home, or anywhere else for that matter, seven days a week. If you’d Motor Company. rather not speak to a customer service representative, you can do most of your banking yourself, either at home on a computer, or on the go with a Where bankers may once have banking app on your smartphone. shunned technology, the opposite is true today. This century we’ve seen Banks are constantly improving the Karen Scott-Howman a massive leap in access to personal functionality of their internet and Chief Executive, digital technology. That’s clearly mobile banking channels. As well as New Zealand Bankers’ Association reflected in how we’re now banking. meeting your everyday banking needs, These technological advances mean online and mobile banking allows you we’re managing our money in ways access to a huge amount of the latest that many did not foresee. What’s information about your bank’s products behind these changes, and what does and services, financial capability the future hold? tools, and how they’re contributing to your community. The extraordinary evolution of banking today is largely driven by Karen leads NZBA’s commitment changes in customer preferences, Soon that wallet stuffed with as the industry’s voice to support a and competition both inside cards will be a thing of the past. It strong and stable banking system and outside the banking sector. will be possible to conduct most that benefits New Zealanders and the Banks have embraced technology of your everyday transactions on New Zealand economy. in the quest to provide an ever your smartphone. Karen has over 15 years’ professional more seamless experience for experience in senior roles in both the their customers. private and public sectors. Before As little as five years ago, the thought Remember the good old days? she became NZBA’s Chief Executive, of banking on your mobile phone We used cheques a lot more, and Karen was Chief Executive at the would not have occurred to most of made bank account deposits and Broadcasting Standards Authority. us. Now we can even make everyday withdrawals by visiting our local bank She has extensive experience as an payments using our mobile phones. branch, filling in handwritten forms; advocate on legal, regulatory and The age of the mobile wallet is here. all within civilised ’bankers’ hours‘ policy issues affecting the banking While contactless card payments from Monday to Friday. You might’ve industry from her previous positions still seem fresh and innovative, it’s found yourself caught short if you as Deputy Chief Executive and now possible to make contactless didn’t withdraw enough cash for the Head of Advocacy at NZBA, and as payments simply by waving your weekend. Bank branches were an Regulatory Director when she first phone over the payment terminal. essential part of every community for joined NZBA in 2009. The mobile payment app on your both households and businesses. smartphone holds your bank card Things started to change in the 1980s information, which is used to make when ATMs appeared. You could finally mobile payments. get cash on the weekend! Since then innovation in banking hasn’t stopped.

Mobile payment apps also have the That’s why bank branches remain an capability to store loyalty cards, public important banking channel. While the transport cards and special offer look and feel of bank branches has vouchers. Soon that wallet stuffed changed over time, they still provide with cards will be a thing of the past. access to traditional banking services. It will be possible to conduct most The focus of branches these days, of your everyday transactions on however, is more on providing advisory your smartphone. services. Branches also help us to maintain a physical brand presence in Current innovations are propelling the communities that we’re part of. us towards banking that is seamless and integrated with other personal Customers overwhelmingly now technology. Nobody wants a prefer to use more convenient ways of mortgage; they want a home. Nobody banking, which means some branches wants a student loan; they want an no longer make commercial sense. education. In a similar way, banking They’re often replaced with smart is likely to become more focused on ATMs that can accept and count notes life events and personal aspirations, and coins, which are instantly available rather than financial transactions. as cleared funds in your account. Given the drive for seamlessness and Some banks are also providing digital convenience, it’s quite possible that educators, to help customers learn the future of banking means you won’t how to get the most out of online even realise you’re banking. banking services. Customers aren’t the only ones driving Current innovations are propelling changes in banking. Other digital us towards banking that is enterprises are challenging banks seamless and integrated with other in their own sector. They include personal technology. peer-to-peer lenders and alternative payment platforms. Once again, it’s about providing people with seamless This innovation in banking services and convenient financial services. has come in response to customer Banks operate in a very competitive demand and behaviour. In a highly environment, which is good for both competitive environment, we have our customers and the industry. We worked out that attracting and welcome the entry of the ’Fintechs‘ retaining customers is essential to because it encourages us to keep our success. To do that we need improving the experience of the to keep our customers happy. And all-important customers we seek to to keep customers happy, we’ve attract and keep. vastly improved access to banking services. Better access to banking It’s an exciting time for banks and their services mirrors the industry’s customers. We can enjoy innovations customer satisfaction ratings. The undreamt of even a few years ago, latest Consumer NZ banking survey while retaining traditional banking found that 86% of bank customers are channels. Banking as we know it satisfied with their bank. will continue to change over time, and customers will continue to drive While banks are constantly looking at those changes. what’s next in providing even better access to banking services, we’re also conscious of meeting the needs of all our customers.

Digital disruption: two words Artificial Intelligence and that, when combined, often Predictive Analytics = ‘Chat Bots’ stir anxious provocation. To illustrate the possible disruptive According to the KPMG 2016 opportunities and increasing Global CEO Outlook, 82% automation within banking and of CEOs are concerned that finance, we look at the emergence of sophisticated digital assistants, chat their current products and bots, built on artificial intelligence (AI) services may not be relevant and predictive analytics. One of the first publicly released banking chat to customers three years from bots is from Bank of America, named now. The root of the CEO Erica. Erica is meant to go live later apprehension may stem from this year, and banking customers will be able to interact using both text the speed of digital change. and voice. Steve Graham The difference with Erica is that she Director – Head of Digital Futures pushes ‘insightful’ information toward KPMG The exponential explosion of users based on a better understanding technology applications and the of what they want, rather than only assumption that digital solutions providing users with requested Steve leads KPMG’s Digital are the panacea for all the corporate (pull) information. practice, specialising in foresight, ills will only perpetuate the role innovation and design thinking. of digital disruption. Despite this He provides strategic foresight perpetuation, industry is being Some believe the future of banking and works with clients to develop is here now. future state frameworks and design disrupted by more than just digital outcomes based on stakeholder sources. Consequently, it’s important insights. Steve is also passionate to develop a comprehensive view AI is picking up momentum and, about organisational change of disruption that not only includes according to consulting firm Forrester, and the approach to systemic new technologies, but looks at new 6% of jobs will be lost to AI within the innovation adoption. business models, simplification of processes, competitive threats, next five years, exacerbating a fear customer behaviour and the within the banking sector of being left transformational mindset, which is behind. However, Forrester goes on critical to the way forward. to say that banks should avoid offering chat bots to customers for another two As the Head of Digital Futures at to three years, as they don’t think the KPMG New Zealand, I am of the view maturity of the technology is there yet. that successful financial firms will systematically develop plausible future Despite the Forrester prediction, state scenarios. Perhaps some of some believe the future of banking the trends that are highlighted in this is here now and is synonymous with article will contribute to the framing of the BankBot, a prototype application a transformed digital future. designed by the Polish digital design and communication agency K2. BankBot itself is a robotic bank teller, financial advisor, and personal assistant all in one. “It understands natural language, so you can ask BankBot to transfer money, open a new account, cancel a credit card, et cetera,” says Maciek Lipiec from K2.

K2 proposes a new banking standard. Start-ups with high levels of New mental models are critical to No more waiting in a queue for the automation, unconstrained by legacy the future of industry, in other words, administrator behind the desk to log IT systems, will be able to rapidly thinking in a new way. Albert Einstein on, find your details and check your pivot according to customer desire, said, “We cannot solve problems date of birth while simultaneously potentially attracting some of the most with the same thinking that created answering the phone. The administrator profitable customers from traditional them”. Outdated mental models are can now turn their attention to more banking firms. According to the intellectually bankrupting our future important or exceptional activities. popular business book Exponential economic prosperity, so the time to Organisations, by Salim Ismail, “New reimagine the future is now. organisations are ten times better, Simplification of The sheer pace of change and market faster and cheaper than yours.” transaction processes disruptions are forcing leadership Banking experts agree that there will teams to create a more structured way be significant cost reductions on the Lessons from to anticipate the future. The temptation horizon due to technology solutions other industries to remain focused on the certainty providing financial institutions with Long-established industries – of current operational approaches is simplified transaction processing. e.g. newspaper, photography and understandable, but ultimately will The elimination of old vertical practices music, have all been decimated by they prove to be strategically effective? and statistical modelling will be made technological change. Less high Perhaps this is why leaders worry so possible by highly effective algorithms profile industries have also been much about future relevance. based on AI, cognitive computing, digitally/technologically disrupted. Leaders must talk about the vision big data, Internet of Things (IoT) Author Jeremy Rifkin notes the of a digital future and recognise the and sensors. Anything predictable energy sector is in the throes of inherent possibilities that change or repeatable will be automated by being disrupted, highlighting that the brings. It’s also important to engage robots, leaving the human being to marginal cost of renewable energy is the disruptive thinkers within your other forms of work. zero and therefore energy eventually organisation. Management guru Gary becomes free. As this scenario Hamel has said that young people, unfolds, the impact on traditional dissidents and those working on the Anything predictable or repeatable revenue is significant. In Germany, geographic and mental peripheries will be automated by robots, in less than seven years 25% of of your organisation are the most leaving the human being to other electricity is now green electricity. interesting, free and open thinkers. forms of work. How? A million buildings are using Look for rebels. The good news is that technology to convert to micro power they won’t be difficult to find and they plants. Germany is now producing can be excellent participants in the significant ‘free’ energy, decoupling Change in competition development of future scenarios. from the traditional grid and breaking The innovative Fintech space is ‘hot’ the reliance on the multi-billion dollar The need to embrace uncertainty and and underpins the disruptive nature of global power and electricity companies drive the strategic conversation is change supported by new business – e.g. E.ON, EnBW. Did they anticipate now more vital than ever. A strategic models. Additionally, digitally focused the speed of change and erosion foresight framework provides the organisations with strong balance of market share? Which disruptors structure to achieve this. It enables sheets and significant networks of loyal will break the reliance on traditional leaders to explore future worlds, customers – e.g. Apple, are potential banking services? develop a collective understanding of competitive threats in the banking preferred future state scenarios and and finance space. Alibaba is already a The way forward challenge existing assumptions. competitor. Despite being recognised as the world’s largest e-commerce How do we govern amidst continuous You may also choose to do nothing, business, the Chinese company went technology change and the need for and as one of my favourite cartoons public and raised billions of dollars transformation? What can we do to illustrates: “Instead of risking anything through the largest initial public prepare ourselves? How do we lead new, let’s play it safe by continuing our offering in history within the US in in a volatile, uncertain, complex and slow decline into obsolescence!” 2015. Alibaba has established an all- ambiguous emergent future? digital online bank, with no physical branches and 24/7 operating hours.

Interest in blockchain technologies is growing rapidly if measured by the total value of venture capital investment in blockchain technologies and Bitcoin (a new form of digital currency) companies. This interest in distributed ledger technologies is remarkable given that five years ago, it was barely a blip on investors’ radars, known mostly for

Mike Clarke underpinning the Bitcoin Partner – Head of IT Advisory digital currency. KPMG

Interest in blockchain Mike leads KPMG’s IT Advisory gaining momentum practice in New Zealand, which is These days, a wide range of focused on IT Transformation to help companies are exploring blockchain organisations build the IT capability as the potential solution to numerous they need to meet their business ambitions. Having previously been a challenges both inside and outside the CIO, he brings a practical perspective banking sector. During 2015, Citibank, to the challenges of transformation Santander, Wells Fargo, HSBC and and is excited by the potential of numerous other big banks announced digital platforms and emerging partnerships with Fintech companies technologies such as Blockchain. looking to leverage blockchain to make banking processes more efficient, timely and secure. Other organisations such as the Australian Stock Exchange have been public about their blockchain initiatives.

These organisations, along with a Corporate investors need to qualify What is blockchain number of others, believe the potential their expectations when it comes disruption blockchain could create – in to blockchain and the obstacles technology (also terms of decreasing transaction times, associated with achieving value. The known as distributed self-automating smart contracts, technology is not a silver bullet that lowering transaction costs, minimising can solve every problem tomorrow. ledger technology)? fraud and opening the door to micro- As with every technology, blockchain The description below is from transactions – is impossible to ignore. solutions will need time to be tested Blockgeeks.com. As a result, interest in blockchain is and to be adapted to the industry gaining momentum, with investment requirements at scale. We already see Picture a spreadsheet that is expected to grow throughout 2017. early adoption in some payments use duplicated thousands of times cases, but as the complications grow across a network of computers. with asset transfers, for example, Then imagine that this network Being honest about the more time will be needed to qualify is designed to update this challenges with blockchain the technology and understand the spreadsheet regularly and you But does the potential live up to the full implications. have a basic understanding of hype? While blockchain’s potential the blockchain. is interesting, there are substantial To get the most value from blockchain, barriers that must be overcome in corporate investors need to encourage Information held on a blockchain order to implement it successfully industry experts to define the exists as a shared and continually within banking and capital markets. problems blockchain can help resolve, reconciled database. This is Regulatory and market changes, in find the best and most cost-effective a way of using the network particular, could hamper blockchain’s technology solutions, and work that has obvious benefits. The use on a global scale. Some analysts through any limitations to scope, blockchain database isn’t stored also suggest that blockchain has scalability, velocity and usability. in any single location, meaning been burdened with excessive the records it keeps are truly The key to success is the combination investor expectations – ones that public and easily verifiable. of the right skills: cannot realistically be fulfilled. At No centralised version of this the rate investment is growing, it’s information exists for a hacker —— cryptography; possible that investors looking for to corrupt. Hosted by millions of —— distributed ledger technology; immediate, short-term success may computers simultaneously, its be disappointed. —— deep industry and regulatory data is accessible to anyone on experience and knowledge; and the internet. —— technologists who can effectively Some cases where blockchain The technology is not a silver navigate clients through the current technology could be utilised are: bullet that can solve every IT landscape. problem tomorrow. As with every There are challenges in each of these —— smart contracts; technology, blockchain solutions areas when it comes to deployment —— governance; will need time to be tested and of distributed ledger solutions to to be adapted to the industry —— supply chain auditing; the mainstream components of the requirements at scale. —— prediction markets; banking system. —— protection of intellectual property; —— identity management; —— anti-money laundering (AML) and know your customer (KYC); —— land title registration; and —— stock trading.

For example, many banks continue to Now is the time for A balanced approach work with legacy IT systems, which experimentation Having said that, investors need to may not be capable of supporting Given how the technology is evolving, take a balanced approach to their blockchain initiatives or will provide at KPMG we believe that now is blockchain investment strategies. To significant challenges if linked to new the time for experimentation to be the disruptor investors envision, blockchain technologies. In the area understand the practical benefits. blockchain protocols and solutions of payments, the technology based Corporates that encourage use-case must evolve to support the reliability, on Bitcoin consensus mechanism testing – whether for the securities efficiency and scalability requirements consumes more computing power and trading lifecycle, the processing of expected in the industry. It also will require initially more resources a loan or digital identity verification needs to be a differentiator, rather than the current solutions used by – and whoever can learn from this than simply an enabler, and it needs many banks provide. Beyond these experimentation will be better to be adoptable by all parties in the technical challenges, there are some positioned to understand, possibly banking supply chain – a fact that will specific areas where fundamental adjust course and quickly achieve the require significant collaboration across issues relating to business models most value. industry, regulatory bodies and those need to be addressed. supporting potential solutions. In regard to testing, we see some In spite of these challenges, short- early examples of this trend taking In this regard, we see many term blockchain opportunities do hold in the marketplace. A great organisations and engineers now exist, and there remain many reasons number of the major financial services undertaking deeper analysis on to continue to pursue innovation in institutions we work with have proof of blockchain and a more balanced and distributed ledger technologies as concept (POC) and prototype initiatives pragmatic view emerging. We see the potential benefits associated with underway related to blockchain. ourselves as part of this group and a breakthrough down the road are Larger financial institutions are now advocate for selective and targeted great. One area we see the technology considering how to test for scalability, experimentation as a first priority offering particular benefit in the short validate initial hypotheses, build that will yield greater benefit down term is digital identity, or what others longer-term target operating models the road. are calling a digital financial passport. and enhance business cases based on Many banks are excited about this their POC/prototype results. opportunity and can see positive improvements related to how digital identity is currently being facilitated Corporates that encourage use-case and enabled at banks. Improvements testing – whether for the securities in this area could enable better choice trading lifecycle, the processing of and portability of customers between a loan or digital identity verification financial institutions and ultimately – and whoever can learn from this higher customer satisfaction as experimentation will be better individuals are able to take control positioned to adjust course and over and gain benefit from their own achieve the most value. identity. Beyond digital identity, there are a number of other important niches where blockchain could make early We are also seeing work being done gains as well. related to enhanced international payment capabilities as well as the application of distributed ledger principles to needs for identity management and other areas. It is clear that the move to test and experiment with distributed ledger technologies is well underway in financial services.

The implementation date of The US Financial Accounting Standards Board (FASB) and the International IFRS 9 is fast approaching Accounting Standards Board (IASB) for registered banks in originally embarked on a project to New Zealand. IFRS 9 Financial have a single set of standards on financial instruments accounting. Instruments is expected to However, due to divergence on certain be one of the most significant aspects of the project, particularly standards to impact bank impairment, this was not achievable. financial reporting since The IASB published the complete version of IFRS 9 on 24 July 2014 the introduction of IFRS which was adopted by the External in New Zealand. Banks in Reporting Board (XRB) in New Zealand New Zealand should now have on 4 September 2014. However, the macro hedging project that at least commenced their deals with the portfolio interest rate Rajesh Megchiani assessment of the impact of hedging carried out by banks is still Director – Financial Risk Management IFRS 9. Through this process, being finalised by the IASB. Until KPMG the completion of this, banks have gaps relating to systems, an accounting policy choice under data and resources should be IFRS 9 to continue applying the hedge identified and a roadmap for accounting requirements under Rajesh leads KPMG’s financial IAS 39. instruments accounting advisory implementation developed. practice and has an in-depth Implementation status – understanding of the practical globally and in the region implications of IFRS 9 on the financial services sector. Rajesh has In this article, we discuss the Globally, banks have begun significant experience in advising implementation status of IFRS 9 to significantly intensify their clients on implementation of IFRS 9 projects globally and in the region. implementation efforts towards the and its interaction with treasury We have also highlighted some of adoption of IFRS 9. A number of risk management strategies and the practical challenges that banks large global banks are well into their regulatory capital. He sits on KPMG’s face and how they are rising to implementation projects, but equally, financial instruments Asia Pacific these challenges. there are many who still have much topic team which discusses IFRS 9 work left to do. Almost all banks feel implementation issues in the region Background to IFRS 9 and that they have less time for a parallel and is able to bring practical insights current status run than they originally anticipated. This is a bit of a concern as management to dealing with some of the complex IFRS 9, the new financial instruments may not have adequate time to assess issues financial institutions deal with. accounting standard, will replace the drivers for difference in the level of IAS 39 Financial Instruments: provisions when compared to IAS 39. Recognition and Measurement and is effective for annual periods beginning on or after 1 January 2018. Globally, the regulators are very The IAS 39 replacement project was active in the IFRS 9 space. largely driven by requests from the G20 following the global financial crisis, to reduce the complexity of accounting for financial instruments and to move to a more forward-looking model for the recognition of expected losses on financial assets.

In New Zealand, most of the Impairment is on top of the Although IRB banks can leverage from larger banks have the advantage agenda and will have an the expected loss modelling currently of relying on the IFRS 9 projects uneven impact on banks carried out under Basel, we can see run by their parents. However, care that operationally there are differences Most of the time and effort on the should be taken to ensure that the between Basel’s and IFRS 9’s IFRS 9 projects globally and within impairment models developed for ‘expected loss’ concepts which the the region is being spent on the the New Zealand entities adequately IRB banks will need to work through. impairment aspects. This is consistent reflect the impact on the specific The banks that are using the IRB with the fact that this area is probably characteristics of their portfolio in approach are Australian subsidiaries the most complex within the standard the context of the New Zealand where most of IFRS 9 impairment and difficult to interpret. IFRS 9 is economic environment and that local model design work is being carried out a principles-based standard and management is able to understand the by the Australian parent. generally does not prescribe specific differences between the regulatory details on methods of application. and accounting expected loss models. Hence, selecting techniques and For the other banks that do not have The availability of quality data and estimating credit losses to develop or the advantage of relying on their resources for implementation of change existing regulatory expected parents to provide a solution, there is a IFRS 9 is a significant concern for loss models involves a high degree of relatively different challenge ahead of standardised banks. management judgement and methods developing expected loss models that may vary between institutions. Strong meet the requirements of IFRS 9. governance and controls would be Standardised banks face a different expected in the way judgement challenge as the impairment for There are significant disclosure is exercised, with the oversight regulatory capital purposes is based implications of the standards. of the board audit committees on current ‘incurred loss’ accounting throughout implementation. provisions under IAS 39, and hence any increase in the level of provisions Globally, the regulators are is likely to have a direct impact IFRS 9 is a principles-based very active in the IFRS 9 space. on their regulatory capital ratio. standard and generally does Prudential, securities and audit Standardised banks may also be at a not prescribe specific details on regulators are watching very closely. disadvantage as they don’t currently methods of application. They are expecting robust, high- have the systems and models to quality implementation of the new calculate expected loss like the IRB requirements and transparent banks. The availability of quality data The financial and operational impact disclosure of the impacts. and resources for implementation of the new impairment requirements of IFRS 9 is a significant concern for There are significant disclosure on banks in New Zealand will differ standardised banks. IFRS 9 does implications of the standards. depending on whether they apply result in standardised banks having to However, most of the banks standardised or internal rating based put in complex expected loss models are currently more focussed on (IRB) approaches for calculating that, although they do not need to be determining their impairment regulatory capital. accredited by most regulators, will still methodology than on the related Banks using IRB already use an need to meet the requirement of the disclosures. The qualitative and expected loss approach, and hence accounting standards which are not quantitative disclosure requirements the impact on capital may be minimal. as prescribed as Basel and hence will have extensively increased, and However, these banks may be be challenging. banks will soon need to design grappling with situations where the these new disclosures and identify IFRS 9 expected losses may exceed gaps in the data that would need the expected regulatory losses during to be filled to meet the new an economic downturn, as IFRS 9 disclosure requirements. applies the ‘point-in-time’ approach compared to ‘through-the-cycle’ approach required by Basel.

