Financial Institutions Performance Survey FIPS Review of 2017

1 3.68% 7.35% escalation in growth in NPAT operating expenses

8 2

3.94% 3 1.17% rise in net decrease in provisions interest income

9 bps 4 4.68% decline in net increase in interest margins gross lending

7 5

7.30% 6 40 bps drop in gross drop in average impaired assets funding costs Contents

2 The Survey 4 A KPMG view from the editor KPMG’s Financial Services team provides 6 Industry overview 16 Timeline of events focused and practical audit, tax and advisory 20 Some of the significant management changes in the sector services to the insurance, retail banking, 22 Sector performance 30 Analysis of annual results corporate and investment banking, and 38 Major banks – Quarterly analysis 42 Getting practical with blockchain investment management sectors. 46 Conduct, robo-advice and good client outcomes 50 Revolutionising the banking eco‑system 54 Getting past compliance crisis management Our professionals have an in-depth 60 Customer friction – reducing through emerging trends in Fintech innovation understanding of the key issues 64 RBNZ: Modernising disclosures with Bank Financial Strength Dashboard facing financial institutions. 66 FMA: Show us better outcomes for your customers 68 NZBA: Code of Banking Practice breaks new ground Our team is led by senior partners with a 70 Massey: Banking industry forecasts 74 Ownership and credit ratings wealth of client experience and relationships 75 Descriptions of the credit rating grades 76 Definitions with many of the market players, regulators 77 KPMG’s Financial Services Team 78 Contact us and leading industry bodies. 2 | KPMG | FIPS 2017 FIPS 2017 | KPMG | 3 The Survey

The KPMG Financial TABLE 1: ENTITY MOVEMENTS Institutions Performance Who’s out Who’s in Survey (FIPS) report of 2017 Deutsche Bank AG, Banks: 241 —— Nil represents the 31st year that New Zealand Group KPMG has provided in-depth insights into New Zealand’s banking sector. In this edition, we will be presenting industry As with all previous FIPS Surveys, We wish to thank the survey the information used in compiling participants for their valued commentary and analysis our analysis is extracted from contributions in the following two on the performance of the publicly available annual reports ways: for the additional information New Zealand registered and disclosure statements for each provided and for the time made organisation, with the exception of available to meet and discuss the banks, together with a range certain information provided by the industry issues with us. of topical articles from other survey participants. Massey University continues to be a partner and key contributor to the key stakeholders such as In late 2017, we published and compilation of this publication by industry experts, regulators launched our Non-bank Financial assisting with the data collection and Institutions Performance Survey (Non- and our own business leaders. drafting the banks’ profit forecasting bank FIPS) separately, as opposed to section of this survey. We thank the combined Banks and Non-Banks them for their continued assistance launch in prior years. Accordingly, and contribution. the Non-bank FIPS document is The survey covers registered banks no longer appended to the rear of External contributors continue to with balance dates between 1 October this publication. The Non-bank FIPS play a vital role in our publication by 2016 and 30 September 2017. As providing insight on key issues and document can be downloaded from a result, registered banks with the developments that we might not KPMG’s website and located at the balance date of 31 December will otherwise have. We would like to following link: https://home.kpmg.com/ have their 31 December 2016 financial acknowledge the contributors from nz/en/home/insights/2017/12/fips-non- results included in this year’s survey the RBNZ, the Financial Markets as their most recent results. The banks banks--review-of-2017.html. Authority (FMA), and New Zealand with 31 December balance dates are Following the announcement of Bankers’ Association (NZBA) for their Bank of China, China Construction its withdrawal from New Zealand, exceptional contributions toward the Bank, Citibank, Industrial and Deutsche Bank has since surrendered compilation of this publication. Commercial Bank of China, JPMorgan its banking license to the Reserve We have supplemented their external Chase Bank, Kookmin Bank, Rabobank Bank of New Zealand (Reserve Bank thought leadership commentary with and The Hongkong and Shanghai or RBNZ) in August of 2016. Hence, some of KPMG’s own business line Banking Corporation. Deutsche Bank is no longer included in thought leadership. We trust you will this publication. find this survey’s content of interest.