…but other aspects of IFRS 9 With respect to the new hedge However, before the benefits of IFRS 9 should not be missed accounting requirements, due to the can be realised, the road towards the deferral option available for banks, January 2018 deadline appears to be Beyond impairment, banks this is not an area many banks have very bumpy. have realised that they cannot focused on, and they are waiting for underestimate the impact of the macro hedge accounting project to classification and measurement Interaction with regulatory be finalised. However, banks that do aspects of the standard. Classification stress testing and see volatility in the income statement of financial assets will be based on the capital planning under IAS 39 should consider whether type of contractual cash flows and the The Bank of England recently made an there are opportunities to remove business model for managing those announcement that all banks would or reduce this under IFRS 9 which assets. Banks should evaluate the have to calculate their 2017 stress- is aligned more closely with risk terms of their existing financial assets, test results and capital planning under management strategies, for example, particularly loans and investment IFRS 9, which is believed to cause a hedging of aggregated exposures and securities, to ensure that they are larger hit to capital. However, it still hedging using cross currency interest classified and measured appropriately. indicates banks will soon need to rate swaps. In some instances, certain financial be ready to build the requirements assets that were previously measured of IFRS 9 into their existing stress at amortised cost are now required Opportunity to align finance testing and capital planning models. to be measured at fair value, which and risk data It is a matter of time before the stress will introduce volatility in the income Successful implementation of this testing and capital planning carried statement. Banks should also ensure standard will require leadership by out in New Zealand will need to that their new product approval both the CFO and the CRO to ensure incorporate the impacts of IFRS 9. process takes into consideration the that the impact of the standards implication of the new classification is well understood and can be and measurement principles of IFRS 9. articulated to stakeholders. A number The need to engage with IFRS 9 Some examples of features that of organisations, both globally and becomes more pressing by the day. banks are considering may impact the locally, are looking to use this as classification and measurement are an opportunity for risk and finance as follows: prepayment options where data aggregation. The need to engage with IFRS 9 the penalty for prepayment does not becomes more pressing by the meet the reasonable compensation day. Banks that have not yet started criteria of IFRS 9 and insurance The road towards the January 2018 considering the implications should bundled loan products. In addition, deadline appears to be very bumpy. start straight away, and banks that new processes may need to be put in have IFRS 9 projects in place should place to assess the business model ensure that their plans are on track under which financial assets are held. If successfully implemented, it will to address the key challenges and For example, principles need to be encourage the finance and risk evolving interpretations of IFRS 9. established for sales within the held- departments at financial institutions, to-collect business model under which who had historically operated investment portfolios are held, and somewhat in silos, to move towards processes need to be put in place to convergence and start using the same monitor these sales. underlying assumptions, practices and calculations to model future events. In the long run, it will hopefully lead Banks have realised that they to increased transparency for the cannot underestimate the impact stakeholders who will be able to get of classification and measurement a more accurate understanding of the aspects of the standard. underlying risks of a bank through the financial statements they receive.

Having collected real estate REINZ is fortunate that REINZ Chairman, Dame Rosanne Meo, has data for more than 25 years, an existing working relationship with the Real Estate Institute of head of Motu and former chairman New Zealand (REINZ) holds of the RBNZ, Dr. Arthur Grimes. Dr. Grimes has a good understanding an invaluable set of house of REINZ and current methods price information. Over recent to measure housing activity. He years REINZ has invested in understood the potential held in REINZ data and kindly introduced significant improvements and the REINZ team to Bernard Hodgetts innovations in data capture to and the Macro-Financial Team at the ensure this data was being RBNZ. Through this introduction, a partnership was formed to do an leveraged to add value to its empirical analysis on HPI methods members and the industry. using REINZ proprietary data. Bindi Norwell In 2016 REINZ partnered The RBNZ reviewed four of the most Chief Executive with the Reserve Bank of common methodologies used globally Real Estate Institute of New Zealand to create a HPI which included: New Zealand (RBNZ) to sale price assessment ratio (SPAR), enhance their existing House hedonic, repeat sales and stratified Price Index (HPI). median. All methodologies could have produced a reasonable result. However, the SPAR methodology proved to be the most accurate and flexible when Measuring house price trends is a data from all areas of the country were vital part of New Zealand’s economic considered. It displayed the lowest agenda and with housing typically month-to-month volatility, it was not being one of the largest investments subject to modelling changes over time people make in their lifetime, and provided robust measurements fluctuations in prices are important to of underlying house market values. help track and understand underlying As shown in Table 8 on page 75, market activity. This inevitably impacts Bindi is an experienced business a person’s perspective of how the on household wealth, and therefore, leader and strategist who has worked market is moving, and to what degree has a trickle-down effect to other in New Zealand, Australia and the it is moving, is highly influenced by areas of the economy. Figure 24 UK. She has a strong background whether they observe median price looks at the Tauranga City market in digital media and technology and movements, average price movements over time. It shows how the tough most recently, Executive Director or the movements of a HPI. For an economic environments of the early of TNS Global, a customer and accurate representation of underlying 2000s and the Global Financial Crisis marketing insights-based consultancy market forces, we advocate using were captured more completely by working with a diverse network of the REINZ HPI as it incorporates not the HPI than the raw median price. New Zealand Companies. only the market factors that influence The housing market is constantly changes in sales price, but also the Since commencing her role as CEO in the media spotlight for this very market factors that influence the in December 2016, Bindi has been reason and it is essential that the underlying value of the properties getting to know REINZ members, key fundamentals behind the tools being sold. industry stakeholders and partners. used to measure this sector are the Bindi has also been involved in best available. strategy, research and preparing This analysis was the first time the launch of some of REINZ new that the RBNZ had utilised such products and services. a rich data source to compare 24 SEE FIGURE 24 – PAGE 77 • common methodologies.

TABLE 8: YEAR-ON-YEAR PERCENTAGE COMPARISON: AVERAGE VS. MEDIAN VS. HPI – BY COUNCIL54

Auckland City Christchurch City Tauranga City Wellington City

Average Average Average Average Date sale Median HPI sale Median HPI sale Median HPI sale Median HPI price Yo Y Yo Y price Yo Y Yo Y price Yo Y Yo Y price Yo Y Yo Y Yo Y Yo Y Yo Y Yo Y

2010 November 2.8% 2.9% 0.0% -1.4% 1.2% -1.4% 2.4% -4.7% -3.1% -0.3% 1.2% -1.4%

2 011 November 0.0% 3.7% 7.2% 10.6% 6.4% 4.2% -1.1% 0.8% 0.2% -5.6% -3.1% -0.8%

2012 November 14.4% 12.6% 11.9% -1.3% 4.3% 6.5% -1.5% -1.5% 2.6% 9.5% 6.4% 3.1%

2013 November 7.4% 8.3% 13.0% 10.8% 6.7% 10.6% 8.4% 8.4% 4.7% 5.0% 5.2% 1.9%

2014 November 13.6% 13.6% 11.8% 10.7% 11.0% 7.1% 6.8% 7.7% 2.7% -1.7% -1.3% 1.2%

2015 November 13.0% 8.6% 21.9% 0.8% 1.5% 1.7% 18.7% 17.5% 26.0% 3.5% 4.8% 8.1%

2016 November 20.8% 17.4% 12.2% 3.7% 2.5% 4.1% 28.3% 26.0% 21.5% 16.4% 16.9% 23.5%

Collecting unconditional sales data The ability to disaggregate an By further leveraging the data from 14,000 REINZ members is one index enables users to have more available, the enhanced HPI is of the clear advantages of REINZ data, confidence in the trends reported a quantum leap in the level and it is more timely than council provided as outliers are managed and one-off frequency of housing market reporting, sales information and data. REINZ now items that can skew data are removed. bringing New Zealand in line with has a HPI which is world class with It also presents reports that contain world class standards. the benefits of timeliness, accuracy of a higher level of market intelligence The new HPI is the tip of the iceberg using up-to-the-moment data and the investigating a deeper level of for REINZ. The level of insights stability provided by having a national market activity. available will add tangible benefits to data set that is 25 years old. With the our understanding, and New Zealand’s enhanced REINZ HPI process it is understanding of the housing market. possible to generate an index specific 25 SEE FIGURE 25 – PAGE 77 to custom parameters, subject to the We are excited about sharing our data population being large enough. enhanced HPI with our members, For example, it is possible to generate • banks, economists and the public, to an index for three bedroom houses help make better informed decisions in a suburb in Auckland. This flexibility REINZ are providing the new HPI on the shape of the New Zealand makes the REINZ HPI highly valuable as a complimentary service at a housing market. in market analysis. council level. Figure 25 shows another example of this flexibility with an index generated REINZ takes pride in its innovations for council wards within Wellington, in property data to maximise value to although this could be any geographical its members, key stakeholders and boundary or property attribute, such as the Real Estate Industry. bedrooms or school zones.

REINZ HOUSING PRICE REINZ HPI MEDIAN SALE PRICE 24 INDEX TO MEDIAN SALE 2,600 $750,000 PRICE: TAURANGA CITY55

MEASURE TYPE 2,200 $600,000

REINZ HPI (LHS)

MEDIAN SALE PRICE (RHS) 1,800 $450,000

1,400 $300,000

1,000 $150,000

600 $0 SOURCE: REINZ 2000 2002 2004 2006 2008 2010 2012 2014 2016 Date (as calculated in December)

REINZ HPI FOR WELLINGTON WELLINGTON INDEX VALUES 25 WARDS: TO DECEMBER 201656 27,500 25,000

WELLINGTON WARDS 22,500

EASTERN 20,000

LAMBTON 17,500 15,000 NORTHERN 12,500 ONSLOW/WESTERN 10,000 SOUTHERN 7,500 5,000

2,500 0 SOURCE: REINZ 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 Date of calculation

New Zealand banks have Some of the drivers of the underlying demonstrated a strong track structural cost problems include: record of stability and growth, —— A shifting and broadening of customer expectations. Groups ranked highly in cost-to- of customers’ expectations are income ratio comparisons shifting, creating a different and with international banking broader set of expectations and needs. peers. This has come from —— New competition. New forms a combination of robust of competition are entering increases in income, the market that are geared for innovation. They have the ability as well as disciplined to cherry-pick markets and they management of costs and are not constrained by physical process improvement. infrastructure or geography —— Increasing complexity. Product Dylan Marsh portfolios have increased to Senior Manager – Advisory provide a greater range of options KPMG However, New Zealand banking now to customers, raising complexity faces the greatest array of challenges and increasing frontline time in over 30 years. While the global requirements which bring into Dylan leads the Customer practice in financial crisis dented customer question the profitability of KPMG’s Performance Advisory team. confidence and returns, the industry different products. He has experience and a passion is now facing a barrage of challenges for working with Financial Services —— Inconsistent use of internal and including ‘lower for longer’ levels external services. Sourcing vs. leaders to improve and better of revenue growth and return on position their businesses for the internal capability vs. specialisation equity, regulatory change, disruption vs. managed services adds future. Dylan’s expertise centres on and disintermediation, heightened profitability analytics, operating model complexity, bureaucracy and customer demand for better value unnecessary cost burdens. design and operational improvement. products and services, and growing —— The regulatory and compliance community concerns over the burden continues to industry’s conduct. grow unfettered. —— Staffing and operating models. It is clear that a radically different Staffing levels and salaries have approach to productivity… is grown consistently over time with required to release resources, low spans of control, and a skew create the financial capacity to to non-customer facing roles, invest in transformation and deliver particularly in head office and acceptable financial results. supervisory functions. —— Reliance on third party origination results in sub-scale We strongly support the need to and inefficient physical distribution continue to invest in the medium term channels and service. to address these demands, but it is clear that a radically different approach These pressures both focus senior to productivity – akin to the sort of leaders on optimising the current cost structural transformation last seen base for profitability while positioning in the 1990s – is required to release the business to navigate future resources, create the financial capacity challenges. So how can banks rethink to invest in transformation and deliver their approach to productivity to acceptable financial results. achieve both?

Typically, successful banks are pursuing cost productivity in a consistent way: —— Leverage analytics and customer insights to rationalise customer, channel, product and regional investment and make business decisions with certainty. —— Improve customer satisfaction by aligning acquisition and service processes to the needs of priority segments, creating a nimbler corporate core and management layer, and creating a culture of personal accountability. —— Optimising channels by designing cross-channel experiences that seamlessly fit into the lives of customers while being economical. —— Customer coverage refocused on sectors and segments that deliver value. —— Revert to core by exiting non-core businesses, products and markets. —— Develop strategic outsourcing/ offshoring propositions and partnerships to leverage scale and innovations. —— Obsess about digitisation and simplification of end-to-end processes and products. —— Transform technology through infrastructure, change delivery and system/platform rationalisation. Leading financial services firms are tackling these challenges through clear business-wide strategies that are built on tangible insights and that draw from the innovation of others – both within financial services and from other sectors (e.g. technology).

FATCA and GATCA – or its official acronym AEOI/CRS – have, or will become part of the common parlance for the financial sector. They impose tax due diligence and reporting requirements for financial institutions on their customers and join the myriad of other KYC (Know your customer) regulations on the sector. This is on top Rachel Piper Darshana Elwela of the normal reporting of Partner – Tax National Director – Tax interest and other investment KPMG KPMG income to the Inland Revenue, the scope of which is also Rachel Piper is a Partner in KPMG’s Darshana Elwela is KPMG’s National being extended (but more on tax team, based in Auckland. Rachel Tax Director. Darshana joined KPMG has over 20 years’ experience in 2007 and has over 15 years’ that later). advising financial institutions, experience as a tax advisor and including retail banks, branch banks, senior IRD policy official. He is based leasing companies and other financial in Auckland and specialises in funds For New Zealand’s financial services providers. Rachel has also management and international institutions, this is part of the steady provided specialist advice on the tax taxation issues. In his role as KPMG’s creep of new regulation, as tax treatment of financial instruments National Tax Director, Darshana is authorities in New Zealand and around to a number of large New Zealand heavily involved in working with tax the world seek greater and more corporates and has extensive policy officials and Government on frequent reporting on customers, knowledge on the interaction various tax policy changes, including their assets, and their income. between the tax rules for financial on behalf of a range of clients. Technology has made it inevitable that instruments and the IFRS treatment. customers and users expect access to their financial account information in real time. If you are a tax authority, you would be asking – why not me as well? AEOI or ’automatic exchange of information‘ is an international initiative aimed at combating tax evasion from moving financial assets offshore. It places the heavy lifting – the need for reporting on non-resident customers’ and their financial account information under a ’common reporting standard‘ (the CRS part) – on foreign financial institutions. New Zealand, along with about 100 other countries, has signed up to AEOI. New Zealand’s commitment takes effect from

1 July 2017, with the first reporting of Practically, this involves a combination For financial institutions, there is an information by New Zealand financial of moving to the digital delivery of acknowledgement that there will be institutions due in mid-2018. services and a greater reliance on some transitional costs from updating various intermediaries and third their reporting and withholding While colloquially called GATCA, parties in the tax system to source systems. However, there is an and inspired by and modelled on information on taxpayers. underlying assumption that financial the US FATCA requirements, AEOI institutions will largely have the is not a FATCA clone. There are For financial institutions, the key information required on hand and this, subtle but important differences. impact of Business Transformation will together with proposed reductions in This will impact the design of your be more regular and greater reporting their year-end reporting to investors, customer due diligence processes. of customers’ investment income should help to offset some of the Furthermore, separate reporting of information (such as interest) to the additional compliance costs. financial account and account holder Inland Revenue. The Inland Revenue information under AEOI and FATCA to expects that there will be efficiency Based on our experience, there may the Inland Revenue will be required gains for it, taxpayers and the broader be significant costs to upgrading (initially at least). This is likely to integrity of the tax system as a result. systems so that this information can result in a duplication of processes. be provided within the timeframes Under proposals released last year, (In December last year, the Inland required, particularly where legacy most financial institutions will need to Revenue released draft guidance on systems are currently being used report customers’ investment income, how AEOI will apply, which sets out for withholding tax and reporting tax and recipient details to Inland some of the issues for consideration.57 tax information. Revenue more frequently than they do However, AEOI and FATCA are not the now. That is, monthly or at the time of In addition, financial institutions end of the story. payment, compared with annually. will also need to manage customer concerns and expectations regarding The New Zealand Government and the the accuracy of the information Inland Revenue have embarked on an The Inland Revenue expects that stored in their systems, particularly ambitious journey, aimed at ensuring there will be efficiency gains for it, as the information provided may now that New Zealand’s tax system is taxpayers and the broader integrity impact customers’ tax and social purpose-fit for 21st century needs. of the tax system as a result. policy entitlements or liabilities in real This will change how taxpayers and time. This applies equally for tax KYC intermediaries interact with the Inland required under FATCA and AEOI. Revenue (and vice versa). This is so Inland Revenue can cross check information (such as whether The new investment income reporting the correct tax details and withholding proposals have been developed The goal of Business Transformation rate have been supplied), use this independently of the FATCA and is to make it simpler and faster for information to calculate changes to AEOI initiatives. Given the overlap New Zealanders to pay their taxes, customers’ entitlements in ’real time‘, of information collected under these receive information, and have more and pre-populate tax returns. measures, there was the opportunity certainty that their tax liabilities for rationalising reporting requirements and entitlements are correct. The new system relies on correct to minimise duplication. Sadly, IRD numbers being held by financial that opportunity appears to have institutions and if an IRD number is not been missed. As a result, financial The use of technology is at the heart provided by a customer, a new 45% institutions need to focus on each set of the Inland Revenue’s billion dollar non-declaration rate is proposed. of requirements and ensure that their ’Business Transformation‘ project. systems are able to cope. The goal of Business Transformation is to make it simpler and faster for New Zealanders to pay their taxes, receive information, and have more certainty that their tax liabilities and entitlements are correct.

We then revisit the forecast “A study of economics usually provided in last year’s survey to see reveals that the best time to buy how accurate it was, review the anything is last year.” performance of the New Zealand economy in 2016, and provide an Marty Allen, Comedian economic outlook for 2017.

In this section, we forecast 26 SEE FIGURE 26 – PAGE 83 the key performance drivers for the New Zealand banking • We expect the banking industry’s profit industry, namely lending, net before tax to dip slightly in the fourth interest margin, and credit quarter of 2016 (the actual data is not available yet). The dip is caused by an loss rate. Christoph Schumacher increase in the Credit Loss Rate (CLR) and flat Net Interest Margins (NIM). Professor of Innovation and Economics The increase in CLR may be due to an Massey University already overheated property market Based on these drivers, we provide an with banks taking on increasingly outlook for the banking industry’s profit more lending. When we allow for before tax. We use a combination interaction between the performance of macroeconomic variables and drivers, the expected growth for 2017 time-series analysis to provide and 2018 is almost stagnant, rising quarterly forecasts for the next two from $1.67 billion in Q1 of 2017 to years ending in December 2018. In $1.71 billion in Q4 of 2018. The outlook Professor Christoph Schumacher last year’s survey, we introduced a is similar to the growth forecast of the joined Massey University in 2003. VAR58 model to our analysis as an New Zealand economy, very modest He is Professor of Innovation and alternative to the ARIMA59 model we and almost stagnant. The fact that Economics at the university and have used over the past five years. A profits show growth at all is driven by Director of the Auckland Knowledge VAR model enables us to investigate an increase in lending volume, which Exchange Hub. how interaction between our variables offsets the continued increase in CLR. changes the forecast. The model Before coming to New Zealand he worked well to forecast future profit completed undergraduate and post- before tax, and we have focused solely SEE FIGURE 27 – PAGE 87 graduate degrees in Engineering, on the VAR model in this current issue. 27 Economics and International Business It is important to note that although at Karlsruhe University in Germany and macroeconomic indicators are not the University of Auckland and a PhD • explicitly used in the VAR model, the Let’s now take a closer look at the in mathematical economics at Massey impact of these indicators is already industry performance drivers. In our University. Christoph has previously factored into past values of the VAR model, we use the collection worked as a business consultant in performance drivers. The results of of past values of our drivers and Germany and New Zealand. our analysis are displayed in Table 9 on before tax profits; that is, a vector of Christoph’s area of specialisation page 83. time series, in order to predict future is game theory with research values. The key benefit of the VAR interests in mathematical economics, model is its ability to rely not only on health economics and sports and previous values of past drivers, but economics. His work has been also on previous values of profit thus published in the Journal of Health providing a two-way interaction within Economics, Applied Economics, the the model. European Journal of Marketing, the Journal of Industrial Economics and Economics Letters.

The definitions of industry drivers are: —— Lending – the total volume of 26 FORECASTING APPROACH lending broadly defined, that is, all interest-earning assets.

—— Net interest margin – the Regulation difference between interest Determine constraints within income and interest expense, which entities expressed as a percentage have to operate of lending. —— Credit loss rate – provision for credit impairment, expressed as a percentage of lending. Industry Industry drivers profit or loss Macro-economy – Lending – Net interest Total industry lending is expected – Unemployment – Net interest income to increase at a reasonable pace – Inflation margin – Provision for – Interest rates for the next two years. Our model – Credit loss impairment sees lending volume increase from rate charges $445 billion to $496 billion. The Auckland housing market, although slowing slightly, refuses to cool down, encouraging further development in other main centres, particularly Competition Influences Hamilton and Tauranga. Continued industry dynamics rapid growth in population teamed with high housing demand fuels this lending increase which will continue well into 2017 and 2018. In recent months, we have seen a low CLRs and manage the ongoing The possibility of a deliberate conscious slowdown in lending by demand for housing related loans. slowdown in the lending volume New Zealand banks. As cheaper Overall, however, we still anticipate cannot be incorporated into the VAR sources of funding become scarce, an increase in lending volume, but forecast model as all previous lending consumers can expect interest rate possibly at a slower pace than in the figures suggest an upward trend. increases as banks look to maintain previous year.

TABLE 9: LIST OF MACRO-ECONOMIC INDICATORS Macro variable Description Units Source Gross Domestic Product gdp $mn, nominal index RBNZ (expenditure based) bankbill90 90-day bank bills rate %, annualised RBNZ govbond10y 10-year government bond yield %, annualised RBNZ Number of registered unemployed Number RBNZ unemployed Average number of home loans avgqhouseloancount Number RBNZ approved Estimated population of estpop Thousands Statistics NZ New Zealand cpindx Consumer Price Index Index level RBNZ housepricendx REINZ house price index Index level REINZ weeklyearnings Weekly earnings $, nominal Statistics NZ nzstocksndx New Zealand all stocks index Index level NZSE

This trend suggests that the lending Inflation is a key factor that is positively growth indicator would be the most associated with the NIMs of banks. SEE FIGURE 30 – PAGE 87 likely of the three drivers to cause 30 While inflation results in an increase in fluctuation in the forecast of the both bank lending and deposit rates, banking industry’s profit before tax • it tends to be the case that lending provided in this section. Changes in our macroeconomic rates increase at a faster pace. This indicators may impact the industry is because environments of higher drivers used in our VAR model. inflation often entail greater credit The regression results suggest risk, which banks then need to offset 28 SEE FIGURE 28 – PAGE 87 that changes in lending volume with greater margins. New Zealand’s are inversely related to changes inflation rate in 2016 continued a slow • in unemployment. New Zealand’s descent to 0.4% at the end of 2016. NIMs are expected to remain fairly unemployment rate is expected to Although the RBNZ has limited scope constant over the next two years. No stabilise or decrease slightly in the to deal with continually decreasing new banks entered the New Zealand coming years providing a stable inflation, recent developments in the market this year and a relatively low platform for lending by banks. US economy have put pressure on risk business environment paired with As the OCR remains at record the Federal Reserve to hike interest a low OCR contributes to steady NIM lows, borrowing is cheaper which rates, which would see a downward figures. We anticipate NIMs to sit contributes to the anticipated increase movement in the Kiwi dollar. Indeed, between 2.2% and 2.1% throughout in lending volume. Another factor that if this occurs and the positive 2017 and 2018. will likely exert a positive influence on relationship between NIMs and The CLR has remained stable the lending volumes of banks is the inflation continues, then it is expected throughout 2015 and 2016. We expect growth in New Zealand’s population. that NIMs will stabilise and may even this trend to continue in 2017 with a Throughout 2015, New Zealand’s relax slightly. Forecast stagnant NIMs slight increase in 2018 (from 0.1% in population grew at its fastest rate in combined with slight increases in Q4 of 2016 to 0.2% in Q4 of 2018). over a decade. Overall the country’s CLRs are the key factors that, we The increase, however, is marginal population increased by 97,300 people believe, will moderate the growth of and overall the CLR is low due to or 2.1%, in the year to June 2016. the banking industry’s profits over the the stringent lending policies of The net migration of 69,100 people will next two years. New Zealand’s banks. especially contribute to the anticipated increase in lending volumes as more people will deposit their capital into New Zealand and utilise the lending 29 SEE FIGURE 29 – PAGE 87 facilities of our banks (natural increase • of 28,200).60 TABLE 10: FORECASTING RESULTS VAR VAR industry driver 2016 Q1 2016 Q2 2016 Q3 2016 Q4 2017 Q1 2017 Q2 2017 Q3 2017 Q4 2018 Q1 2018 Q2 2018 Q3 2018 Q4 Actual Actual Actual Forecast Forecast Forecast Forecast Forecast Forecast Forecast Forecast Forecast Upper CI 450 464 477 489 501 514 526 538 550 Lending Forecast 448 454 458 437 445 453 460 468 475 482 489 496 ($Billion) Lower CI 424 427 430 433 437 440 443 446 448 Upper CI 2.4% 2.4% 2.4% 2.4% 2.4% 2.4% 2.4% 2.4% 2.4% Net Interest Forecast 2.19% 2.00% 2.11% 2.2% 2.2% 2.2% 2.2% 2.1% 2.1% 2.1% 2.1% 2.1% Margin (%) Lower CI 2.0% 2.0% 1.9% 1.9% 1.9% 1.9% 1.9% 1.9% 1.9% Upper CI 0.2% 0.3% 0.3% 0.3% 0.4% 0.4% 0.4% 0.4% 0.4% Credit Loss Forecast 0.08% 0.10% 0.11% 0.1% 0.1% 0.1% 0.1% 0.2% 0.2% 0.2% 0.2% 0.2% Rate (%) Lower CI 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Profit Before Tax Forecast 1.77 1.71 1.62 1.68 1.67 1.67 1.67 1.68 1.68 1.69 1.70 1.71 ($Billion)*

* Note: Forecasts for profit before-tax will seem less than in the forecasts of previous publications due to the fact that the figures are not annualised.

Interest rates are expected to fall Comparing our 2016 forecast of The New Zealand dollar strengthened even further, which historically industry drivers and industry profit through most of 2016 on the back leads to a drop in the CLR (a drop before tax61 with how these drivers of interest rates of around 2% – the in interest rates puts less pressure actually fared in 2016, we find that highest in the G10. The demand for on borrowers resulting in a lower all our predictions are well within our dollar was further supported by number of defaults). However, this the 95% confidence interval. Profits a rebound of dairy prices, a rise in trend may be dominated by an were slightly higher than anticipated tourism numbers and a 10% increase increase in household debt in 2016. In in the first two quarters as a result in demand for kiwifruit, apples, September 2015, household debt as of a marginally lower CLR in Q1 and wine and seafood. The strong dollar, a percentage of disposable income Q2 and a slightly higher NIM in Q1. however, has put a lot of pressure was 160%, up from 156.2% earlier However, as a result of a drop of the on the export and import-competing in the year. By June 2016 the figure OCR in August and November by 0.25, sectors – export volumes decreased reached 165%. Although the present profits fell slightly below our prediction by 16% even with dairy prices on the levels of household debt are not in Q3. Our forecast of the lending rise and conversely the increased particularly alarming compared with volume (marginal rise throughout the buying power of the dollar saw imports other countries, the rate at which year) was accurate. increase by 14%. Overall, the terms households become increasingly of trade decreased by 1.8%. In its We now take a closer look at the leveraged is a factor to watch. This 22 September 2016 statement, the performance of the New Zealand is possibly reflected in the slight RBNZ expressed concerns about the economy. In 2016, the New Zealand increase in the CLR. Another related high exchange rate and indicated that economy bounced back from weak factor that deserves consideration is it will take action. This was followed by GDP growth in 2015 with a 3.6% rural debt-to-income ratios. Last year, a reduction of the OCR in November. increase of real GDP. This stems from weak commodity prices resulted in While the New Zealand dollar is a 6.9% decrease in unemployment decreasing dairy exports straining rural expected to stay strong, indications in 2016 and continued business borrowers. However, the outlook for are that it will trade a little lower in the confidence. Additionally, a rise in dairy exports into 2017 is good and near future. private consumption supported GDP forecasted milk prices should see the growth with boosted household Globally, 2016 has been an interesting agricultural sector gaining ground on spending. The November earthquakes year. Political developments in Britain last year’s weak performance. in the central North Island saw with the ‘Brexit’ and in the US with See Table 10 on page 84 with GDP take an initial hit, but with their recent elections have cast some Forecasting Results VAR. over $3 billion in demolition and uncertainty over the economy for the reparations, in the long term this next few years. These developments Despite their obvious importance, we could see increases in both GDP could affect New Zealand trade, do not attempt to take into account and employment. migration and travel with these regulatory changes in this analysis. countries. Further struggles in the This is a limitation since regulatory Initial reactions to tightened lending European powerhouses of France changes can clearly have a large regulations have subsided in 2016 and Germany, with terrorism and impact on lending volume, margins, with renewed demand for housing the refugee crisis, could cause extra and CLRs. Preventative lending spreading into other main centres in strain on their already overburdened measures such as increased LVRs New Zealand. Specifically, Tauranga economies. The Chinese economy have not eased in 2016. Instead, there has seen dramatic increases in seems to have stabilized somewhat have been further indications that the construction and housing demand since 2015 as fears of unsustainable RBNZ will continue to tighten lending as Auckland housing prices become growth subside while tension in the regulations as it attempts to balance increasingly unaffordable. In terms of Middle East and Russia continues out low inflation using the OCR. Fiscal dwelling consent volumes, numbers to build. policy has looked to aid the already in Wellington have increased by 7.5% heated housing market by selling off while growth in other areas in modest state-owned housing, but has done with Canterbury experiencing slightly little to support the RBNZ in their bid to negative growth, a continued trend boost inflation. from previous years.

Overall, the New Zealand economy is in good shape with modest GDP growth expectations, a stabilising unemployment rate, low inflation and a low OCR. Stabilised dairy prices may contribute to the ongoing stability of net exports and GDP growth. Potential risk factors to our GDP growth are a slowdown of lending volume and international uncertainties related to trade and immigration with Britain and the United States. Furthermore, the continued strengthening of the NZ- AUD exchange rate may hurt export volumes to Australia, one of our largest trading partners. While the recent decline in oil prices will surely hurt oil-producing countries, it will offer benefits to New Zealand. That is, New Zealand oil prices have quite a strong cost-push effect on consumer prices, largely driven by higher transport services costs. If oil prices continue to decline, consumers should not only expect cheaper petrol prices, but also cheaper prices for consumer goods that undergo substantial transportation. To conclude, the banking industry and the New Zealand economy are in good shape. The industry outlook closely follows the economic performance of New Zealand; our banks continue to generate healthy profits while also maintaining strong capital ratios. However, profit growth is expected to be very modest or stagnant, similar to the anticipated GDP growth.

$BILLION 27 VAR PROFIT BEFORE TAX 2.5

2.0

PROFIT BEFORETAX (ACTUAL) 1.5

PROFIT BEFORETAX (FORECAST) 1.0 0.5

0.0

-0.5

-1.0

-1.5 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

$BILLION 28 VAR INDUSTRY LENDING 700

600 LENDING (ACTUAL) 500 LENDING (FORECAST) 400 UPPER 95% CONFIDENCE INTERVAL 300 LOWER 95% CONFIDENCE INTERVAL 200

100

0 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

VAR INDUSTRY NET % 29 INTEREST MARGIN 3.0

2.5 NET INTEREST MARGIN (ACTUAL) 2.0 NET INTEREST MARGIN (FORECAST)

UPPER 95% CONFIDENCE INTERVAL 1.5

LOWER 95% CONFIDENCE INTERVAL 1.0

0.5

0.0 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

% 30 VAR CREDIT LOSS RATE 2.0

1.5 CREDIT LOSS RATE (ACTUAL) 1.0 CREDIT LOSS RATE (FORECAST) 0.5 UPPER 95% CONFIDENCE INTERVAL 0.0 LOWER 95% CONFIDENCE INTERVAL -0.5

-1.0

-1.5 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Non-banks industry overview

The non-bank sector has Normalised net interest margin (NIM) for the sector continues to be under once again delivered a strong pressure in 2016 due to a prevailing performance with current competitive market caused by a year net profit after tax (NPAT) mixture of continued low mortgage rates (particularly for credit unions increasing by 8.17% to and finance companies), the growth $207.78 million. of peer-to-peer (P2P) lending, and tighter funding channels. Normalised NIM (excluding the results of EFN (New Zealand) Limited) fell by However, if we were to exclude NPAT 24 basis points (bps) to 5.85% for of $8.14 million for EFN (New Zealand) the current year (5.68% for the Limited due to the lack of comparative whole sector including EFN). Lower data (EFN purchased the equipment funding costs were not sufficient finance and fleet solutions business to counteract the competitive from GE Capital and was incorporated pressures that were pushing lending on 27 July 2015), normalised62 NPAT John Kensington rates down. Partner – Audit showed a more modest growth of Head of Banking and Finance 3.93% or $7.55 million. Normalised The sector’s loan book has seen KPMG NPAT growth was driven by an another year of strong growth and low increase in net interest income and impairment levels. Total gross loans non-interest income of $19.67 million and advances grew by 13.70% or John has been with KPMG’s Financial (3.68%) and $10.30 million (6.41%), $1.06 billion, for which EFN accounted Services audit team for 30‑plus years, respectively. Record high vehicle sales, for $0.42 billion. This result supports 21 of these as a partner working with on the back of strong momentum Executives’ comments around the a wide range of financial services from the prior year, certainly had an amount of good quality lending audit clients, specialising in banks and impact on the increase in profitability that is still very much available just finance companies. for the sector as five out of the outside the edge of the banking seven vehicle finance companies sector’s ‘blackbox’63 and the perceived John has a wealth of experience in reported a combined NPAT growth of tightening of the size of the ‘blackbox’ auditing and accounting for banking $9.98 million. Finance companies have as banks focussed more closely on products and services including also enjoyed an increase in profits on their mortgage lending. treasury, retail offerings, corporate the back of strong loan growth. Credit loans and loan provisioning. He is union results were mixed, with half currently Head of KPMG’s Banking of them experiencing an increase in Total gross loans and advances and Finance team, Head of Financial profits while the other half experienced grew by 13.70% or $1.06 billion. Services Audit and editor of this a reduction. publication. John is also a Trustee of the Kidscan Charitable Trust, and The sector’s operating expense over Deputy Chairman of the New Zealand Record high vehicle sales, on the operating income ratio has remained Audit and Assurance Standards Board back of strong momentum from the fairly consistent with last year’s level, (NZAuASB) and a member of the prior year, certainly had an impact with a marginal improvement from External Reporting Board (XRB). John on the increase in profitability for 56.13% to 55.43%. Operating costs is also a member of CAANZ and the the sector. remained in line with operating income Institute of Directors. growth; however, the coming years could see a surge in operating costs as survey participants increase their spending in developing and investing more resources into their front-end technological capabilities to remain competitive and provide a better customer experience.

Many survey participants talked about The Reserve Bank of New Zealand Competition comes the importance of a digital strategy (RBNZ) has taken a more concerted from all fronts and takes to achieve this better customer approach to slow the property market different forms experience by delivering loans together with IRD-imposed bank The finance company sector is an ever- and scoring and managing credit accounts, IRD number requirements, changing landscape that never fails to more quickly. and increased lending restrictions. bring about an engaging discussion on This, together with changes to In many respects the non-bank sector competition during the interviews with capital requirements, inter-subsidiary continues to operate as it has in the survey participants. The sale of Fisher lending guidelines, and voluntary past, focusing efforts on their area of & Paykel and GE Capital, the rise of impositions by the four banks on the speciality/niche where they are most the P2P lending sector, house price use of offshore income might be comfortable. Participants do not feel growth giving people a sense of home finally starting to slow the market. To that they have experienced as much in balance sheet improvement, growing date this is just anecdotal evidence the way of competition from the banks use of Fintech applications, changing from the real estate industry. It will or disruption, other than from the P2P consumer behaviour and increased be interesting to see what Bank lenders; however, all agree that the LVR restrictions are just some of Executives will have to say in our next wave of disruptors will come from the more obvious elements that are bank survey in this regard when we the Fintech space. changing the landscape in which meet them later this month and early survey participants operate. next year. Operating costs remained in line with operating income growth. Competitive pressures are currently Non-bank deposit takers (NBDTs) being felt by market participants on are experiencing strong competition both ends of the spectrum. coming from banks within the local Executives have noticed a voluntary deposit market. tightening of the credit market coming from the banking sector. The banking Competitive pressures are currently sector is expressing some level of being felt by market participants on The tightening of the credit market anxiety over the property market both ends of the spectrum: the lending has, in turn, caused a flow-on effect and is taking a cautious approach in and the funding side. From the lending onto some participants of the non- extending its exposure to the property side, there is competition between bank sector in recent months, as they market. The main question that is the non-bank sector and the banking have begun to find it more challenging probably on everyone’s mind right now sector for high-quality loans that pay to secure the necessary funds they is just how much longer can property an appropriate yield. Although there is require. Non-bank deposit takers prices in New Zealand grow at less competition from banks for newly (NBDTs) are experiencing strong unsustainable rates? Lenders fear that originated mortgage loans, especially competition coming from banks within sharply falling property prices could at the higher LVR’s, Executives have the local deposit market and have challenge the market and, if severe pointed out that the non-bank sector found themselves challenged to match enough, result in mortgage’s security is experiencing a higher than usual the special deposit interest rates being values coming under pressure. The level of ‘churn’. The majority of the offered by banks. currently high employment rates, and Executives are of the opinion that the low interest rates and confidence Finance companies that are backed banks are being more aggressive this brought about by home balance sheet and funded by a bank are also being year in taking away loans from the strengthening, have no doubt helped cautioned that they can no longer sector participants, particularly in cases to minimise these issues to date. borrow the same level of funds at the where that loan did not previously same historically low interest rates meet the banks’ lending criteria, but that they have enjoyed. This is a clear now does because the customer This is a clear signal from the signal from the banking sector to has since paid down some of the banking sector to expect tougher expect tougher times ahead as they loan balance and enjoyed a security times ahead. shore up their capital balances and valuation increase. source additional deposits, while also trying to rein in lending growth.

These loans initially started out with Sector participants perceived that This puts credit unions and building a non-bank entity as opposed to a the banking sector’s ‘blackbox’ has societies in a particularly challenging bank, as the borrower might have not fundamentally changed from last position, as their legal structure limits had a minor credit issue (e.g. a late year, but what they are seeing is that them as to where they are legally repayment history on a loan) and/or the banking sector is being more allowed to source funds. Credit unions a high LVR. But after a year or two, selective in its approval process for and building societies are only allowed the borrower has gone on to build mortgage loans. Some Executives to source funds from mutual parties up a strong credit history, and with do foresee further voluntary credit and, as such, attracting sufficient funds house price inflation, the LVR on their tightening by the major banks in the from the local deposit market is vital mortgage now falls within the bank’s upcoming months, amidst the risk of for their growth and profitability, and lending criteria. global uncertainty and pressure on the this is increasingly a challenge. availability of funding.

From the lending side, there is One area that the banks continue to Finance companies are competition between the non- venture into is the personal financing encountering more instances bank sector and the banking sector space. The banks’ behaviour in this whereby potential borrowers for high-quality loans that pay an space appears to be unusual as, think that having security on appropriate yield. according to some Executives, it personal loan is neither necessary appears that some banks are turning nor required. away mortgage loans that do not quite In relation to the LVR restrictions fit the ‘blackbox’, but are then providing that were put in place this year, the credit card and debt consolidation The P2P sector has continued to new set of rules presented the non- loans, which could be considered a have a significant impact on the bank sector with an opportunity to riskier lending space. way the non-bank sector operates. capitalise on mortgage loans that were Some Executives have found that the previously unavailable to them. In growing presence and accessibility of From the funding side, there is recent months, some Executives have the P2P sector to potential borrowers a pronounced dip in the level seen a record number of mortgage have begun to change the average of wholesale offshore funding loan enquiries being received where borrower’s behaviour and expectations that is currently available to the LVRs were higher than the applicable in the market. Most noticeably, finance sector’s participants. 60% or 80% for either investors or companies are encountering more occupiers, respectively. Executives instances whereby potential borrowers said that they have had to turn many think that having security on a personal On the funding side, there is a enquiries away as they have not loan is neither necessary nor required. pronounced dip in the level of historically done any lending in this In this respect, the non-bank sector is wholesale offshore funding that is space. Despite having the ability finding it increasingly hard to compete currently available to the sector’s to enter the LVR > 60% or 80% with the P2P sector as borrowers participants, when compared to the mortgage lending space, sector seem to be more inclined to go with a same period last year. Executives participants do not have an unlimited lender that will not require any security have noted that they are finding it appetite to do so due to the risks to be held against the loan. increasingly difficult to compete with involved. Survey participants do the banks in the local deposit market, The digital offerings that these believe that there is still a generous especially when the banks carry out entities have are also mentioned as amount of responsible lending that can special six-to-nine-month deposit highlighting how important speed and be done just on the edge of the bank’s offers at a rate that is on par with what ease of dealing is to the consumer. ‘blackbox’, and that they should be credit unions and building societies are However, it is possible that this focusing their resources and efforts in offering their members. Executives advantage might be short-lived as those areas. within both the banking and non- other non-bank entities acquire bank sectors have been echoing their similar channels. One area that the banks continue concerns over rising funding costs and to venture into is the personal the increased reliance on the offshore financing space. funding market. They put the blame on increased geopolitical and global economic instability over the past year.