© 2018 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. © 2018 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. 4 | KPMG | FIPS 2017 FIPS 2017 | KPMG | 5 A KPMG view from the editor

Following on from a trying and The key takeaways from the 2017 —— It is clear that banks are still trying —— The implementation of NZ —— The constant threat of disruption year highlighted by the survey are to understand the ‘customer IFRS 9 Financial Instruments has and the growth of digitisation in volatile 2016, industry profits as follows: of tomorrow’, they are trying to begun, with banks set to notice the banking sector are issues rebounded in 2017. align their strategy in a customer an impact resulting from a credit that continue to be a challenge —— One aspect that continues to centric environment. The subtle model recognising ‘expected loss’ as the sector builds its pace. underpin the banking sector’s move from ‘customer service’ to rather than the previous ‘incurred All Executives have said they performance is the strength of its ‘customer experience’ is crucial loss’. BNZ is on the forefront of will continue to digitise their balance sheet. to ensure that overall customer implementation and impacts have offerings. Some survey participants In some respects, the year appears —— In contrast to 2016, the banking satisfaction is reached. been felt on their bottom line. remarked that the most successful to have been as if it were one of two sector produced an impressive initiative would likely be in the halves. During the first half of the year, —— Fintech continues to be a hot topic. A careful examination of the future increase in profitability. The form of partnerships with Fintech the advent of revisions to Australian The industry acknowledges that reveals that the banking sector is combination of growth in net start-ups, as banks do not have Prudential Standards (APS) 110 Capital one major aspect of customer facing a time of increased challenges interest income and non-interest the time, money, or resources Adequacy and APS 120 Securitisation centricity is appropriately aligning and uncertainty. income, as well as a significant to successfully create their led to intense competition for Fintech with the needs and wants increase in asset quality, has —— Two prospective areas of prime own projects. deposits, thus resulting in some of customers. Although customers contributed to this record result. interest will be how the new banks refinancing and altering internal have emphasised that digital —— In regards to Fintech and These changes outweighed the government operates during its policies while slowing their lending solutions and Fintech are priorities digitisation, although having an John Kensington increase in operating expenses. first year in office and how possible books’ growth. Meanwhile, the second when choosing a bank, any issues automated online process is Partner – Audit —— The sector margin decreased by new legislation changes (such as half of the year saw lending growth that arise, however, must be desirable, when an issue goes Head of Banking and Finance 9 basis points (bps) from 2.17% to exclusion of foreign investment accelerate again, although more slowly handled with efficiency and by a awry, customers want to talk to KPMG 2.08%. This decline was caused home ownership, the impact on than historic levels. The New Zealand human (if necessary). Most banks a person and help them resolve primarily by increased competition immigration numbers and the economy still remains strong in spite of agreed that a successful Fintech the issue at that moment rather on the lending side offset with possible flow on to tourism) will some uncertainty, particularly around launch or uptake would involve than read a webpage of frequently partial relief on the funding side. impact on the economy and the issues pertaining to the housing market partnerships with overseas-parent- asked questions. Fortunately, banking sector. and construction. Nevertheless, other —— Asset quality is going from owned innovation labs or with banks are beginning to recognise pockets such as tourism, and the strength to strength with the ratio Fintech start-ups. —— The local regulatory space is going this trend and note that the primary sector performed well on the of total provisions to average gross —— One area that always provides to grow and gain momentum customer experience cannot be back of stronger commodity prices loans and advances decreasing animated discussion is regulation. with a number of changes that a branch solely full of automated and a weaker NZD. Unemployment 5 bps this year. This reduction, The current period has been no will soon come into effect, as the machines yet. is at an all-time low. Views remain combined with a significant decline exception. At present, outsourcing RBNZ’s dashboard approach starts mixed around the potential effects in impairment expense due to still remains the biggest area of being used, the outsourcing policy arising from some of the new coalition banks tightening their selection focus. Also, a number of large continues to be implemented, and government’s policies, as their policies criteria, has resulted in the positive banks noted that outsourcing is a changing over-the-counter (OTC) have contributed to further to the outcome of better asset quality. much bigger task than they initially derivatives margin requirements feelings of uncertainty, especially when —— Non-major banking participants thought. The new dashboard also gain momentum. regarding immigration and foreign have noticed the effect of the approach for quarterly reporting is ownership. A cautious approach is stricter Australian regulations on yet another hot topic for many. A required so as to not deter foreign capital levels in New Zealand, a number of banks are supportive investment, the migration of skilled development which has led to of the approach, but called for workers, and tourists, all of which are slower lending by the Australian- more consistent definitions than key contributors to New Zealand’s owned banks in the sector than previously provided; additionally, economic growth. There was a very real they used to practice. The major they raised some concerns feeling that things are on hold in a ‘wait banks have reiterated that prior regarding confidential information and see’ pattern. years’ trends of low lending rates being controlled on a third and high volume growth will be party website. unlikely to continue.

© 2018 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. © 2018 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. 6 | KPMG | FIPS 2017 FIPS 2017 | KPMG | 7 Industry overview

A number of key themes were Buzzwords and beyond Such a demand for tech solutions Some survey participants with The most common agreed-on Chained together The banking sector is gazing into its comes with a warning – when the app, a significant ‘bricks-and-mortar’ approach from other participants was Blockchain (distributed ledger continually brought up and AI or logarithm gives the millennial- ‘crystal ball’, seeking to determine presence commented on their branch that their approach would be based processing) has garnered much thinking customer an answer or an discussed in the conversations what the customer of tomorrow network and indicated that they may around partnerships with local or attention in recent years, with the outcome they dislike, there needs we had with survey expects and values in relation to start, or, in some cases, continue, to overseas-parent-owned innovation labs ‘face’ of Blockchain, also known as to be an equally quick resolution financial products, tools and platforms. gradually rationalise both the way they or Fintech start-ups. Bitcoin, attracting more excitement participants. These themes, to the problem raised. This group provide service in the branch and the The ability to digitise, innovate and Banks which might have initially been day by day. Just a couple of months as well as other relevant does not want to read 20 frequently branches’ opening hours over time. adapt to customer demands is crucial wary of the disruptive force of start- ago, for the first time ever in asked questions (FAQs) or wait in a The major banks appear to believe that observations impacting the to the survival of any company. This ups have now come to recognise New Zealand, a property was listed call centre queue. Since they want their online, telephone banking and criteria includes mortgage-focussed their own strengths in the form of for sale using Bitcoin instead of fiat sector, are discussed in instant gratification and solutions, if smart ATM service offerings can form banks which operate according to some barriers to start-ups’ entry currency. This pioneering local feat they do not receive it, they will change an almost-complete suite of services detail below. long-standing, time-tested models, into the market, barriers which are happened in Kaiuma Bay, Marlborough their service provider as they have together. However, as anyone who as the speed of both the changes in enforced through regulation and scale. Sounds, and attracted a great deal no loyalty to a particular brand or has waded through a seemingly customer demands, and the speed in Regardless of whether the next wave of attention.3 service provider. endless list of FAQs or had a circular which the customer expects their bank of Fintech will be a go-alone project discussion with a ‘Chabot’ can attest to adapt, are increasing. by a bank, arrive by way of a start-up Banks are open for business to, customers still want the human ‘Customer experience’ disruptor, or emerge in the form of a Digital interactions are de rigueur. touch when the app or machine is underpins the bank of the Since the concept of ‘open banking’ partnership, it is clear that any tech Digitisation and other themes/ is trending around the world, why just not working or giving the answer future solution will need to broker a happy tools such as Artificial Intelligence should New Zealand be far behind? they want, or they need to make a marriage between design/creative Blockchain is much more than just One of the key focuses for banks (AI), machine learning, Robotic ‘Open banking’ is being tipped as the significant financial decision such as genius, operational/strategic fit, and cryptocurrency, as the concept also is customer centricity. A solid Process Automation (RPA), digital “invisible banking reform that could obtaining a mortgage or life insurance. potentially regulatory compliance, lends itself to providing a pragmatic understanding of the customer labour, ‘Crowd Funding’, the ‘sharing fundamentally change how people while placing the customer at the solution to clearing and settling of today – and the customer of economy’, ‘cloud computing’, the manage money” and how new centre of all of it. payments. the future – is unmistakeably ‘Internet of Things’, and hyper- entrants might enter the market.2 Customers still want the human required to ensure that product and personalisation, are at least partly touch when the app or machine technological innovations which are is just not working or giving the Does automation mean influenced by a customer-centric, Some investors view Bitcoin as a developed and launched are relevant. answer they want, or they need to hands-free? millennial-serving approach which kind of store of value and therefore Customer centricity necessitates make a significant financial decision banks are being urged to embrace in Aside from transforming the customer an alternative to gold, with worldwide properly understanding the identity order to stay competitive. Since the concept of ‘open banking’ experience, digital tools such as supply of the digital currency being of the customer and customers’ machine learning, AI, and RPA can In a relatively short time, this lexicon is trending around the world, why limited (akin to a scare commodity) expectations, needs and behaviours. Nevertheless, this issue is possibly an also be used to transform the way has infiltrated our current daily lives should New Zealand be far behind? to 21 million Bitcoins. Despite this Many survey participants remarked on area of opportunity. For example, an and speed with which information is through products and services such constraint on supply, recent price the effect of technology and the need innovative tool or platform could step processed. Implementing these tools as Apple Pay, Siri, Alexa, Uber, and growth has been somewhat stymied to continue to innovate to keep up in and lower the perceived trade-off can free up staff and management Google Drive. Furthermore, one For further details around the concept through regulators ramping up with changing customer expectations. between the speed and impersonal to concentrate on tasks where should recall that, while the term of open banking, please read the their scrutiny of the digital currency Clearly, the profile of the ‘customer nature of a fully digital application judgement is required or areas where ‘millennial’ is commonplace when article included in this publication on exchanges around the world. When of tomorrow’ – one that might shun process, and the reassurance and they can add value. describing current-day customer page 50 which has been written by examining the aspect of demand-side the tired and lengthy paper-based comfort that can be found in a good experience standards of 16–35 year KPMG’s Financial Services Sector pressures, however, we see that application process in favour of instant customer service relationship. Aside from taking care of the routine Driver, Nicola Raynes. Bitcoin has been linked to criminal digital interactions – is driving the olds, millennials’ expectations and processing tasks, cutting-edge behaviours have been largely adopted activities such as money laundering, strategies and changes of today. Disruption is coming, but technology can also be leveraged by most other generations and are But are we side-stepping the to assist banks in achieving or drug smuggling, and the illegal arms now seen more as a way of thinking. branch? from where? maintaining compliance with trade, due to its transactional and Many survey participants remarked An ever increasing number of Survey participants’ opinions around regulations, to perform ‘know-your- regulatory anonymity. This fast paced integrated way of and approaches to Fintech were on the effect of technology and the customers are side-stepping the customer’ (KYC) procedures, and to Nevertheless, market participants transacting is embraced by those that diverse. Approaches towards Fintech need to continue to innovate branch altogether and using multiple detect fraud. would do well to recall that Blockchain are ‘time poor’, social media rich and ran the gamut from participants so-called ‘glass platforms’ (iPads, is much more than just cryptocurrency tech savvy because it gives them back who had developed apps and savvy smartphones and computers) to as the concept also lends itself to time to do things that are important front ends and self-identified as tech manage their finances. However, providing a pragmatic solution to to them. innovators, to participants that do not banks that respond by abandoning clearing and settling payments. branches altogether have sometimes have the budget to implement any left a sour taste in the local significant tech solutions. community’s mouths.