Regulation embedded in Conduct risk is in the front of In recent months, there has been the culture Executives’ minds, with many much discussion in the media expressing that the sector is moving and between regulators and key Several Executives have expressed a to be more conduct risk regulated. stakeholders in the financial market positive stance towards having a more The feeling expressed was that about the implementation of Debt-to- rigorous regulatory environment. They New Zealand has yet to be hit by quite Income (DTI) mortgage restrictions in believe that current regulation such the same wave of issues in this area New Zealand. This could be the next as the Credit Contract and Consumer as some overseas jurisdictions. One hurdle for the finance companies to Finance Act 2003 (CCCFA), Anti- of the themes arising from the survey implement and Executives are anxious Money Laundering and Countering interviews was that most Executives about what form this would take and Financing of Terrorism Act 2009 were surprisingly confident that their how it would be implemented. Their (AML) and Financial Markets Conduct organisation was not at risk in this unease has since been alleviated Act 2013 (FMC), while costly and area and that they had things fairly momentarily as RBNZ Governor, time-consuming to implement, have well covered. While they might think Graeme Wheeler, recently announced become business as usual and are that their organisation would not do in November that the RBNZ has no warranted in order to ensure that some of the things that have caused intention to introduce DTI measures unscrupulous entities are kept out of consternation in overseas jurisdictions, as of yet.64 This remark was made the market and that a level playing field one thing to be aware of is that the based on recent data that showed is maintained. landscape is changing rapidly in this that the housing market is beginning Other survey participants noted that area and behaviours that are accepted to demonstrate signs of relief from in the current market, with deposit or even ‘business as usual’ today inflationary pressure. It is not clear rates being at historically low levels, might not be appropriate tomorrow or if this is the result of the new LVR the ability to have access to the NBDT in a digital world. A simple negative restrictions that went into effect in market may have some advantages. In tweet or Facebook post from an October, or whether it is the result the last few surveys, many Executives unhappy customer could lead to local, of banks taking a proactive effort to had commented that having the NBDT national or even global exposure of rein in higher LVR lending. However, status was expensive and demanding the issue in such an explosive and viral with that being said, the RBNZ is to maintain, but now many see it as manner that the resultant damage is still continuing to seek permission a good tool to have available in order difficult to contain. from the Government to include DTI to diversify its funding and tap into a measures in its toolbox so as to be There is an expectation among survey very large sector of the market that is able to bring them to use in a timely participants that regulations such as starting to become aware of just how manner when the right circumstance the CCCFA and FMC could be refined low interest rates are and how long or situation calls for it.65 further to avoid unnecessary burdens they have been at those levels. It will on the lender. For instance, one of Motor Trade Finance’s appeal of the be interesting to see what messages the Executives believed that it is recent ruling made against it was are received from the banks when unnecessary to establish a whole new dismissed by the Supreme Court in we interview them for the second AML process for a customer that has, May. The sector has been keeping half of the survey, as in recent weeks, at one point in time, had a loan with a close eye on this case for a while, following these comments by non- the entity, has paid it off and is now and this development has now bank participants, a number of entities returning for another loan. established a precedence on how in both the bank and non-bank sector participants should be structuring have indicated that deposit rates could Regulatory pressures can also come their credit fee charges on consumer be about to rise. from unexpected fronts and have loan contracts. In response to this, unforeseen complications, as is the the Commerce Commission in case with finance companies that have September of this year released a Conduct risk is in the front of securitised vehicles funded by banks. set of draft guidelines that outlines a Executives’ minds, with many These entities appear as though they set of principles which lenders could expressing that the sector is are being pushed to comply with the adopt to be compliant with the CCCFA. moving to be more conduct same rules that banks do, as the bank The guidelines stipulate that lenders, risk regulated. lender is required to apply the same regardless of type or form, are only lending and capital requirements to allowed to charge fees by way of loans that they are indirectly funding through finance companies.

recovering reasonable specific direct this would mean they would have a The use of partnerships was another transaction costs incurred in instituting business model under which they may theme that consistently emerged a consumer loan contract. not be able to recover their costs as from comments made by Executives the fee levels would be prescribed this year. Partnerships with other key However, it is important to note that and there would be no interest earned members within a value chain, either the guidelines from the Commission to offset any other costs. Those horizontally or vertically, to come to a are not legally binding and it is subscribing to this view argue that mutually beneficial arrangement that ultimately the lender’s responsibility such a model would never work and will help promote further sales and to exercise professional judgement this cannot be what was envisaged business growth for both parties were in determining a fee structure that and is not the way things work in mentioned, possibly showing that the is compliant with the CCCFA. The other jurisdictions. The other view is Executives do realise their business Commission is currently seeking that a consumer loan is a consumer will have to change, but acknowledge feedback from the public and the loan no matter how it is executed and that they do not know exactly how. industry, with the intention to finalise there should be the same protections In particular, a number of participants the guidelines by early 2017. and guidelines. Clearly, this is open were considering how a partnership to interpretation both ways, and this with a Fintech might bring some new The P2P lending sector has is why all lenders, P2P and others, product or service to the market. The also been under scrutiny by and the regulators, are keen to challenge with this lies in ensuring the Commission. see clarification. that the right kind of partnership is established with organisations that Opportunities and share the same values and vision The P2P lending sector has also been challenges as themselves. under scrutiny by the Commission A recurrent theme among survey A good example of this concept is since the Commission decided participants this year was the Flexi Card (formerly known as Fisher to formally bring civil proceedings sentiment towards the property & Paykel Finance), who has partnered against Harmoney in August 2016. The market. Contrary to what many would with MasterCard and Farmers to Commission is doing this to formally think, most of the Executives do not develop the Q MasterCard and seek a ruling from the Auckland High see the new LVR restrictions on the Farmers Finance Card. The partnership Court that will clear the confusion as banking sector as an opportunity to has allowed Flexi Card to leverage to whether ‘platform fees’ charged to expand their market share and those on MasterCard’s robust digital borrowers should be subjected to the that do acknowledge that it must security programme to secure their CCCFA.66 An unfavourable ruling could be done carefully. While finance credit cards, and give its customers bring into question the sustainability of companies do sometimes operate access to a greater range of retailers the current P2P model. in spaces that fall just outside of throughout New Zealand and the rest the banking sector’s ‘blackbox’, the The uncertainty has arisen as the of the world. In addition, the Farmers Executives emphasised that their platforms and the legislation under Finance Card entitles its members focus in the property market has which they were licenced are new and to exclusive offers that would not been responsible and not solely on untested. The initial concept of a P2P otherwise be available to them. loans with a high LVR. In regard to lender, and therefore the legislation MasterCard benefits by receiving apartment projects, the non-bank under which they were licenced, increased transaction fee revenue sector as a whole is erring on the side is that the platform doesn’t do the when more transactions are processed of caution as they tread lightly into lending, and therefore they are not through the use of the Q MasterCard. what is a relatively new lending market able to charge interest (only a lender Farmers, on the other hand, will likely in Auckland. is able to do that) and the extension enjoy higher sales as its customers are is that as a result they are able to now able to finance large purchases with greater ease. charge fees, but they should not be A number of participants were prescribed by the CCCFA as those considering how a partnership with fees relate to where lending interest a Fintech might bring some new is also earned. A potential worst case product or service to market. scenario would see the platform unable to earn interest and only charge fees in accordance with the CCCFA;

Non-bank participants are also making a launched. Many expressed a mix of automation, starting from the conscious effort to explore beyond their nervous confidence and concern about submission of the application conventional operating model to find their entity’s defences, but all of them through to the disbursement/ potential products that will complement noted that it was an area where they receipt of funds, right through the service/product offering for which would undoubtedly be tested in the to the process for collecting and their customer initially approached future. The development of each new allocating repayment and dealing them. For the vehicle financing industry, product or distribution channel, while with arrears and defaults. The one this means identifying additional necessary to enhance the customer click away technology-driven front value-added services/products that experience, brings with it another end that speeds things up was they can add onto the purchase of a area needing to be protected from frequently mentioned. vehicle. This could range from providing cyber threats. 2. Encouraging financial literacy extended warranties, liability insurance, by providing customers with maintenance service contracts, parts, The relationship between interactive tools and data that will accessories and finance. Turners’ Fintech and disruptors educate and enable them to make purchase of Autosure from Suncorp In last year’s publication, many of the well-informed financial decisions. in November is a good illustration of Executives surveyed agreed that the this movement within the finance It is crucial that before an entity growth of the P2P sector would be a company market. disruptor to the non-bank sector. In just embarks on a Fintech campaign, it properly considers whether the Executives from a range of a year, significant changes have taken implementation would complement organisations have identified the place within the personal/consumer existing service/product offerings and potential for a captive insurer market lending space that have been brought support the sale of more business, or whereby the entity provides a loan, about by the entry of P2P lenders whether it would replace it. and some form of insurance is into the market. Survey participants established with the individual. agree on the increasing importance of Another judgement that needs to be Fintech technologies to the non-bank considered is when to ‘turn off’ the sector. Executives expect Fintech old model and rely solely on the new With the future digitalisation of the innovations to give rise to disruption model for doing business. In addition, industry, incumbent players also in the foreseeable future. In response it is important to recognise that the need to be prepared to change as to the likely threat, several Executives true power of the disruptor is not at the industry does. have gone on to mention how they the high-tech front end as a transaction are taking a proactive approach to enabler, but deeper where existing seeking out collaborative opportunities margins are reduced and/or shared by While this strategy may have helped with Fintech companies and even all participants together with the risk. increase sales for the time being, if not banks to assist them. The aim of the To date, the disruptors have displayed managed appropriately it could divert new partnerships is to assist them the initial technologies well, but are much-needed resources and attention in developing sophisticated Fintech only just starting to move into the risk away from core activities. In addition, capabilities of their own, or to set and reward share space. with the future digitalisation of the themselves up to be ready for the next industry, incumbent players also need wave of disruptors that is expected to to be prepared to change to survive as arrive from the Fintech industry. Companies that have yet to the industry does. embrace data analytics might find themselves lagging behind, or even Another area that Executives all Survey participants agree on the commented on was the risk of a cyber out of business, as they struggle to increasing importance of Fintech keep up with competitors. attack and how important it was to technologies to the non-bank sector. have a coordinated approach to staying up with the latest intrusion techniques and sources due to the increasing The expansion of the use of data is a The two major lessons to date from frequency and complexity of cyber shift from solely using data analytics the P2P platform have been: attacks. All the Executives spoke of to identify new business opportunities the need to spend more time and 1. Building a faster and more through the analysis of transactions, to effort to protect against intrusion and, streamlined ‘know your customer’ taking it to the next level by developing in particular, the need to stay abreast and deposit and loan processing technological capabilities to predict of where and how attacks were being system through the use of and capitalise on those opportunities.

In the future, companies that have yet way that things currently work is that conclusion of its review. Most recently, to embrace data analytics might find when they are young they struggle to in August S&P’s downgraded UDC’s themselves lagging behind, or even afford a home; as the children grow long-term issuer credit rating by three out of business, as they struggle to they live in what they can afford (a notches based on the expectation keep up with competitors. smaller home than they would like); that UDC will be sold within the next and they finally afford the family home year and Heartland’s CEO reiterated While having the entire lending they want just as the family has grown that UDC would be a good fit within process transitioned to an online up. What if finance could change to its business. platform may reduce processing time, enable intergenerational groups to it is not without its risks. The ability leverage value in the parents’ home to to capture generic information about allow the second generation to enjoy a The non-bank sector is truly a tough the loan applicant through an online bigger home sooner? lending space. platform is one thing, but being able to meet the applicant face to face At the consumer finance end of the allows the decision maker to obtain market the day will come when, as The non-bank sector is truly a tough the necessary depth of information you pass a retail store, your device will lending space, an area where not specific to the individual’s situation automatically know where you are and only is there a myriad of competitors, in order to make a responsible and a financier will let you know the credit both old and new, but every so often properly informed lending decision. you have so that you enter the store the banks also have the tendency Lenders will need to consider the with a pre-approved limit to purchase to enter into the sector if they spot trade-off between the speed and ease an item your device has guided you to, an opportunity to do some quality of getting a loan out to a customer, because a Fintech has used data about lending or raise much-needed and ensuring that the necessary your past actions and preferences to domestic deposits. and appropriate level of checks have select the product for you. been performed in accordance with Despite the challenges they face, the responsible lending code. For Organic growth vs. Executives have explained that they example, a non-English speaking inorganic growth are perfectly comfortable with where person who does not truly understand they are currently sitting in the sector. The sales of GE Capital and Fisher the documentation may be quickly They remain content with operating in & Paykel Finance were the key identified in a person-to-person the niche where they readily consider highlights in last year’s publication. As application, but might not be picked up themselves as being good at what at 30 September 2016, the sales of during an online application process. they do, in an area where there is these respective entities have been still a potential for steady margin and With today’s society being more completed, and the new entities lending growth. This year, the main consumer driven, the demand from are now in full operation under their focus has been on organic growth. borrowers for easier and quicker new structure. This means growing the business in access to funds and from depositors In contrast to last year, we have not a way that is sustainable in the long for a different type of return, will only seen much in the way of acquisitions term for all key stakeholders (i.e. build. As the non-bank sector moves or mergers. In the earlier part of the both borrowers and lenders), being its lending and deposit processes year, however, speculation about the selective about where they invest online, it will be intriguing to see how sale of UDC Finance was floated in the their money or who they lend to, and the sector will address the trade- media,67 and this prompted Macquarie nurturing lasting relationships with key off between loan growth, socially Group and Heartland Bank to stakeholders that will ultimately drive responsible lending, and the sharing announce their interest in purchasing repeat business. of risk. UDC should the finance company be There is also a general consensus The way finance is obtained and put up for sale by its parent company, amongst Executives that increased provided could change radically. Uber, ANZ NZ Bank. In May, ANZ NZ CEO regulation, significant operational Amazon and Netflix have all seen David Hisco firmly reiterated that issues or the lack of strategic traditional customer views and models ANZ’s ownership in UDC is currently resources will be the main catalysts challenged. The same will happen undergoing a strategic review and that that will drive the next big round of in the finance space. People don’t no plans have been drawn up for its acquisitions or mergers within the non- 68 actually want a mortgage, they want sale. He did not, however, rule out bank sector in New Zealand. a home that suits their needs, but the the possibility of a sale following the

The future Increasing geopolitical and economic as the Global Financial Crisis (GFC), As a result of world events over the uncertainty has caused Executives to and just how much longer will these past year, many Executives have be certain of one thing: a continued good times last. In short, they see the expressed some level of apprehension rise in offshore funding costs during New Zealand economy as being in as to how New Zealand’s financial the foreseeable months. This could a good place locally and, if it is to be market will be impacted in the place further tension on the local affected, they generally believe it will upcoming months, largely due to: deposit market as both the bank and be as a result of the contagion effect non-bank sector continue to step up of a global issue. 1. Ambiguity over how EU and global efforts to secure sufficient funding. trade relations with the UK will Lastly, the future will bring greater look like following Brexit, and New Zealand continues to track well collaboration in the finance industry most recently; economically after another relatively in order to remain competitive in an benign year, with high employment industry that continues to evolve. As 2. US president-elect, Donald Trump, levels and low interest rates for yet a result, strategic partnerships are and what his American protectionist another year. However, this has left expected to develop between market policies could mean to both global many Executives pondering whether participants as the nature of delivery of economic and military stability, the sector is adequately prepared to the customer experience changes and should he decide to follow through deal with another financial crisis such disruptors challenge existing models. with them.

© 2017 KPMG, a New Zealand partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. non-bank sector non-bank the at Looking back 98 |KPMGFIPS2016 © 2017 KPMG, aNew Zealand partnership andamember firmof theKPMG network ofindependent member firms affiliated with KPMG International Cooperative (“KPMGInternational”), a Swiss entity.reserved. Allrights SAVINGS FINANCE Nelson BuildingSociety Fisher &Paykel Finance BMW FinancialServices Credit UnionBaywide Motor Trade Finance is Mortgage TrustFirst John Deere Finance Credit UnionSouth EFN (New Zealand) Credit UnionNorth Medical Securities Fuji Xerox Finance Financial Services Financial Services First Credit Union Police &Families Custom FleetNZ Nissan Financial Building Society Services NZPty Instant Finance Mercedes-Benz The Warehouse Toyota Finance Avanti Finance GE Finance& New Zealand UDC Finance Credit Union LeasePlan Wairarapa Heartland Insurance Limited Ricoh ORIX

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GE Capital New Zealand structure given the change in ownership

Business Divisions Branding Under Details of GE Capital’s Sale Public Disclosure Under GE Capital New Ownership of Financial (Prior to Sale) Statements Under New Ownership Commercial Wells Fargo On 31 October 2015, Wells Fargo & Not available Distribution Finance Commercial Company announced the purchase Distribution Finance of GE Capital’s Commercial Distribution Finance division for an (Ultimate Parent undisclosed amount. – Wells Fargo & Company)

Equipment Finance EFN (New Zealand) On 29 June 2015, Element Available Limited Financial Corporation purchased GE Capital’s fleet management (Ultimate Parent – in the US, Mexico, Australia and Element Financial New Zealand for US$6.9 billion. The Corporation) sale also included a portion of GE Capital’s New Zealand Equipment GE Capital Finance division. (New Zealand) Fleet Solutions On 10 November 2015, GE Capital sold the remaining portion of its Australian and New Zealand commercial lending and leasing portfolios to Sankaty Advisors for an undisclosed amount.

Legacy Solutions Latitude Financial On 15 March 2015, investment Not available (GE Money) Services manager Varde Partners, private equity firm KKR, and Deutsche (Ultimate Parent Bank purchased both the – KVD Singapore New Zealand and Australian Pte Ltd) consumer finance division of GE Capital (GE Money) for A$8.2 billion.

• Jan. 2016 • May 2016 • Aug. 2016 • 28th • 4th • 1st The RBNZ leaves the Official Cash ANZ NZ CEO, David Hisco, affirms The Commerce Commission formally Rate (OCR) unchanged at 2.50%. that UDC Finance is not for sale. files charges against Harmoney under the Fair Trading Act for misleading • 6th consumers into believing they had • Feb. 2016 RBNZ statistics reports a record high been pre-approved for a personal • 17th of $1.7 billion of mortgage lending loan. Harmoney pleads guilty to those The RBNZ approves Scorecard Pty approved in a single week. charges, for which it could potentially Limited to be the fourth credit rating face a six-figure fine. 12th agency to provide credit ratings for • Motor Trade Finance’s appeal over Wells Fargo completes acquisition of NBDTs in New Zealand. The other the recent ruling made against it GE Capital’s Commercial Distribution three credit rating agencies include for charging unreasonable fees on Finance business in Australia and Standard & Poor’s (S&P’s), Moody’s loan contracts is dismissed by the New Zealand. and Fitch Ratings. Supreme Court. • 11th • 29th Harmoney revises its fee structure, The RBNZ cuts the OCR by 25 bps The sale of LeasePlan New Zealand replacing the service fee on to 2.00%. Limited to LP Group BV receives repayments with a lender fee that 25th approval from the Overseas will only be charged on the interest • S&P’s expresses concern over the Investment Office. earned by the lender. growing use of interest-only mortgage • Mar. 2016 • Jun. 2016 loans in New Zealand. 29th 9th • • 10th • The Commerce Commission The RBNZ cuts the OCR by 25 bps The RBNZ leaves the OCR unchanged formally files civil proceedings to 2.25%. at 2.25%. against Harmoney in a bid to get the Auckland High Court to clarify how • Apr. 2016 the Credit Contract and Consumer • Jul. 2016 Finance Act 2003 (CCCFA) applies to 21st • 6th consumer loans offered through peer- S&P’s places UDC Finance’s • Ricoh announces a partnership with to-peer lenders. ‘AA-’ long-term credit rating on a 2 Degrees as it seeks to expand its negative outlook. managed IT service business. 28th • 14th The RBNZ leaves the OCR unchanged • Lending Crowd seeks to raise at 2.25%. $5 million in capital for marketing and PledgeMe becomes the fifth P2P product development initiatives. lender in New Zealand after having its licence approved by the Financial • 22nd Markets Authority (FMA). Former Wairarapa Building Society employee found to have been misappropriating funds; no member accounts were affected.