In fact, in 2017, New Zealand’s According to the FMA, this exemption 2. Should we not seek to keep other Local banks, particularly the big four KlickEx group teamed up with IBM to allow ‘robo-advice’ is expected matters such as cyber-security who are subsidiaries of the Aussie New Zealand’s comparative and US-based Blockchain network, to “foster innovation and improve and data privacy regulations at top big four banks (CBA, NAB, Westpac advantages over other economies – Stellar, and announced that it had consumer access to advice”.5 of mind? and ANZ) which are caught in this Nevertheless, the IMF stated that and, arguably, the country’s ability set up a Blockchain-based service to inquiry, would hardly like to wake up to ‘punch above its weight’ – were While the FMA “decided not to impose 3. If operational and financial “…while the baseline outlook is financial institutions. to similar headlines and suffer the clearly reflected in the country’s financial limits on personalised controls will need to evolve as the strengthening, growth remains weak resulting damage to their reputations. ranking at 13th. The developers of this system claim ‘robo-advice’ and the eligible product technology used evolves, how in many countries.” Furthermore, the Due to this, New Zealand’s banks have that it will accelerate the speed at list has been expanded to include can we defend the bank against IMF noted a few significant hazards conduct risk at front and centre of which international payments are mortgages and personal insurance risks such as hacking, plus seek that could lead to a darker spell mind at all levels. Areas where New Zealand was processed and reduce the cost products”, applicants will be required to to prevent the inevitable fallout emanating from many concerns such praised through high rankings within of performing such transactions. “provide the FMA with good character of financial losses, business Some in the industry see this a chance as the following: a more rapid and the ‘Top 10’ of the surveyed countries According to the founders, this system declarations for directors and senior disruptions, and reputational ‘black to bring some balance to the debate sizeable tightening of monetary policy were as follows: ‘Financial market “has been designed to augment managers as well as information marks’ that tend to have long-lasting around banks, especially because than that which is currently expected, development’ (1st place), ‘Institutions’ financial flows worldwide for all showing they have the capability and and far-reaching consequences. bank bashing is a popular pastime in the persistence of low inflation levels (3rd place), ‘Labour market efficiency’ payment types and values and allows competence to provide the ‘robo-advice’ Australia and while some behaviours (see Figure 2), observed shifts towards (5th place), ‘Health and primary financial institutions to choose the service.” These requirements will be put and instances of misconduct might protectionism evident in nationalist Conducting the train education’ (6th place), ‘Higher settlement network of their choice for in place to ensure that the standards be apparent, the commission will also parties gains’ in recent elections Recently, Australian banks have and in the Brexit referendum, and Education and training’ (7th place), and the exchange of central bank-issued guiding the ‘robo-advice’ service are come under intense public and media give the banks the chance to show 4 geopolitical tensions. ‘Goods market efficiency’ (9th place). digital assets.” consistent with the standards applied scrutiny, the result of which has both sides of the story. 