• Sep. 2016 • Oct. 2016 • Nov. 2016 • 6th • 1st • 1st In response to the recent ruling New LVR rules come into effect, The FMA approves Citizens Brokerage against Motor Trade Finance in May, restricting mortgage lending to Limited’s license to operate as a P2P the Commerce Commission releases residential property investors across lender in New Zealand. draft guidance outlining what amount New Zealand with LVR greater than of consumer credit fees may be 60% to no more than 5%, and no • 2nd constituted as reasonable. more than 10% to owner-occupiers New Zealand’s unemployment rate with LVR greater than 80%. falls to 4.9% for the three months • 13th ended 30 September 2016, a first Fisher & Paykel Finance announces • 14th since 2008. its new branding as Flexi Cards Heartland invests $4 million into after having been acquired by Flexi Harmoney to boost its stake to 13%. • 3rd New vehicle registrations in Group last year, along with the 17th announcement of its partnership • New Zealand for the month of Fitch Ratings gives Credit Union with MasterCard to launch the October top the 14,000 mark to hit a Baywide its first credit rating at ‘BB’ Q MasterCard. Flexi Cards is the first 32‑year high. for long-term debt issues. non-bank to be granted a MasterCard 7th issuing licence in New Zealand. 25th • • Trade Me purchases an additional S&P’s downgrades UDC Finance’s $670,000 in shares to maintain a 15th long-term credit rating by • 14.4% shareholding in Harmoney. Motor Trade Finance announces three notches, from AA- to A-, due additional borrowings of $220 million to its potential sale. No formal 10th from institutional investors, by way of • announcement has been made The RBNZ cuts the OCR by 25 bps securitising its finance receivables. by its parent company, Australia & to 1.75%. Warehouse Money’s Visa cards New Zealand Banking Group, as to receive A+ certification after having the sale of UDC Finance. • 11th SCFL Management Limited, wholly met Payment Card Industry Data The RBNZ announces its intention to owned by Southern Cross Financial Security Standards. release formal OCR projections from Holdings Limited, receives its November onwards. • 22nd license from the FMA to operate in The RBNZ leaves the OCR unchanged • 28th New Zealand as a P2P lender. at 2.00%. Fitch Ratings re-establishes an 22nd ‘A’ long-term issuer rating for the • 30th Tuners purchases Autosure insurance • Australian parent company of John The RBNZ approves Medical business from Suncorp Group for Deere Financial Limited. Securities Limited’s request to cancel $34 million. its NBDT licence.

Last year, I wrote an article (Removal of Unrelated Lender Liability) Amendment Bill and the Commerce for inclusion in the KPMG Commission’s draft guidance on Financial Institutions consumer credit fees – among others. Performance Survey With exposure drafts of amended which largely reflected on Financial Advisers and Anti-Money what Financial Services Laundering legislation expected to be consulted on and enacted in Federation (FSF) members 2017 (again, among others), I’m not had been doing. This seemed prepared this year to tempt fate by saying that our regulatory reform days appropriate at the time, are behind us, or even that they are particularly as in 2015 the tapering off. FSF celebrated the 50th In regard to the former of these, in anniversary of our founding. particular, we still remain hopeful that common sense will prevail and Lyn McMorran Also, because we felt we that the provision of consumer credit Executive Director were coming to the end of the will be removed from the scope of Financial Services Federation Inc. ‘once-in-a-lifetime’ regulatory an amended Financial Advisers Act. Under the current Act, consumer reform of the financial credit is a category two product and services sector forced upon any ‘advice’ provided in relation to us by the events of the Global this, such as the suitability of a loan for the borrower’s purposes, how it Financial Crisis. might be structured to suit their needs, or helping them to understand their Lyn McMorran is the Executive obligations under a loan agreement, is Director of the Financial Services At that time, we were hopeful that covered by both the Financial Advisers Federation Inc., which is the industry in 2016 we would be able to let our Act (FAA) and the Credit Contracts and body representing responsible compliance obligations take care Consumer Finance Act (CCCFA). We finance and leasing providers in of themselves because systems believe this overlapping regulation is an New Zealand (www.fsf.org.nz). and processes were largely in place anomaly that the amended FAA could Prior to joining the FSF in 2012, Lyn and that we would be able to turn take the opportunity to fix. was Area Manager for Westpac’s our attention to innovation and Realistically, we believe the reforms Private Bank in the Lower North and business growth. to the CCCFA and the introduction of South Islands. How that has actually panned out has the Responsible Lending Code provide A Certified Financial Planner, Lyn is been interesting, and it’s fair to say the the necessary consumer protections a past President of the Institute of results have been mixed. around the provision of consumer Financial Advisers of New Zealand. credit, and this Act would always It certainly has not been the case that take precedence over the FAA if any Lyn holds a Graduate Certificate in the need to respond to regulatory concerns arose from the regulator as Management and a Post-Graduate matters has diminished, with the to the provision of credit ‘advice’. Diploma in Business Studies FSF having provided more than a (Personal Financial Planning) and dozen submissions on behalf of is a Fellow of both the Institute of members this year to date. These One area of particular concern Financial Advisers and the Financial have included responses to the to some of them has been the Services Institute of Australasia. Options Paper on possible changes increase and greater sophistication She is also a Trustee of the Skylight to the Financial Advisers Act, Phase 2 of identity and other types of fraud Trust and a Commissioner for the of the Anti-Money Laundering and that they have been subjected to. Insurance and Savings Ombudsman Countering Financing of Terrorism disputes resolution scheme. regime, the Consumer Guarantees

The upside, however, is that it has There are many technology providers not at all been about compliance for who can help lenders meet their We understand that the tick-box our members this year and certainly Lender Responsibility Principle approach will not be good enough the mood among them is that 2016 obligations when transacting with in the lending situation. has been a good year for lending with their customers digitally. For example, volumes high and arrears low. there are ways to satisfactorily achieve electronic identity verification, to This is important to our members One area of particular concern to some access borrowers’ bank account data because we, like the regulators, of them has been the increase and to verify income and expenditure believe that consumers are entitled greater sophistication of identity and and determine whether the loan is to the same protections regardless of other types of fraud that they have affordable, and for the borrower to the channel they use to interact with been subjected to. Greater vigilance electronically sign loan agreements. lenders, and for that reason we have has been required to spot these also been reasonably vocal about the instances because the documentation The gap is in providing lenders with fact that care needs to be taken not to being provided is of such high quality the certainty that borrowers are be seduced by the idea of ’disruptors‘ that this has not been easy. making an informed decision and that they do in fact understand the in the industry that then allows them The FSF as a body is now looking terms and conditions of the lending an easier ride in respect to compliance. at ways in which we can facilitate agreement they are entering into, In our view, a loan is a loan whether it’s more information sharing amongst when the lender is not able to assess provided by a lender in a branch, via a our members to try to prevent that understanding face-to-face. We all platform by an intermediary such as a instances of identity fraud or the use know how easy it is when accessing peer-to-peer lender, via on-line means, of fraudulent account information to products and services on-line to tick or whatever. The only difference is the verify loan affordability. the box that says that we have read channel by which the loan is accessed. The future is certainly in digitally the terms and conditions without There is clearly plenty to occupy providing consumers with access to having read them at all – it’s a question us and, like many, particularly after credit. The demand is most certainly of wanting to buy the product and the events of recent days in North there for borrowers to be able to move on. Canterbury and Wellington, we will access credit through their online We understand that the tick-box be pleased to welcome in 2017 with devices without having to use a branch approach will not be good enough in whatever that has in store for us. network. They want money when they the lending situation, particularly when want it and fast. it comes to the protection of those The difficulty for lenders is in customers who might be regarded as being able to meet the consumer being vulnerable, for example, when demand while still satisfying the they are people for whom English is a regulator that they are meeting their second language. So, as a Federation, responsibilities as responsible lenders. we are looking to help members to The Commerce Commission rightly formulate the means to meet their feels that consumers deserve the responsible lending obligations and same protections no matter what still be able to innovate and offer their channel they use to access products customers access to products via a and services. variety of channels.

The non-bank sector 31 MOVEMENT IN NET PROFIT AFTER TAX showed an 8.17% growth in overall reported net profit, $MILLION up by $15.70 million to 300 $207.78 million. 250

Out of the 23 participants, 200 15 reported higher profit levels, and 10 of those 150 achieved double-digit growth. 100 Despite tighter margins due to a decrease in lending 50 rates and market volatility 0 creating cost of funds 2015 NET NET NON- OPERATING IMPAIRED TAX 2016 NET PROFIT INTEREST INTEREST EXPENSES ASSET EXPENSE PROFIT pressure, the non-bank sector AFTERTAX INCOME INCOME EXPENSES AFTERTAX demonstrated steady growth in net interest income and Nissan Financial Services, in its Services, Ricoh and Toyota Finance, non-interest income that led second full year of operation, is all of whom achieved NPAT growth continuing to show significant growth ranging from 23.11% to 44.51%. to the increase in profitability. as it continues to establish its footing The top three performers, in terms of within the local vehicle financing dollar value increases ranging from sector in New Zealand, supporting $3.15 million to $3.75 million, were Non-banks’ profitability the sale of its vehicle brand and the Avanti, Mercedes-Benz Financial increases on the back of Nissan dealership network. Nissan Services and Toyota Finance. Financial Services’ NPAT growth of In contrast, Fuji Xerox Finance strong loan growth 201.90% was driven by increased net reported a $10.66 million reduction Non-bank survey participants had a interest income of $4.98 million or in net profit for the year, dropping strong year in 2016 with the sector 98.17%, alongside net interest margin from a $3.95 million net profit in achieving an increase in net profit (NIM) growth of 45 bps to 4.04%. 2015 to a $6.71 million net loss in of $15.70 million to $207.78 million Similarly, Wairarapa Building Society 2016. Fuji Xerox Finance is the only compared to the previous year. had a $317k or 13.32% increase in net participant that reported a loss this If we ignore the impact of EFN interest income this year. (New Zealand) Limited, which is year. The contraction in NPAT was included in the survey for the first Other notable mentions are Avanti driven by several factors, including time since it started operations on Finance, First Mortgage Trust, Medical a $2.57 million (10.66%) reduction 27 July 2015, the sector showed Securities, Mercedes-Benz Financial in interest income, a contraction a normalised74 growth of 3.93% to $199.64 million. Out of the 23 participants, 15 reported positive TABLE 11: PERFORMANCE METRICS Total increases to NPAT levels. Nissan Increase in total assets 17.40% Financial Services and Wairarapa Increase in net profit after tax (npat) 8.17% Building Society were the standout performers this year with triple- Movement of impaired asset expense digit NPAT growth of 201.90% (as a percentage of average gross loans and advances) bps 4 (from $1.26 million to $3.81 million) Decrease in interest margin bps -41 and 467.92% (from $106k to Decrease in NPAT/Average total assets bps -9 $602k), respectively. Decrease in NPAT/Average equity bps -23

of 138 bps in NIM to 2.79%, a Overall, the non-bank sector delivered Normalised interest income for the further $1.05 million reduction in plenty of positives this year as sector is up $20.82 million or 2.43%, non-interest income, and lastly, a over half of our survey participants while normalised interest earning assets steep increase of $10.25 million improved their profitability, despite increased to $9.78 billion, a growth (from $635k) in impairment expense. new challenges that arose and tougher rate of 6.93% or $633.34 million. Positively, Fuji Xerox Finance reported competitive pressures from P2P Of the seven survey participants that a 7.72% or $441k reduction in lenders and the banking sector. saw NIM growth, Ricoh and Instant operating expenses. Summary of non-bank sector Finance were the top performers, with With reports of record vehicle sales profitability measurements (see increases of 121 bps and 105 bps, in the media over the past couple Figure 31 – page 104): respectively. The remaining five months, a closer look at this segment competitors recorded improvements —— NPAT grew by $15.70 million or of the sector revealed that five of the in the range of 2 to 45 bps. These two, 8.17%, to achieve $207.78 million seven vehicle financing companies along with Nissan Financial Services (normalised growth of 3.93%). contributed a total of $9.98 million who had the 3rd highest NIM gain towards normalised (excluding —— Net interest income went up of 45 bps, were the only participants EFN) NPAT growth for the non-bank by $29.78 million, to reach who were able to benefit from both sector. BMW Financial Services $563.72 million (normalised favourable lending and funding and ORIX were the only ones that increase of $19.67 million conditions (i.e. achieving a higher reported reductions in profits from or 3.68%). interest income over interest earning last year of 24.57% ($2.32 million) and asset ratio, while simultaneously —— Non-interest income increased 0.84% ($132k), respectively. Weaker driving down its interest expense over by $20.92 million, to reach performance from BMW Financial interest bearing liability ratio). $181.53 million (normalised gain of Services stemmed from a decrease $10.30 million). On the other hand, Avanti Finance of $1.43 million in net interest income, and Fuji Xerox Finance had the largest the majority of which came from a —— Impairment asset expense NIM declines of 96 bps to 9.98% and decline in interest income as interest increased by $7.83 million, 138 bps to 2.79%, respectively. expense remained flat. Worsening climbing to a total of $47.80 million credit quality also had a significant (normalised of $7.47 million Instant Finance continues to have impact on the deterioration of its NPAT or an 18.70% hike in impaired the highest NIM at 22.30%, followed as impairment expenses rose $952k asset expense). by ORIX at 12.22% and Fisher for the year, followed by a marginal & Paykel Finance at 11.30%. On —— Operating expenses increased by reduction in non-interest income of the other end, Wairarapa Building $23.20 million. $259k as well. Society, Nelson Building Society, —— Tax expense went up by and Fuji Xerox Finance held the In relation to non-interest income, $3.98 million. weakest NIMs at 2.25%, 2.30% and we continue to see the same theme 2.79%, respectively. from previous years, with vehicle financing companies contributing Net interest margin over $12.57 million to the overall continues to contract $10.30 million (6.41%) growth in Participants in the sector are finding 32 SEE FIGURE 32 – PAGE 106 normalised non-interest income. it increasingly difficult to maintain The largest increase in non-interest their NIMs. This year, only 7 out of income came from Toyota Finance, • the 23 survey participants were able Despite normalised NIM levels Nissan Financial Services and to increase their NIM levels, with reducing this year, normalised interest LeasePlan, which reported increases one participant’s NIM staying flat. income grew by 2.43% for the year, of $5.66 million, $3.40 million and Normalised NIM contracted by 24 bps, compared to an impressive 12.73% $2.95 million, respectively. declining from 6.09% to 5.85%. growth last year. Nissan Financial Margin pressures primarily stemmed Services and Avanti Finance once from lower lending rates as a result of again saw impressive results this year ever-increasing competition within the with increases in interest income of sector, without sufficient relief from $8.66 million and $8.57 million, up the lending side of the equation. from last year by 84.18% and 37.13%,

$MILLION % NET INTEREST INCOME 1,000 6.6 32 ANALYSIS 900 6.4

INTEREST INCOME (LHS) 800 6.2

INTEREST EXPENSE (LHS) 700 6.0 600 5.8 NET INTEREST INCOME (LHS) 500 5.6 NET INTEREST MARGIN (RHS) 400 5.4

300 5.2

200 5.0

100 4.8

0 4.6 2012 2013 2014 2015 2016

GROSS LOANS AND $MILLION % 33 ADVANCES VS. NET 10,000 7. 0 INTEREST MARGIN 9,000 6.5

GROSS LOANS AND ADVANCES (LHS) 8,000 6.0

NET INTEREST MARGIN (RHS) 7, 000 5.5 6,000 5.0

5,000 4.5

4,000 4.0

3,000 3.5

2,000 3.0

1,000 2.5

0 2.0 2012 2013 2014 2015 2016

$BILLION LENDING BY NON-BANK 30 34 SECTOR

25 CONSUMER FINANCE INSTITUTIONS (NON-REGISTERED BANKS) 20

OTHER BUSINESS 15 PROPERTY & BUSINESS SERVICES FINANCE INSTITUTIONS (REGISTERED BANKS) 10

HOUSING 5 AGRICULTURE

0 SOURCE: RESERVE BANK OF NEW ZEALAND STATISTICS 2012 2013 2014 2015 2016

$MILLION GROSS IMPAIRED AND 200 35 PAST DUE ASSETS 175 GROSS IMPAIRED ASSETS 150 PAST DUE ASSETS 125 TOTAL PROVISION 100

0 2012 2013 2014 2015 2016

$MILLION % 36 IMPAIRED ASSET ANALYSIS 60 0.8

50 0.7 IMPAIRED ASSET EXPENSE (LHS) IMPAIRED ASSET EXPENSE/ AVERAGE LOANS AND ADVANCES (RHS) 40 0.6

30 0.5

20 0.4

10 0.3

0 0.2 2012 2013 2014 2015 2016

OPERATING EXPENSES VS. $MILLION % 37 OPERATING EXPENSES/ 450 70 OPERATING INCOME 400 65

OPERATING EXPENSES (LHS) 350 60 OPERATING EXPENSES/ 300 55 OPERATING INCOME (RHS) SUM OF OPERATING EXPENSES/ 250 50 GROSS REVENUES (RHS) 200 45

150 40

100 35

50 30

0 25 2012 2013 2014 2015 2016

respectively. Of the 23 participants TABLE 12: GROSS LOANS 2016 2015 Movement Movement surveyed, 15 saw increases in interest $’000 $’000 $’000 % income for the year. Entity Going forward, the sector will no Avanti Finance Limited 239,940 152,977 86,963 56.85% longer be able to rely on lower funding BMW Financial Services 353,714 369,427 -15,713 -4.25% costs to alleviate the pressures felt New Zealand Limited on the lending side, as the cost of funds will likely come under further Credit Union Baywide 213,276 215,041 -1,765 -0.82% pressure. Non-banks’ Executives have Credit Union South 107,894 93,867 14,027 14.94% commented on the expected rise of offshore wholesale funding costs EFN (New Zealand) Limited 424,684 n/a n/a n/a as investors demand higher returns First Credit Union 181,295 183,340 -2,045 -1.12% during these increasingly uncertain times. The competition for funds First Mortgage Trust 284,282 219,436 64,846 29.55% within the local deposit market will Fisher & Paykel Finance drive up funding costs, as the major 694,193 656,469 37,724 5.75% banks are no longer able to rely on Holdings Limited their Australian parents to provide as Fuji Xerox Finance Limited 427,213 438,111 -10,898 -2.49% much funding as they have previously. Regulatory developments across the Instant Finance Limited 95,722 92,210 3,512 3.81% Tasman over the past year have meant John Deere Financial Limited 151,550 144,503 7,047 4.88% that Australian banks have reduced LeasePlan New Zealand funding levels to their New Zealand 8,588 5,491 3,097 56.40% subsidiaries. This was to ensure that Limited they remained compliant with rules Medical Securities Limited 134,618 159,464 -24,846 -15.58% that restricted the bank’s non-equity exposure to 5%, and for them to Mercedes-Benz Financial 545,557 513,722 31,835 6.20% shore up funds to meet the capital Services requirements as set out by APS 110 Motor Trade Finance Limited 540,565 517,250 23,315 4.51% and APS 120. Nelson Building Society 402,168 361,228 40,940 11.33% Total assets continue Nissan Financial Services NZ 297,572 202,437 95,135 46.99% to grow Pty Limited The sector continues to achieve strong asset growth as total assets climbed a ORIX New Zealand Limited 37,504 35,614 1,890 5.31% further $1.63 billion to $11.01 billion, a Police & Families Credit Union 60,701 64,400 -3,699 -5.74% rise of 17.40% over last year. It should be noted that $982.25 million relates Ricoh New Zealand Limited 86,239 88,651 -2,412 -2.72% to the inclusion of EFN in this year’s Toyota Finance New Zealand 776,512 720,654 55,858 7.75% survey, for which no comparatives Limited are available since this is its first year of operation. Asset growth continues UDC Finance Limited 2,601,939 2,378,692 223,247 9.39% to be fuelled by the increase in the Wairarapa Building Society 108,787 104,013 4,774 4.59% sector’s loan book as gross loans and advances increased from $7.72 billion Sector Total 8,774,513 7,716,997 1,057,516 13.70% to $8.77 billion. n/a = not available •33 SEE FIGURE 33 – PAGE 106

Avanti Finance, First Mortgage Trust, TABLE 13: MOVEMENT IN INTEREST 2016 2015 Movement Nelson Building Society, Nissan % % (bps) Financial Services and UDC Finance MARGIN registered the largest growth in Entity interest earning assets in the range Avanti Finance Limited 9.98 10.94 -96 of $75.55 million to $224.17 million. BMW Financial Services New Zealand Collectively, these five participants 6.82 7.20 -38 account for over 91.24% of the Limited $633.34 million increase in interest Credit Union Baywide 4.73 5.16 -43 earning assets (excluding EFN). Credit Union South 7.69 8.08 -39 Of the 15 participants that had larger loan books this year, Avanti Finance EFN (New Zealand) Limited n/a n/a n/a and Nissan Financial Services stood First Credit Union 4.01 4.57 -56 out as having the highest growth rates in terms of both dollar and First Mortgage Trust 7.17 7.69 -52 percentage increases to their loan books. After a triple-digit percentage Fisher & Paykel Finance Holdings Limited 11.30 11.01 29 growth of 150.28% last year, Nissan Fuji Xerox Finance Limited 2.79 4.17 -138 Financial Services went on to add a further $95.14 million to its loan book, Instant Finance Limited 22.30 21.25 105 up by more than 46.99%. Similarly, John Deere Financial Limited 3.63 3.63 0 Avanti Finance grew its loan book to $239.94 million, an increase of LeasePlan New Zealand Limited 9.67 9.91 -24 $86.96 million. The bulk of Avanti’s Medical Securities Limited 4.03 3.68 35 growth was derived from an increase in its mortgage book, a space in which Mercedes-Benz Financial Services 4.13 4.23 -10 it has only established a presence in Motor Trade Finance Limited 8.61 9.06 -45 the last two years. UDC Finance reported the highest Nelson Building Society 2.30 2.57 -27 dollar growth of $223.25 million to Nissan Financial Services NZ Pty Limited 4.04 3.59 45 total gross loans of $2.60 billion, the largest among our survey participants. ORIX New Zealand Limited 12.22 12.35 -12 LeasePlan had a growth rate of Police & Families Credit Union 4.58 4.78 -20 56.40% to a loan book of $8.59 million; this was the second fastest growth Ricoh New Zealand Limited 9.52 8.30 122 rate when compared to Avanti Toyota Finance New Zealand Limited 4.50 4.43 7 Finance who achieved a growth rate of 56.85%. UDC Finance Limited 4.50 4.87 -37

EFN (New Zealand), who was Wairarapa Building Society 2.25 2.22 3 previously known as part of the fleet Sector Average 5.68 6.09 -41 solutions and equipment finance division of GE Capital, has the n/a = not available third largest total asset holdings of $982.25 million, but only the seventh- highest gross loans and advances balance at $424.68 million.