5 to authorised financial advisors. been a Royal Commission Inquiry Within these broad ‘pillars’, the into alleged misconduct. According What’s lighting up the global global organisation complimented to an article from Bloomberg News, stage? the country on its particular areas of financial strength which were ‘Ease the “banks have been damaged by a The International Monetary Fund (IMF) Due to the risk of possible aggression of access to loans’ and ‘Soundness of Bots: the beginning At the time of writing, we have yet see string of scandals over the provision of issued its biannual World Economic from either North Korea or the USA, banks’. The study gave the Commerce Across the Tasman and in other the launch of ‘robo-advice’ in the local misleading financial advice, attempted Outlook in October 2017.7 In this geopolitical tension is high and would Commission credit by praising the advanced economies, banks and market. We look forward to what will rate rigging and the alleged improper report, the IMF projected that global likely result in a significant spike in the ‘Effectiveness of the anti-monopoly wealth advisors have had success in happen in this regard, not only in the refusal of insurance claims”. growth will put on a great show by IMF’s geopolitical risk monitor (see policy’, and also appeared to approve implementing so-called ‘robo-advice’. In anticipation of ‘robo-advice’ improving rising to 3.7% in 2018, up 0.1% from Figure 3). of certain government policies the third quarter of 2017, the Financial the general public’s access to crucial the earlier forecast in April 2017 (see reflected in the high rankings of Markets Authority (FMA) announced financial advice about matters such as Recently, Australian banks have Figure 1), up on a forecast 2017 growth the ease of starting a business, that they would fast-track the changes KiwiSaver funds, but also assessing come under intense public and rate of 3.6% and a sluggish actual the ‘Diversion of public funds’, and required to allow ‘robo-advice’ (i.e. the uptake of this by customers who media scrutiny, the result of which growth rate of 3.2% in 2016. As shown the ‘Transparency of government financial advice dispensed by a non- seem to demand something in the has been a Royal Commission in Figure 1, the rosy spotlight over NZ Inc.: In the ring and policy making’. natural person) and that firms would be spectrum of automated and fast, yet Inquiry into alleged misconduct. global growth is supported by large- punching above its weight able to apply to the FMA for leave to do personal and flexible. scale growth in advanced economies The Global Competitiveness Report Businesses’ policies and structures, this from early 2018 onwards.5 in addition to strong and seemingly 2017–2018, a report published annually such as the ‘Ethical behaviour of firms’, How do you keep a machine The Royal Commission Inquiry more stable growth in China and other the ‘Efficacy of corporate boards’ and comes after more than a year of by the World Economic Forum on the straight and narrow? emerging markets. (WEF), was released in September ‘Strength of investor protection’ (the dithering, during which the big four last one is likely due to a mix between Before we become too engrossed by 2 0 1 7. 8 New Zealand’s comparative Australian banks and the Australian regulation and business policy), the digital revolution to think clearly, advantages over other economies – Prime Minister opposed the inquiry. were also lauded. These polices and we should consider the many potential and, arguably, the country’s ability to The FMA announced that they However, the government eventually structures support the view that risks associated with it. In relation ‘punch above its weight’ – were clearly would fast-track the changes considered launching the inquiry to local banks are taking conduct and to regulatory compliance, some reflected in the country’s ranking at required to allow ‘robo-advice’. be a matter of necessity, due to the Global growth is supported by reputational risks seriously through important questions that should pique 13th of 137 countries. “national interest for the political large-scale growth in advanced our interest would be as follows: ensuring that governance and internal uncertainty [caused by the crisis] economies in addition to strong and controls meet acceptable standards. This ‘fast-track’ follows on from a 1. Is it possible to perform effective to end”.6 seemingly more stable growth in consultation phase, during which the KYC procedures and jump through China and other emerging markets. regulator received 49 submissions. all the Anti-Money Laundering and Most respondents indicated that Countering Financing of Terrorism they are in support of ‘robo-advice’ (AML/CFT) hoops if the customer is arriving sooner than on the previously effectively embodied in a few taps proposed date of April 2019. and keystrokes?