In terms of market share for gross (19.60%) to $47.80 million from asset expense as a percentage of loans and advances (excluding EFN), last year, while total impairment gross loans and advances would have UDC Finance continues to the hold provision increased for the year improved by 10 bps, decreasing from the lead at 31.16% with a 34 bps by 10.53% to $122.70 million. The 0.52% to 0.42%. Mercedes-Benz increase this year. Avanti Finance and increase in impairment provision Financial Services and UDC Finance Nissan Financial Services had the was the result of specific provisions had the largest decreases in impaired largest gains of 89 bps and 94 bps, rising from $35.54 million in 2015 asset expense of $4.06 million and respectively, as would be expected to $45.77 million in 2016, for which $3.01 million, respectively. Overall, 15 given the magnitude of their increase an increase of $10.25 million by Fuji out of 23 participants had an impaired as mentioned above. Overall, 15 Xerox Finance was the main cause. asset expense over gross loans and of our 23 survey participants had a The collective provision for the advances ratio in the range of 0% shrinking market share for gross loans year increased to $76.94 million, a to 0.91%. and advances. $1.46 million (or 1.94%) increase from While the sector continues to report the previous year. positive recurring trends in asset quality year after year, the Executives 34 SEE FIGURE 34 – PAGE 106 all explained that this was an area that 35 SEE FIGURE 35 – PAGE 107 they will continue to monitor carefully: • the adequacy of provisions held in light The ongoing expansion of the sector’s • of a growing loan book. gross loans and advances balance is As in previous years, credit quality has a testament to the strong consumer improved year on year. The percentage Improved operating confidence levels in New Zealand at of gross loans and advances over efficiency ratio despite the moment. Consumer confidence impairment provision improved slightly higher operating costs levels in the New Zealand market are for the year at 1.40%, a movement Operating expense for the sector impacted by record low interest rates, of -4 bps from last year. Of those rose by 5.95% to $413.08 million, and high employment levels and general surveyed, 15 out of 23 showed of the $23.20 million increase, EFN confidence from the strengthening of an impairment provision to gross accounted for $10.48 million. On the the household balance sheet. loans and advances ratio that was other hand, the non-bank sector also unchanged or lower by an amount in reported higher operating income Asset quality the range of 0 to 127 bps. ORIX had levels of 7.30% or $50.71 million, to Although competition in the lending the largest improvement in terms reach $745.26 million. The inclusion market continues to be intense, of basis points and percentage change, of EFN had an impact on this result non-banks’ Executives have stressed decreasing its impairment provision as EFN contributed $20.74 million in that they will not compromise on to gross loans and advances ratio by additional operating income, more than asset quality in order to write more 127 bps, from 1.37% to 0.10%. 40% of the total increase. loans. The current focus on market Despite higher operating costs, the discipline and responsible lending is sector achieved better than expected not just a talking point resulting from SEE FIGURE 36 – PAGE 107 36 operating efficiencies, as the operating recent legislation. Executives do expense over operating income ratio remember the pattern from the post- decreased by 70 bps, from 56.13% GFC era, and not fondly. • Impaired asset expense as a to 55.43%. In isolating the effect of Asset quality for the sector percentage of gross loans and EFN on our calculation of this year’s softened with a slight deterioration advances rose by 2 bps over the operating efficiency ratio, it was coming through from credit quality current year, from 0.52% to 0.54%. noted that exclusion of EFN only had measurements. Although impairment However, excluding Fuji Xerox a minor impact, as the sector still expense and total bad debt provision Finance, which had an abnormal delivered 56 bps in efficiency savings levels for the sector rose in the current increase in impaired asset expense as normalised operating expense to year, the increase is not large in the of $10.25 million (or 1,613.39%), operating income fell from 56.13% context of the size and growth of the impairment expense for the sector to 55.57%. sector’s loan book. Impaired asset would have decreased by $2.41 million expense increased by $7.83 million (or 6.13%). At that level, impaired

operating efficiency ratio. Nelson In light of comments from Executives Building Society, Motor Trade Finance, about investing more in the way of SEE FIGURE 37 – PAGE 107 37 ORIX and UDC Finance were the only Fintech to further develop their front entities whose operating efficiency end technological capabilities, it is • ratio remained largely consistent expected that operating costs will Operating costs often tend to be with last year, with changes of just continue to increase in the future. highly fixed in nature, comprising of 2 bps, 20 bps, 9 bps and 20 bps, Partnerships with Fintech companies items such as employee remuneration respectively. Looking into the detail, and/or banks will be on the agenda costs and administration expenses 10 entities had an operating ratio that of non-banks’ Executives in order (e.g. overhead and rent). Whereas was better than the industry average to leverage the IT capabilities and operating income can be considered of 55.43%. Of those, First Mortgage resources that they already have in to be more variable/volatile in nature Trust, Nissan Financial Services and place, in exchange for a small fee for due to its susceptibility to interest UDC Finance had the best operating the use of its innovation. Non-bank rate changes, fair value adjustments, ratios at 24.06%, 18.26% and 26.25%, entities are aware that the banking and a myriad of other factors that can respectively. Given that the ultimate sector has made significant headway drastically change an entity’s operating objective of a credit union is not to in this area as Fintech entities are income level from year to year, despite make a profit, but rather to maximise becoming an increasing threat to having no fundamental change to interest paid to its members (i.e. them in the markets where they its operations. interest expense), it is reasonable that traditionally operate. Therefore, it is At an individual level, the results they would have the highest operating likely to see partnerships with these were a bit mixed, with 12 out of expense over operating income ratio types of entities as beneficial to 23 participants showing an improved within the sector. combat disruptors and protect their customer base.

In the previous year, 2. borrowers expecting to be able to In the previous year, we asked borrow without providing security. questions about how P2P lenders we profiled P2P lending would provide visibility into loan The increase in P2P lending is largely explaining what it is, performances and the extent to which attributable to Harmoney’s growing credit losses are being recognised. how it works, where it is presence with over $357 million in Harmoney has made significant lending done through its platform going, and its potential headway in this area by presenting to date. This is considerably higher place in New Zealand’s key performance metrics such as than the combined lending of its loan performance by credit grade financial market. competitors. Despite Executives being (i.e. default and arrears rate), realised impressed with the technological annual return by investor type and capabilities of P2P lenders in distribution of loans by grade.76 developing a sophisticated and At this stage, it is still too early to Squirrel Money has done this to a impressive front-end technologies, they comment on the financial performance more limited extent by providing continue to express reservations as of P2P lenders as a segment of the investors with information about the to the quality of lending that is taking non-bank sector, as the platforms current lending book size, the amount place given that lending decisions are are not required to report their in arrears, the value of write-offs, and being made in minutes and the reliance performance. The conditions of their the size of the reserve fund. Harmoney on credit scoring models. license require them to report the has had the benefit of a larger pool of results of the entity that manages the On the regulatory side, legal actions transactional data from which they can platform. Although Harmoney is not that have been brought against leverage, whereas newer companies required to disclose any information Harmoney during the year could have will require a little more time to relating to its platform, it has taken the significant implications for the P2P obtain more transactional data before initiative to do so. However, the figures market. The most significant of these they can provide meaningful and disclosed have not been audited. are the civil proceedings brought insightful information disclosures of a against Harmoney by the Commerce similar nature. In the current year, the FMA has Commission in a bid to get the granted PledgeMe Limited, Citizens P2P lenders could have an incentive Auckland High Court to clarify how the Brokerage Limited and SCFL to provide such disclosures as it Credit Contract and Consumer Finance Management Limited licenses to promotes investor confidence and Act 2003 (CCCFA) applies to personal operate in New Zealand as P2P encourages them to provide the funds loans offered through P2P lenders. The lenders. The P2P subsector also that are needed to meet the demands draft consumer credit fee guideline that includes Lend Me, Lending Crowd and of the platform’s borrowers. Such was recently published in September Squirrel Money, all of whom received disclosures will help give investors states that under the CCCFA, the fees their license from the FMA last year insight as to the accuracy of the P2P charged by lenders under a consumer and have since begun operations. lender’s credit rating model and the credit contract ‘can not generate potential level of returns they can As P2P lending begins to establish profit or recover more than the costs expect. P2P lenders that do not make a foothold in New Zealand, it is permitted by the Act’.75 such voluntary disclosures as part of becoming evident that there is no their business model may stand to hard and fast rule to dictate how a Harmoney’s position has been that lose out in this respect. One question P2P lender ought to operate or what it the whole premise of a P2P lender that will be asked is whether this should look like. This flexibility works in is that, in providing a platform where information is reliable and presented favour of P2P lenders as it allows them borrowers are matched to potential in a consistent manner (i.e. all P2P to exercise creativity in differentiating investors for a fixed fee, the CCCFA lenders use commonly understood themselves from the competition and does not apply to the platform as it is forms of accounting principles such as in developing a competitive advantage. not the party undertaking the lending. NZ GAAP and NZ IFRS). When we talk Several of our survey participants have An unfavourable ruling for Harmoney about presenting reliable figures, we noted an impact from the growing – that the CCCFA does apply – could may also mean figures that have been presence and influence of P2P lenders have a significant impact on the audited. To date, the only accounts in the market, particularly around: structure and compliance regimes of its business. The developments in this that the P2P lenders are required to 1. the speed with which they are able area will be something to watch. present and have audited are those of to process and complete a client the company that manages the lending loan or deposit application; and platform. From those early accounts,

we will notice losses typically incurred 3. difficulty in achieving economies and deposits, rates that are more by new companies as they incur of scale at a level required to turn a suitable, access to different risk-return setup costs. healthy profit due to low business profiles, finance when and for things margins and the limited size of the consumer wants, and all that right On 10 October 2016, the FMA New Zealand’s financial market. now, and done more fairly vis a vis released a consultation paper risk and reward. In its early phase of ‘Regulatory Returns for Prescribed One P2P Executive we spoke to holds growth, the focus of the P2P market Intermediary Services’. Submission the opinion that P2P lending can only has been to integrate state of the art closed on 28 October 2016. The survive in the near term as an add- technologies into their lending platform paper proposes what information P2P on to the back of another business to provide an enhanced customer and Crowdfunding providers should to support its growth. In addition to experience based around automation provide to the FMA in their regulatory its core business offering, the lender and speed of interaction. returns. This information is designed might offer a P2P complementary to help the FMA access the platform’s service until it is at a point where it Going forward, the next phase for the performance and to consider whether is profitable enough to stand alone. industry will be to focus its efforts on its license requires any additional This was also supported by the view leveraging the technologies that it has terms. It is however, unlikely that the that to survive in the P2P industry in place to support a more meaningful information will be made public. the lender must move beyond just total customer experience and a being a faster, one-click front end sharing of the risks and rewards. Several Executives have questioned customer touch point and reporting whether P2P lending in New Zealand It therefore still remains to be seen platform. The P2P lender must also is sustainable. The main reasons for whether the comment made by Neil provide an enhanced overall customer this are the: Roberts, CEO of Harmoney, is still experience by regularly incorporating valid, namely that the New Zealand 1. low business margins due to fees new and sophisticated technological market has the potential to develop being their only source of revenue; innovations, and by sharing with its into a $10 billion per year lending customers the rewards (and risks) 2. high churn rate of 30–40% with industry if the P2P market gets the that come from being a disruptor of borrowers being able to either right support from business leaders, the finance industry. This will mean obtain cheaper refinancing options regulators and investors.77 Only time providing faster access to becoming a or electing to pay off the loan will tell who holds the right view. customer, faster completion of loans quicker; and

Size & strength measures Growth measures Provision for Net loans and Increase in net profit Increase in total Impaired asset doubtful debts/ Rank by total Total assets Net assets Entity Balance date Year advances after tax assets expense Gross loans & assets $000 $000 $000 % % $000 advances % 15 31-Mar 2016 245,398 33,664 235,526 44.51 54.71 3,607 1.84 Avanti Finance Limited 2015 158,614 25,633 148,874 -15.87 45.61 2,525 2.68 9 31-Dec 2015 358,164 25,772 344,100 -24.57 -4.80 2,922 2.72 BMW Financial Services New Zealand Limited 2014 376,204 18,645 361,500 17.65 4.59 1,970 2.15 14 30-Jun 2016 293,580 38,674 212,550 16.17 10.36 202 0.34 Credit Union Baywide 2015 266,031 36,669 213,588 0.23 5.56 412 0.68 21 30-Jun 2016 129,857 21,132 107,250 -47.43 4.09 983 0.60 Credit Union South 2015 124,749 20,748 92,945 130.47 10.51 559 0.98 EFN (New Zealand) Limited 3 31-Dec 2015 982,253 8,234 424,248 n/a n/a 361 0.10 11 30-Jun 2016 334,421 53,683 178,836 -23.34 13.36 395 1.36 First Credit Union 2015 295,007 49,955 180,613 57.98 18.37 661 1.49 10 31-Mar 2016 353,831 351,567 283,332 23.11 27.30 225 0.33 First Mortgage Trust 2015 277,951 276,174 218,586 32.10 24.84 514 0.39 4 31-Dec 2015 786,224 79,246 674,598 -1.37 4.36 14,608 2.82 Fisher & Paykel Finance Holdings Limited 2014 753,399 80,000 639,236 42.06 6.89 13,340 2.63 8 31-Mar 2016 443,537 34,256 416,333 -269.81 -1.88 10,880 2.55 Fuji Xerox Finance Limited 2015 452,025 40,965 437,476 -73.30 25.10 635 0.14 23 31-Mar 2016 99,415 27,487 91,894 18.13 2.87 2,380 4.00 Instant Finance Limited 2015 96,643 25,771 88,490 11.48 9.17 2,365 4.03 17 31-Oct 2015 157,905 17,066 151,550 6.43 4.76 0 0.00 John Deere Financial Limited 2014 150,733 14,765 144,503 -28.17 11. 17 0 0.00 13 31-Dec 2015 300,359 88,851 8,588 4.61 7.50 51 n/d LeasePlan New Zealand Limited 2014 279,400 76,015 5,491 -14.81 10.06 22 n/d 18 31-Mar 2016 141,199 26,140 134,465 32.81 -28.62 -111 0.11 Medical Securities Limited 2015 197,815 38,188 159,161 -39.15 -2.49 -129 0.19 6 31-Dec 2015 567,045 47,011 538,436 38.86 8.65 -845 1.31 Mercedes-Benz Financial Services 2014 521,923 35,841 504,549 -10.03 12.42 3,217 1.79 5 30-Sep 2016 596,520 85,174 535,237 3.27 5.30 95 0.99 Motor Trade Finance Limited 2015 566,501 82,621 512,151 13.01 4.73 105 0.99 7 31-Mar 2016 558,666 36,323 401,258 6.83 21.53 287 0.23 Nelson Building Society 2015 459,706 30,724 360,478 17.51 10.98 354 0.21 12 31-Mar 2016 302,254 6,202 294,946 201.90 46.13 1,765 0.88 Nissan Financial Services NZ Pty Limited 2015 206,839 2,395 201,212 2,435.19 134.75 1,294 0.61 16 31-Mar 2016 229,862 162,666 37,465 -0.84 -2.97 -406 0.10 ORIX New Zealand Limited 2015 236,893 147,342 35,126 -5.33 3.19 -245 1.37 22 30-Jun 2016 118,835 21,133 60,591 -10.95 9.19 8 0.18 Police & Families Credit Union 2015 108,829 19,319 64,284 26.30 10.56 -30 0.18 20 31-Mar 2016 136,592 65,557 84,578 26.18 -10.97 1,679 1.93 Ricoh New Zealand Limited79 2015 153,421 56,542 87,732 -23.49 12.50 640 1.04 2 31-Mar 2016 1,069,499 146,272 754,412 29.45 -5.32 1,183 2.85 Toyota Finance New Zealand Limited 2015 1,129,650 142,521 698,954 -55.47 -0.81 1,273 3.01 1 30-Sep 2016 2,665,019 423,999 2,573,030 2.61 9.19 7,418 1. 11 UDC Finance Limited 2015 2,440,613 365,462 2,347,163 10.68 3.66 10,427 1.33 19 31-Mar 2016 139,189 16,746 108,587 467.92 11.77 112 0.18 Wairarapa Building Society 2015 124,537 16,128 103,870 -62.54 9.09 56 0.14 2016 11,009,624 1,816,855 8,651,810 8.17 17.40 47,799 1.40 Sector Total 2015 9,377,483 1,602,423 7,605,982 -5.91 8.64 39,965 1.44 n/d = not disclosed; n/a = not available

Credit quality measures Profitability measures Efficiency measures

Impaired asset Operating Gross Operating Past due expense/ Net interest Net profit NPAT/Average NPAT/Average expenses/ impaired Interest spread Underlying profit expenses/Gross Entity Year assets Average loans margin after tax total assets equity Operating assets % $000 revenues80 $000 & advances % $000 % % income $000 % % % 2016 1,345 14,205 1.84 9.98 8.86 11,231 15,603 5.56 37.88 27.35 37.78 Avanti Finance Limited 2015 1,193 13,481 1.95 10.94 9.39 7,772 10,764 5.81 33.52 32.40 44.24 2015 n/d n/d 0.81 6.82 6.37 7,128 9,900 1.94 32.10 31.30 50.62 BMW Financial Services New Zealand Limited 2014 n/d n/d 0.55 7.20 6.74 9,450 13,139 2.57 47.44 28.35 45.37 2016 n/d 1,189 0.09 4.73 4.22 2,004 2,004 0.72 5.32 55.95 86.46 Credit Union Baywide 2015 n/d 4,414 0.20 5.16 4.63 1,725 1,725 0.67 4.82 58.08 87.10 2016 n/d 3,320 0.97 7.69 7. 1 5 338 338 0.27 1.61 74.37 91.41 Credit Union South 2015 n/d 1,858 0.63 8.08 7.56 643 643 0.54 3.16 76.49 91.97 EFN (New Zealand) Limited 2015 4,388 n/d n/a n/a n/a 8,143 9,898 n/a n/a 20.55 50.53 2016 786 5,155 0.22 4.01 3.44 1,859 1,859 0.59 3.59 57.18 87.77 First Credit Union 2015 1,628 4,437 0.40 4.57 3.98 2,425 2,425 0.89 5.39 55.49 82.69 2016 1,600 0 0.09 7. 1 7 7. 1 7 16,672 16,861 5.28 5.31 24.06 24.06 First Mortgage Trust 2015 4,388 0 0.25 7.69 7.69 13,542 14,134 5.41 5.45 23.06 23.06 2015 n/d 25,502 2.16 11.30 10.99 23,739 33,143 3.08 20.94 39.95 54.59 Fisher & Paykel Finance Holdings Limited 2014 n/d 21,645 2.10 11. 01 10.59 24,068 33,522 3.30 20.33 38.43 53.24 2016 n/d n/d 2.51 2.79 2.55 -6,709 -8,680 -1.50 -17.84 31.67 70.55 Fuji Xerox Finance Limited 2015 n/d n/d 0.16 4.17 3.97 3,951 6,631 0.97 10.13 28.19 44.01 2016 0 5,787 2.53 22.30 19.80 8,463 11,930 8.63 27.43 52.24 60.73 Instant Finance Limited 2015 0 5,739 2.69 21.25 18.53 7,164 10,298 7. 74 24.44 53.01 62.55 2015 n/d n/d 0.00 3.63 3.28 2,301 3,191 1.49 14.46 22.34 42.58 John Deere Financial Limited 2014 n/d n/d 0.00 3.63 3.34 2,162 3,008 1.51 15.80 22.85 41.48 2015 n/d n/d 0.72 9.67 9.67 6,836 9,528 2.36 8.29 34.10 76.01 LeasePlan New Zealand Limited 2014 n/d n/d 0.35 9.91 9.91 6,535 9,160 2.45 8.98 31.79 74.04 2016 12 n/d -0.08 4.03 3.17 1,352 1,878 0.80 4.20 40.63 75.55 Medical Securities Limited 2015 183 n/d -0.08 3.68 2.83 1,018 1,415 0.51 2.70 42.48 83.21 2015 n/d n/d -0.16 4.13 3.72 11,264 15,687 2.07 27.19 17.32 33.45 Mercedes-Benz Financial Services 2014 n/d n/d 0.67 4.23 3.83 8,112 11,128 1.65 22.13 16.23 30.88 2016 45 216 0.02 8.61 7.71 7,169 10,109 1.23 8.54 57.55 83.14 Motor Trade Finance Limited 2015 77 55 0.02 9.06 8.07 6,942 9,999 1.25 8.50 55.61 82.94 2016 4 150 0.08 2.30 2.06 2,753 3,841 0.54 8.21 26.59 67.50 Nelson Building Society 2015 112 0 0.10 2.57 2.32 2,577 3,587 0.59 9.06 28.34 67.52 2016 n/d n/d 0.71 4.04 3.83 3,807 11,736 1.50 88.57 15.89 18.26 Nissan Financial Services NZ Pty Limited 2015 n/d n/d 0.91 3.59 3.42 1,261 4,806 0.86 71.47 19.80 25.08 2016 n/d 0 -1.11 12.22 9.20 15,663 21,764 6.71 10.10 18.03 41.82 ORIX New Zealand Limited 2015 n/d 26 -0.71 12.35 9.25 15,795 21,950 6.77 11.32 17.26 41.91 2016 0 20 0.01 4.58 4.08 1,813 1,813 1.59 8.96 44.70 66.27 Police & Families Credit Union 2015 110 35 -0.05 4.78 4.21 2,036 2,035 1.96 11. 13 40.18 61.29 2016 n/d 3,645 1.92 9.52 8.73 6,334 8,482 4.37 10.33 81.14 83.57 Ricoh New Zealand Limited80 2015 n/d 3,285 0.75 8.30 7.44 5,020 7,538 3.46 9.19 83.67 87.13 2016 64 2,794 0.16 4.50 3.87 16,483 21,298 1.50 11.42 22.08 57.83 Toyota Finance New Zealand Limited 2015 87 3,234 0.17 4.43 3.77 12,733 1 7, 11 2 1. 12 8.46 20.61 61.99 2016 1,230 17,657 0.30 4.50 3.83 58,537 81,417 2.29 14.83 15.25 26.25 UDC Finance Limited 2015 6,369 18,919 0.45 4.87 4.14 57,050 79,323 2.38 16.14 14.89 26.45 2016 1,279 3,845 0.11 2.25 2.00 602 773 0.46 3.66 32.69 74.96 Wairarapa Building Society 2015 462 4,173 0.06 2.22 1.99 106 359 0.09 0.66 33.90 84.81 2016 10,753 83,485 0.58 5.68 4.97 207,782 284,373 2.04 11.89 33.32 55.43 Sector Total 2015 14,609 81,301 0.54 6.09 5.29 192,087 264,701 2.13 12.12 33.27 56.13 n/d = not disclosed; n/a = not available

Credit quality measures Profitability measures Efficiency measures

Cyber security is an important Understanding the cyber risk concern for every financial The amount of data continues to grow exponentially, as does the rate services organisation. Daily at which organisations share data occurrences demonstrate the through online networks. Billions of risk posed by cyber attackers machines – tablets, smartphones, ATMs, environmental control – from individual, opportunistic systems, and other Internet of Things hackers, to professional and – are all linked together, increasing organised groups of cyber inter-dependencies exponentially. Organisations increasingly open their criminals with strategies for information technology (IT) systems systematically stealing monies to a range of machines and lose direct and intellectual property. control of data security. Furthermore, business continuity, both in society and within companies, is increasingly Philip Whitmore dependent on IT. Disruption to these core processes can have a major Partner – Head of Cyber Security & Financial services organisations impact on service availability. Technology Risk are a prime target for cyber attacks KPMG and management faces the task of ensuring that their organisation Not all organisations are necessarily understands the risks and sets the easy targets for cyber criminals. A partner within KPMG’s IT Advisory right priorities. This is no easy task in team, Philip leads KPMG’s cyber light of the technical jargon involved security and technology risk practices. and the pace of change. Cyber criminals are very aware of Philip helps organisations gain these vulnerabilities. Driven by a insights from their data, maximising Focusing on technology alone to wide range of motivations – from the benefits presented by ‘big data’, address these issues is not enough. pure financial gain, to raising the and managing their IT-related risks, Effectively managing cyber risk profile of an ideology, to espionage or including around cyber security. His means putting in place the right terrorism – individual hackers, activists, detailed IT advisory and assurance governance and the right supporting organised criminals and governments knowledge and experience is processes, along with the right are attacking government networks complemented by his internal enabling technology. with increasing volume and severity. audit, fraud and business process This complexity, however, cannot controls background. be an excuse for management to Philip sits on the boards and divest responsibility to technical What is true for any financial steering committees for a range ‘experts’. It is essential that leaders services organisation is that cyber of professional bodies, including take control of allocating resources crime risks can be controlled. the Information Systems Security to deal with cyber security, actively Certification Consortium (ISC)2 and manage governance and decision- the Information Systems Audit and making over cyber security, and build But while the cyber threat is very real Control Association (ISACA). an informed and knowledgeable and its impact can be debilitating, organisational culture. the media often sketches an alarmist Philip works with organisations to picture of cyber security, creating help them understand the impact of Outlined below are the essential insights for management to get the a culture of disproportionate fear. new technology on their business and Not all organisations are necessarily how to mitigate risks posed. basics right: the world of cyber crime today, the five common cyber security easy targets for cyber criminals. For mistakes and the critical dimensions example, a small or mid-sized company of a strong cyber security model. has a very different risk profile than that of a multinational organisation.

What is true for any financial services Developing the awareness that Organisations can organisation is that cyber crime risks 100 percent protection against can be controlled. Cyber criminals cyber crime is neither a feasible reduce the risks are not invincible geniuses and, nor an appropriate goal is already to their business while they can cause real damage an important step towards a more to your business, you can take steps effective strategy, because it allows by building up to protect yourself against them. you to make choices about your capabilities in three You may not be able to achieve defensive posture. A good defensive 100 percent security, but by treating posture is based on understanding critical areas – cyber security as ‘business as usual’ the threat (i.e. the criminal) relative prevention, detection and balancing investment between to organisational vulnerability risks and potential impacts, your (prevention), establishing mechanisms and response organisation will be well prepared to to detect an imminent or actual breach combat cyber crime. (detection) and establishing a capability Prevention that immediately deals with incidents The five most common (response) to minimise loss. Prevention begins with cyber security mistakes governance and organisation. It The emphasis at most New Zealand is about installing fundamental To many financial services financial services organisations is often measures, including placing organisations, cyber security is a bit of skewed towards prevention – the responsibility for dealing with a mystery. This lack of understanding equivalent to building impenetrable cyber security within the has created many misconceptions walls to keep the intruders out. organisation and developing among management about how to Once you understand that perfect awareness training for key staff. approach cyber security. From our security is an illusion and that cyber years of experience, we have seen the security is ‘business as usual’, you following five cyber security mistakes also understand that just as much Detection repeated over and over – often with emphasis needs to be placed on Through monitoring of critical drastic results. detection and response. After a events and incidents, an cyber crime incident, which may vary from the theft of information to a organisation can strengthen Mistake #1: ‘We have to achieve its technological detection disruptive attack on core systems, an 100 percent security’ measures. Monitoring and organisation must be able to minimise data mining together form an Reality: 100 percent security losses and resolve vulnerabilities. excellent instrument to detect is neither feasible nor the strange patterns in data traffic, appropriate goal Mistake #2: ‘When we invest in to find the location on which the best-of-class technical tools, we attacks focus and to observe are safe’ system performance. Almost every airline company claims that flight safety is its highest priority Reality: Effective cyber security Response while recognising that there is an is less dependent on technology inherent risk in flying. The same than you think Response refers to activating a applies to cyber security. Whether well-rehearsed plan as soon as it remains private or is made public, evidence of a possible attack almost every financial services The world of cyber security is occurs. During an attack, the organisation will, unfortunately, be dominated by IT companies that sell organisation should be able to impacted by cyber crime. technical products. These tools are directly deactivate all technology essential for basic security and must affected. When developing be integrated into the technology a response and recovery Almost every financial services architecture, but they are not the basis plan, an organisation should organisation will unfortunately be of a holistic and robust cyber security perceive cyber security as a impacted by cyber crime. strategy. The investment in technical continuous process and not as a tools should be the output, not the one‑off solution. driver, of cyber security strategy.

Good security starts with developing So, is it useful to keep investing in Reality shows that cyber security a robust cyber defence capability. increasingly sophisticated tools to is very much driven by compliance. Although this is generally led by prevent an attack? So is it useful This is understandable because the IT department, the knowledge to keep investing in increasingly financial services organisations and awareness of the end user is sophisticated tools to prevent attack? have to accommodate a growing critical. The human factor is and range of regulations. However, it is remains, for both IT professionals counterproductive to view compliance and the end user, the weakest link It is critical for management to as the ultimate goal of cyber in relation to security. Investment adopt a flexible, proactive and security policy. in the best tools will only deliver a strategic approach to cyber security. Only a financial services organisation return when people understand their that is capable of understanding responsibilities to keep the systems external developments and incident safe. Social engineering, in which While it is important to keep up-to-date trends, and using this insight to inform hackers manipulate employees to and to obtain insights into the intention policy and strategy, will be successful gain access to systems, is still one of of attackers and their methods, it in combating cyber crime in the the main risks that financial services is critical for management to adopt long term. Therefore, effective cyber organisations face. a flexible, proactive and strategic approach to cyber security. Given the security strategy should be based on immeasurable value of a financial continuous learning and improvement. The world of cyber security is services organisation’s information dominated by IT companies that assets and the severe implication Effective cyber security strategy sell technical products. of any loss to the core business, should be based on continuous cyber security strategy needs to learning and improvement. prioritise investment into critical asset Technology cannot help in this regard, protection, rather than the latest and it is essential that management technology or system to detect every Financial service organisations need takes ownership of dealing with this niche threat. to understand how threats evolve and challenge. They have to show genuine First and foremost, management how to anticipate them. This approach interest and be willing to study how needs to understand what kinds of is ultimately more cost-effective in the best to engage with the workforce to attackers their business attracts and long term than developing ever-higher educate staff and build awareness of why. An organisation may perceive security ‘walls’. This goes beyond the threat of cyber attacks. This is often the value of its assets differently the monitoring of infrastructure; it is about changing the culture so that than a criminal. How willing are you about smart analysis of external and employees are alert to the risks and to accept risks to certain assets over internal patterns in order to understand are proactive in raising concerns. others? Which systems and people the reality of the threat and the store your key assets, keeping in short, medium and long-term risk Mistake #3: ‘Our weapons have mind that business and technology implications. This insight should enable to be better than those of the have developed together and are organisations to make sensible security hackers’ therefore co-dependent on each investment choices. Unfortunately, other’s security? most organisations do not take a Reality: Your security strategy strategic approach and do not collect should primarily be determined and use the internal data available Mistake #4: ‘Cyber security by your goals, not those of to them. your attackers compliance is all about effective monitoring’ Financial services organisations need to ensure that incidents are evaluated in Reality: The ability to learn is The fight against cyber crime is an such a way that lessons can be learned. just as important as the ability example of an unwinnable race. In practice, however, actions are driven to monitor The attackers keep developing new by real-time incidents and often are not methods and technology, and the recorded or evaluated. This destroys defence is always one step behind. the ability of the organisation to learn and put better security arrangements in place in the future.

The same applies to monitoring The six dimensions of Addressing all six of these key attacks. In many cases, financial cyber security dimensions can lead to a holistic cyber services organisations have certain security model, providing the following As management, you want to know monitoring capabilities, but the advantages to any organisation: whether your organisation has an findings are not always shared with adequate approach to cyber security. —— Minimising the risk of an attack on the wider organisation. No lessons, or This involves considering six key an organisation by an outside cyber insufficient lessons, are learned from dimensions that together provide a criminal, as well as limiting the the information received. Furthermore, comprehensive and in-depth view of impact of successful attacks. monitoring needs to be underpinned an organisation’s cyber maturity. by an intelligence requirement. Only —— Better information on cyber crime if you understand what you want to trends and incidents to facilitate monitor does monitoring become an 1. Leadership and Governance decision making. effective tool to detect attacks. Is the organisation’s leadership —— Clearer communication on the demonstrating due diligence, theme of cyber security, enabling Financial services organisations also ownership and effective management everyone to know his or her need to develop an enterprise-wide of risk? responsibilities and what needs method for assessing and reporting to be done when an incident has cyber security risks. This requires 2. Human Factors occurred or is suspected. protocols to determine risk levels and escalations, and methods for What is the level and integration of a —— Improved reputation, as an equipping the board with insight into security culture that empowers and organisation that is well prepared strategic cyber risks and the impacts ensures the right people, skills, culture and has given careful consideration to core business. and knowledge? to its cyber security is better placed to reassure its stakeholders. 3. Information Risk Management —— Increased knowledge of Mistake #5: ‘We need to recruit How robust is the approach to competence in relation to the best professionals to defend achieve comprehensive and effective cyber security. ourselves against cyber crime’ risk management of information Reality: Cyber security is not a throughout the organisation and its department, but an attitude delivery and supply partners?

4. Business Continuity Cyber security is often seen as the Have we made preparations for a responsibility of a team of specialists security event and do we have the in the IT department. This mindset ability to prevent or minimise the may result in a false sense of security impact through successful crisis and and lead to the wider organisation not stakeholder management? taking responsibility. The real challenge is to make cyber 5. Operations and Technology security a mainstream approach. What is the level of control measures This means, for example, that cyber implemented to address identified security should become part of the risks and minimise the impact of boardroom agenda. It also means, compromise? that cyber security should have a central place when developing new 6. Legal and Compliance IT systems, and not, as is often the Are we complying with relevant case with most organisations, be regulatory standards and guidance? given attention only at the end of such projects.

Legal and Leadership Compliance and Governance

Operations andT echnology Human actorsF

Business Information Continuity RMisk anagement

Long-term credit rating

Registered banks Ultimate shareholding % Standard & Poor’s Moody’s Fitch Ratings Australia and New Zealand ANZ Bank New Zealand Limited 100 AA- Negative Aa3 Negative AA- Stable Banking Group Limited Commonwealth Bank of ASB Bank Limited 100 AA- Negative Aa3 Negative AA- Stable Australia Australia and New Zealand Australia and New Zealand Banking Group Limited – 100 AA- Negative Aa2 Negative AA- Stable Banking Group Limited New Zealand Branch81 Bank of Baroda (New Zealand) Bank of Baroda (India) 100 Baa3 Positive BBB- Stable Limited82 Bank of China (New Zealand) Limited83 Bank of China Limited (China) 100 A Stable A1 Negative A Stable Bank of India (New Zealand) Limited84 Bank of India (India) 100 BB+ Stable Baa3 Positive BBB- Stable Bank of New Zealand National Australia Bank Limited 100 AA- Negative Aa3 Negative AA- Stable China Construction Bank China Construction Bank 100 A Stable A1 Negative A Stable (New Zealand) Limited85 Corporation Citibank, N.A. New Zealand Branch Citigroup Inc. 100 A+ Stable A1 Stable A+ Stable and Associated Banking Group86 Commonwealth Bank of Australia – Commonwealth Bank of 100 AA- Negative Aa2 Negative AA- Stable New Zealand Branch87 Australia Heartland New Zealand Heartland Bank Limited 100 BBB Stable Limited Industrial and Commercial Bank of Industrial and Commercial 100 A Stable A1 Negative A Stable China (New Zealand) Limited88 Bank of China Limited (ICBC) JPMorgan Chase Bank, N.A. JPMorgan Chase & Co. 100 A+ Stable Aa2 Stable AA- Stable New Zealand Branch89 New Zealand Post 53 Under NZ Super Fund90 25 Watch review – for Watch Kiwibank Limited A+ Aa3 AA Accident Compensation Neg possible Neg Corporation (ACC)90 22 downgrade Kookmin Bank Auckland Branch91 KB Financial Group Inc. 100 A+ Stable A1 Stable A Stable Rabobank Nederland New Zealand Coöperatieve Centrale 100 A+ Stable Aa2 Negative AA- Stable Banking Group92 Raiffeisen-Boerenleenbank B.A. Coöperatieve Centrale Rabobank New Zealand Limited 100 A Stable Raiffeisen-Boerenleenbank B.A. Southland Building Society Mutual 100 BBB Stable The Bank of Tokyo-Mitsubishi UFJ The Bank of Tokyo-Mitsubishi 100 A+ Negative A1 Stable A Negative Limited, Auckland Branch93 UFJ, Limited The Co-operative Bank Limited Mutual 100 BBB Stable The Hongkong and Shanghai Banking Corporation Limited, HSBC Holdings plc 100 AA- Stable Aa2 Negative AA- Stable New Zealand Branch94 TSB Bank Limited TSB Community Trust 100 A- Stable Westpac Banking Corporation – Westpac Banking Corporation 100 AA- Negative Aa2 Negative AA- Stable New Zealand Division95 Westpac New Zealand Limited Westpac Banking Corporation 100 AA- Negative Aa3 Negative AA- Stable

Rating and Standard & Poor’s Fitch Ratings Moody’s Investment

Rating Outlook Rating Outlook Rating Outlook Rating Outlook

Avanti Finance Limited BB Stable BMW Financial Services New Zealand A+ Stable A2 Positive Limited96 Credit Union Baywide BB Stable Credit Union South BB- Stable EFN (New Zealand) Limited97 First Credit Union BB- Positive First Mortgage Trust Fisher & Paykel Finance Holdings Limited98 Fuji Xerox Finance Limited99 AA Stable Instant Finance Limited John Deere Financial Limited100 A Stable A2 Negative Leaseplan New Zealand Limited101 BBB- Stable BBB+ Stable Baa1 Stable Medical Securities Limited

Mercedes-Benz Financial Services102 A Stable A- Stable A3 Positive Motor Trade Finance Limited Nelson Building Society BB+ Stable Nissan Financial Services NZ Pty A- Positive BBB+ Stable A3 Stable A+ Stable Limited103 ORIX New Zealand Limited104 A- Negative A- Stable Baa1 Stable A+ Stable Police & Families Credit Union BB+ Stable Ricoh New Zealand Limited105 A- Negative AA- Negative Toyota Finance New Zealand Limited106 AA- Stable A Stable Aa3 Stable AA+ Stable Watch UDC Finance Limited A- Neg Wairarapa Building Society BB+ Stable

Non-bank entity Ultimate shareholding % Non-bank entity Ultimate shareholding %

Various investment/ Mercedes-Benz Financial Avanti Finance Limited 100 nominee companies Services New Zealand Daimler AG (Germany) 100 BMW Financial Services Limited BMW AG (Germany) 100 New Zealand Limited Motor Trade Finance Various Licensed Motor 100 Credit Union Baywide Various depositors 100 Limited Vehicle Dealers Credit Union South Various depositors 100 Nelson Building Society Various depositors 100 EFN (New Zealand) EFN (Netherlands) Nissan Financial Services Nissan Motor Co. Ltd 100 100 Limited Cooperatief U.A. NZ Pty Limited (Japan) ORIX New Zealand First Credit Union Various depositors 100 ORIX Corporation (Japan) 100 Limited First Mortgage Trust Various unitholders 100 Police & Families Credit Fisher & Paykel Finance FlexiGroup Limited Various depositors 100 100 Union Holdings Limited (Australia) Ricoh New Zealand Fuji Xerox Finance Ricoh Co. Ltd (Japan) 100 Fuji Xerox Co. Ltd (Japan) 100 Limited Limited Toyota Finance Toyota Motor Corporation Various Private 100 Instant Finance Limited 100 New Zealand Limited (Japan) Shareholders Australia and John Deere Financial Deere & Company (USA) 100 UDC Finance Limited New Zealand Banking 100 Limited Group (Australia) LeasePlan New Zealand LeasePlan Corporation Wairarapa Building 100 Various depositors 100 Limited (Netherlands) Society Medical Assurance Medical Securities Society New Zealand 100 Limited Limited

Long-term credit Description of the steps in the Standard & Poor’s credit rating grades for the rating of the long-term rating grades senior unsecured obligations payable in New Zealand, in New Zealand dollars. assigned by Standard & Poor’s

AAA Extremely strong capacity to meet financial commitments. Highest rating. AA Very strong capacity to meet financial commitments. A Strong capacity to meet financial commitments, but somewhat susceptible to adverse economic conditions and changes in circumstances. BBB Adequate capacity to meet financial commitments, but more subject to adverse economic conditions. BB Less vulnerable in the near-term, but faces major ongoing uncertainties to adverse business, financial and economic conditions. B More vulnerable to adverse business, financial and economic conditions, but currently has the capacity to meet financial commitments. CCC Currently vulnerable and dependent on favourable business, financial and economic conditions to meet financial commitments. CC Currently highly vulnerable. Default has not yet occurred but is expected to be a virtual certainty. Plus (+) or Minus (-) The ratings AA to CCC may be modified by the addition of a plus (+) or minus (-) sign to show relative standing within the major rating categories. BB, B, CCC, and CC Borrowers rated BB, B, CCC and CC are regarded as having significant speculative characteristics. BB indicates the least degree of speculation and CC the highest. While such borrowers will likely have some quality and protective characteristics, these may be outweighed by large uncertainties or major exposures to adverse conditions. Assigned by Moody’s Moody’s Investors Service appends numerical modifiers 1, 2 and 3 in each generic rating classification from Investors Service Aa through Caa. The modifier 1 indicates that the obligation ranks in the higher end of its generic category, the modifier 2 indicates a mid-range ranking and the modifier 3 indicates the lower end of that generic category. Assigned by Fitch Fitch Ratings applies ‘investment grade’ rates ‘AAA’ to ‘BBB’ to indicate relatively low to moderate credit Ratings risk, while for those in the ‘speculative’ or ‘non-investment grade’ categories which have either signalled a higher level of credit risk or that a default has already occurred, Fitch Ratings applies a ‘BB’ to ‘D’ rating. The modifiers ‘+’ or ‘-’ may be appended to a rating to denote relative status within the major rating categories. Credit ratings express risk in relative rank order, which is to say they are ordinal measures of credit risk and not predictive of a specific frequency of default or loss.

Terms and ratios used Definitions used in this survey in this survey

Includes all impaired assets, restructured assets, and assets acquired through the enforcement of security, Gross impaired assets but excludes past due assets.

Includes loans and advances, lease receivables (net of unearned income) and accrued interest receivable Gross loans and (where identifiable), but excludes amounts due from banks, marketable securities, loans to related parties, advances sundry debtors and prepayments.

Gross revenue Includes gross interest income, gross operating lease and net other income.

Impaired asset The charge to the Profit and Loss Account for bad debts and provisions for doubtful debts, which is net of expense recoveries (where identifiable).

Interest bearing Customer deposits (including accrued interest payable where identifiable), balances with banks, debt liabilities securities, subordinated debt and balances with related parties.

Cash on hand, money on call and balances with banks, trading and investment securities, net loans and Interest earning assets advances (including accrued interest receivable where identifiable), leased assets net of depreciation and balances with related parties.

Interest expense Includes all forms of interest or returns paid on debt instruments.

Difference between the average interest rate on average interest earning assets, and the average interest Interest spread rate on average interest bearing liabilities.

Net assets Total assets less total liabilities.

Net interest income Interest income (including net income from acting as a lessor) less interest expense.

Net interest margin Net interest income divided by average interest earning assets.

Net loans and Loans and advances, net of provision for doubtful debts. advances

Includes all expenses charged to arrive at net profit before tax (excluding interest expense, impaired asset Operating expense expense, subvention payments, direct expense related to other income (where identifiable), depreciation of leased assets where a lessor, and amortisation of goodwill and other intangibles (including software).

Net interest income, net operating lease income and net other income (where direct expense related to Operating income other income is identifiable).

Includes any asset which has not been operated by the counterparty within its key terms for 90 days and Past due assets which is not an impaired or restructured asset.

Provision for doubtful Includes both collective and individual provisions for bad and doubtful debts. debts

Total assets Excludes goodwill assets (unless specifically defined).

Ultimate shareholding Identifies the ultimate holding company rather than any intermediate holding companies.

Operating income less operating expense and impaired asset expense. Items of a non-recurring nature, Underlying profit unrelated to the ongoing operations of the entity, are excluded.

Definitions for operating income and operating expense have been adjusted in the current year to provide further clarity as to the calculation of these figures. In certain circumstances, direct expenses relating to other income have been reallocated from operating expense to operating income to ensure consistent presentation of income comparatives between entities. This would subsequently affect the calculation and analysis of performance ratios that are being driven by these figures.

1. Our analysis of registered banks is from the view of the top 24. http://reports.asb.co.nz/report/article/22714/18770/0/asb-fy16- geographic entity in New Zealand for each banking group annual-results-press-release.html. and comprises 21 entities. The following entities hold a 25. https://www.tsbbank.co.nz/about/news/annual-report/2016. separate registered bank licence and are included within top 26. http://www.rbnz.govt.nz/statistics/s8. level banking groups for the purposes of our analysis: ANZ 27. http://www.rbnz.govt.nz/statistics/s8. Bank New Zealand Limited, ASB Bank Limited, Rabobank New Zealand Limited, and Westpac New Zealand Limited. 28. http://www.anz.co.nz/resources/4/0/40473457-e51f- 4648-a89e-fc7d34bde30b/solid-full-year+result. 2. http://www.rbnz.govt.nz/-/media/ReserveBank/Files/ pdf?MOD=AJPERES&CACHEID=40473457-e51f-4648-a89e- Publications/Financial%20stability%20reports/2016/fsr-nov2016. fc7d34bde30b. pdf – see page 26 of the report. 29. http://www.rbnz.govt.nz/-/media/ReserveBank/Files/ 3. http://www.nzherald.co.nz/kapiti-news/news/article.cfm?c_ Publications/Financial%20stability%20reports/2016/fsr-nov2016. id=1503789&objectid=11717550. pdf – see page 22 of the report. 4. https://home.kpmg.com/content/dam/kpmg/uk/pdf/2016/10/ 30. http://www.rbnz.govt.nz/statistics/m10. meet-eva.pdf. 31. https://www.bnz.co.nz/about-us/media/2016/investment- 5. http://www.rbnz.govt.nz/-/media/ReserveBank/Files/regulation- delivers-strong-volume-growth-for-bnz. and-supervision/banks/consultations/Final-consultation- 32. https://www.kiwibank.co.nz/about-us/press-releases/2016-08- outsourcing-policy-for-registered-banks-May2016.pdf?la=en (see 26-financial-results-forkiwi-group-holdings/. page 6, paragraph 22). 33. https://www.westpac.co.nz/who-we-are/newsroom/media- 6. http://www.rbnz.govt.nz/-/media/ReserveBank/Files/ releases-2/07-november-2016/. Publications/Policy-development/Banks/Outsourcing-policy-for- 34. http://www.rbnz.govt.nz/statistics/g3. registered-banks/Summary-of-submissions-outsourcing-policy- registered-banks-Feb17.pdf?la=en. 35. The RBNZ only started compiling data for Common equity tier 1 capital ratio from March 2013 onwards, as part of the adoption 7. http://www.radionz.co.nz/news/national/311225/kiwisavers- of Basel lll requirements. fund-cluster-bombs,-land-mines. 36. A revision on the application of accounting policies for 8. http://www.nzherald.co.nz/business/news/article.cfm?c_ capitalisation of expenditure on internally generated software id=3&objectid=11708202. assets was made, effective 1 October 2015. This has affected 9. http://www.radionz.co.nz/news/national/312409/bnz-latest-to- comparatives for amortization of goodwill and other intangibles. review-kiwisaver-weapons-investments. Prior period comparatives (data and ratios) do not reflect this 10. http://www.stats.govt.nz/browse_for_stats/economic_ change and as such, ratios calculated in this survey may differ indicators/GDP/GrossDomesticProduct_HOTPSep16qtr.aspx if restated 30 September 2015 figures and its prior period – see data spreadsheet. comparatives had been used for the purpose of analysis. 11. http://m.nzherald.co.nz/business/news/article.cfm?c_ 37. Effective from 30 September 2016 onwards, Bank of id=3&objectid=11752869. New Zealand changed its methodology for the calculation of 12. http://www.stats.govt.nz/browse_for_stats/income-and-work/ interest earning assets (to exclude mortgage offset account). employment_and_unemployment/LabourMarketStatistics_ Prior period comparatives (data and ratios) do not reflect the HOTPsep16qtr.aspx. change in methodology and as such, ratios calculated in this survey may differ if restated June 2016 figures and its prior 13. http://www.stuff.co.nz/business/75443924/international- period comparatives had been used for the purpose of analysis. tourism-overtakes-dairy-to-regain-top-spot-as-our-biggest- export-earner. 38. Total capital and tier 1 capital ratios have been restated for 31 December 2014. However, for the purpose of analysis 14. http://www.treasury.govt.nz/economy/mei/may16/03.htm. prior period comparatives (data and ratios) do not reflect this 15. https://www.globaldairytrade.info/en/product-results/. change and as such, ratios calculated in this survey may differ 16. https://www.globaldairytrade.info/en/product-results/. if restated 30 September 2015 figures and its prior period 1 7. https://www.rabobank.com/en/press/search/2016/20161222- comparatives had been used for the purpose of analysis. rabobank-global-dairy-quarterly-q4-2016-supply-crunch-bites. 39. As at 1 July 2015, interest from certain derivatives (transacted html. as economic hedges) are recorded as part of net interest 18. https://www3.fonterra.com/nz/en/our-financials/farmgate-milk- earnings instead of other income. In addition, fixed rate prices.html. prepayment cost recoveries have been reclassified from other 19. https://www.rabobank.co.nz/media-releases/2016/161006-drop- income to interest income in order to align with industry in-global-dairy-supply-expected-to-fuel-price-recovery-into-2017/. practice, effective for the period ended 30 June 2016 onwards. Prior period comparatives (data and ratios) do not reflect the 20. http://www.interest.co.nz/rural-data/dairy-industry-payout- change in methodology and as such, ratios calculated in this history. survey may differ if restated 31 March 2016 figures and its prior 21. https://www.reinz.co.nz/Media/Default/Statistic%20 period comparatives had been used for the purpose of analysis. Documents/2017/Residential/December%202016/Press%20 40. Heartland Bank Limited amalgamated with one of its wholly Release/REINZ%20Residential%20Press%20Release%20 owned subsidiaries, effective from 31 December 2015. -%20December%202016-1.pdf. Prior period comparatives (data and ratios) do not reflect the 22. http://www.stuff.co.nz/business/85708630/Six-months-on-Bill- amalgamation and as such, ratios calculated in this survey may English-demands-more-information-on-debt-to-income-ratios. differ if restated 30 September 2015 figures and its prior period 23. The related articles are hyperlinked to provide the reader with comparatives had been used for the purpose of analysis. the ability to access the respective news releases.

41. As at 30 June 2015, a correction in the measurement of 49. Total Assets = Total Assets - Intangible Assets. hedging items was made which mainly resulted in prior year 50. For a discussion of the Reserve Bank’s approach to prudential restatements for non-interest income, NPAT, interest earning supervision, refer to a speech delivered by Toby Fiennes at the assets and interest bearing liabilities. Prior period comparatives NZ Bankers’ Association in Auckland in September 2016: http:// (data and ratios) do not reflect these changes and as such, ratios www.rbnz.govt.nz/-/media/ReserveBank/Files/Publications/ calculated in this survey may differ if restated 31 March 2015 Speeches/2016/NZs-evolving-approach-to-prudential- figures and its prior period comparatives had been used for the supervision.pdf. purpose of analysis. 51. For more information on the 2016 New Zealand Financial 42. Most recently on 1 April 2015, ‘Investment in associates – held Sector Assessment Programme, refer to: http://www. for sale’ was transferred to a new group structure under TSB rbnz.govt.nz/-/media/ReserveBank/Files/Publications/ Community Trust. In addition to this, certain comparatives in Bulletins/2016/2016apr79-7.pdf. relation to interest income, interest expense, other operating 52. BS 14 (Corporate Governance) policy can be accessed on income and other operating expenses have been restated the Reserve Bank website: http://www.rbnz.govt.nz/-/media/ on numerous occasions in the last few periods. Prior period ReserveBank/Files/regulation-and-supervision/banks/banking- comparatives (data and ratios) do not reflect these changes and supervision-handbook/4269713.pdf?la=en. as such, ratios calculated in this survey may differ if restated 53. https://fma.govt.nz/assets/Guidance/_versions/9210/170202-A- 30 June 2016 figures and its prior period comparatives had been guide-to-the-FMAs-view-of-conduct.1.pdf. used for the purpose of analysis. 54. A comparison between average price change, median price 43. A revision on the application of accounting policies for change and housing price index change, broken down by council capitalisation of expenditure on internally generated software on a year-on-year basis. An HPI is best used to assess underlying assets was made, effective 1 October 2015. This has affected house price trends, while median sale price gives a sense of comparatives for amortization of goodwill and other intangibles. how expensive houses are in any given market. Although easy Prior period comparatives (data and ratios) do not reflect this for consumers to understand, averages lack the strengths of the change and as such, ratios calculated in this survey may differ other measures when assessing market price changes and not if restated 30 September 2015 figures and its prior period utilised in REINZ statistics. comparatives had been used for the purpose of analysis. 55. Shows the trends of an HPI and raw median sale price on 44. Effective from 30 September 2016 onwards, Bank of an annual basis. When the market is weak the index is more New Zealand changed its methodology for the calculation of sensitive than the median and captures the true state of activity interest earning assets (to exclude mortgage offset account). in the housing market. Prior period comparatives (data and ratios) do not reflect the change in methodology and as such, ratios calculated in this 56. Shows the trend for the REINZ HPI calculated every month survey may differ if restated 30 June 2016 figures and its prior for Wellington council wards. This is one example of how the period comparatives had been used for the purpose of analysis. REINZ HPI can be disaggregated to low levels providing flexible data options for users. The disaggregation can use location or 45. As at 1 July 2015, interest from certain derivatives (transacted as property attributes that may affect market segmentations. economic hedges) are recorded as part of net interest earnings instead of other income. In addition, fixed rate prepayment cost 57. http://taxpolicy.ird.govt.nz/news/2016-12-21-aeoi-draft- recoveries have been reclassified from other income to interest guidance‑document. income in order to align with industry practice, effective for the 58. Vector Autoregression. period ended 30 June 2016 onwards. Prior period comparatives 59. Autoregressive Integrated Moving Average. (data and ratios) do not reflect the change in methodology and 60. http://www.stats.govt.nz/browse_for_stats/population/Migration/ as such, ratios calculated in this survey may differ if restated IntTravelAndMigration_HOTPJun16/Commentary.aspx. 31 March 2016 figures and its prior period comparatives had 61. https://home.kpmg.com/content/dam/kpmg/pdf/2016/02/2016- been used for the purpose of analysis. FIPS-Banks-Interactive.pdf. 46. Heartland Bank Limited amalgamated with one of its wholly 62. Certain figures and performance metrics referenced within owned subsidiaries, effective from 31 December 2015. this commentary have been ‘normalised’ for the purpose of Prior period comparatives (data and ratios) do not reflect the excluding the current year comparatives of EFN (New Zealand) amalgamation and as such, ratios calculated in this survey may Limited, so as to provide a more accurate picture of the current differ if restated 30 September 2015 figures and its prior period trends for the non-bank sector. comparatives had been used for the purpose of analysis. 63. The banks’ ‘blackbox’ refers to the perceived model that some 47. Most recently on 1 April 2015, ‘Investment in associates – held survey participants believe that the bank(s) operate within, for sale’ was transferred to a new group structure under TSB being an approval process that scores a loan candidate across Community Trust. In addition to this, certain comparatives in a range of areas such as, but not limited to, repayment ability, relation to interest income, interest expense, other operating loan-to-value ratio (LVR), security offered, credit history, savings income and other operating expenses have been restated history, and the reason for the loan. If the candidate meets all on numerous occasions in the last few periods. Prior period the necessary criteria appropriately, they will be approved for a comparatives (data and ratios) do not reflect these changes and loan very quickly, but if one criteria is not met, they might not be as such, ratios calculated in this survey may differ if restated approved. This can lead to ‘qualifying loans’ being competitively 30 June 2016 figures and its prior period comparatives had been sought after by banks, favourable terms being offered and, as a used for the purpose of analysis. result, loans can be very quickly approved. However, loans that 48. The capital adequacy ratio’s reported are for the overseas have an apparent issue with a criteria might be declined. banking group.

These loans might be able to be structured by a lender who is 79. Ricoh New Zealand Limited transitioned to ‘Tier 2 NZ IFRS prepared to understand and research the issue(s) in a way that RDR’ reporting framework, effective 31 March 2016. As such, makes them a manageable risk until such time as the anomaly data and ratios on 31 March 2015 comparatives used for the is resolved. The structuring could include: additional security, purpose of analysis do not reflect Ricoh’s transition to the new an interest-only period, or a requirement for delayed and then reporting framework. Ratios calculated in this survey may differ accelerated payments. if 31 March 2015 restated comparatives had been used for the 64. http://www.stuff.co.nz/business/86350842/rbnz-says-housing- purpose of analysis. market-has-turned-meaning-debt-to-income-rules-not-needed- 80. The ‘operating expenses over gross revenues’ ratio is presumed for-now. to be a more appropriate benchmark for efficiency measures. As 65. http://www.interest.co.nz/news/84167/rbnz-keen-bolster-its-macro- such, it has replaced the ‘operating expenses over average total prudential-arsenal-debt-income-ratio-limiting-tool-what-might. assets’ ratio in the current year. 66. http://www.comcom.govt.nz/consumer-credit/consumer-credit- 81. Rating of Parent, Australia and New Zealand Banking Group media-releases/detail/2016/commission-asks-the-court-to-clarify- Limited (Australia) – S&P’s, Moody’s and Fitch. how-credit-law-applies-to-harmoney. 82. Rating of Parent, Bank of Baroda (India) – Moody’s. 67. http://www.stuff.co.nz/business/industries/79057498/Heartland- 83. Rating of Parent, Bank of China Limited (China) – S&P’s absolutely-interested-in-UDC-Finance-as-ANZ-Bank-mulls-sale. and Fitch. 68. http://www.interest.co.nz/business/81382/no-sales-process-being- 84. Rating of Parent, Bank of India (India) – Moody’s and Fitch. run-udc-anz-nz-ceo-david-hisco-says-adding-somebody-stirring. 85. Rating of Parent, China Construction Bank Corporation 69. EFN (New Zealand) Limited formerly operated under the GE (China) – Fitch. Capital brand as part of Custom Fleet and Equipment Finance 86. Rating of Parent, Citibank N.A. (United States) – S&P’s, Moody’s New Zealand prior to its sale. See table on page 99 for further and Fitch. information pertaining to its sale. 87. Rating of Parent, Commonwealth Bank of Australia (Australia) – 70. Fisher & Paykel Finance was sold on 27 October 2015 to S&P’s, Moody’s and Fitch. Australian Financial Services FlexiGroup for $315 million. Under 88. Rating of Parent, Industrial and Commercial Bank of China new ownership, they have been rebranded as Flexi Cards Limited (China) – S&P’s and Fitch. Limited as of September 2016. 89. Rating of Parent, JPMorgan Chase Bank N.A. (United States) – 71. On page 99 is a table detailing the sale of GE Capital S&P’s, Moody’s and Fitch. New Zealand, and its new structure given the change 90. The entities listed above are state owned enterprises which are in ownership. wholly owned by the New Zealand Government. 72. Since its acquisition in the previous year, the financial 91. Rating of Parent, Kookmin Bank (South Korea) – S&P’s, Moody’s performance of The Warehouse Financial Services is now and Fitch. reported as part of the 31 July 2016 year-end consolidated figures for the Warehouse Group (parent company). Therefore, 92. Rating of Parent, Coöperatieve Rabobank U.A. (Netherlands) – there are no publicly-available standalone financial statements S&P’s, Moody’s and Fitch. for ‘The Warehouse Financial Services Limited’ and as such the 93. Rating of Parent, The Bank of Tokyo-Mitsubishi UFJ, Limited entity will no longer be part of the survey. (Japan) – S&P’s, Moody’s and Fitch. 73. The related articles are hyperlinked to provide the reader with the 94. Rating of Parent, The Hongkong and Shanghai Banking ability to access the respective news releases. Corporation Limited (Hong Kong) – S&P’s and Fitch. 74. Certain figures and performance metrics referenced within 95. Rating of Parent, Westpac Banking Corporation (Australia) – this commentary have been ‘normalised’ for the purpose of S&P’s, Moody’s and Fitch. excluding the current year comparatives of EFN (New Zealand) 96. Rating of parent company BMW AG (Germany). Limited, so as to provide a more accurate picture of the current 97. Rating of parent company Element Fleet Management trends for the non-bank sector. Corporation (Netherlands). 75. http://www.comcom.govt.nz/consumer-credit/guidelines-post/ 98. Rating of new parent company FlexiGroup Limited (Australia). guidelines-for-credit-fees/. 99. Rating of parent company Fuji Xerox Co. Ltd (Japan). 76. https://www.harmoney.co.nz/investors/marketplace-statistics. 100. Rating of parent company John Deere Financial Limited Australia. 77. http://www.stuff.co.nz/business/86358599/Copy-Brits-to-get-a- 101. Rating of parent company LeasePlan Corporation 10-billion-peer-to-peer-lending-industry-tech-conference-told. N.V. (Netherlands). 78. Certain prior year figures have been adjusted to ensure 102. Rating of parent company Daimler AG (Germany). consistent treatment in the calculation of performance metrics 103. Rating of parent company Nissan Motor Co. Limited (Japan). between entities, and to more accurately reflect the updated 104. Rating of parent company ORIX Corporation (Japan). definitions on page 128. Please see the notes on page 128 for further details regarding the change. The performance metrics 105. Rating of parent company Ricoh Co. Limited (Japan). that were affected: net interest margin, interest spread, and 106. Rating of parent company Toyota Motor Corporation (Japan). operating expense over operating income ratio.

John Kensington Jamie Munro Head of Banking and Finance Partner – Head of Insurance +64 (09) 367 5866 +64 (09) 367 5829 [email protected] [email protected]

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