…But NZ Inc. could slip up in What direction the immigration policy Otherwise, their actions could In October 2017, Statistics the future of the coalition government will slow, stall, or (worse still) send the New Zealand is a young nation New Zealand released an informative eventually follow is currently uncertain, New Zealand economy backwards, without great pools of wealth, and insightful publication entitled Nevertheless, key issues in what what they decide will have an impact the very economy it needs to be it needs capital and access to it Household income and housing cost could be termed ‘forward-looking’ on the demographics of the workforce growing to pay for its ambitious from other countries to help keep statistics: Year ended June 2017.11 areas were also noted in the WEF’s of ‘NZ Inc.’ social programme and to create the growing its economy. report. Aside from the low ranking in opportunities for New Zealanders the ‘Market size’ pillar (64th) which is it talks about. One of the dangers not unexpected given the land area A number of survey participants of its anti-immigration rhetoric is The majority of survey participants and population size of the country, This report revealed that national commented on their own reliance that not only can such rhetoric be discussed this matter and indicated that additional pillars where New Zealand average annual household income (and the broader economy’s misunderstood, but it can also make moving from electioneering policies earned comparatively low rankings from all regular sources increased reliance) on skilled labour workers, investors and tourists alike all into actual reform may be somewhat were as follows: ‘Infrastructure’ by 50.50% over the 10 year period immigrants. feel unwelcome. tricky and would require a careful It remains to be seen whether any (23rd), ‘Business sophistication’ to June 2017, while average weekly 8 and considered approach. Given the future legislative change which curbs (24th) and ‘Innovation’ (20th). Survey participants noted a genuine housing costs which great at a slightly predicted surge in applications being immigration figures would result in slowing of the economy and loss higher rate of 56% over the same Aside from the impact on diversity, referred to the OIO, survey participants a decrease in inflationary pressures of business confidence since the period. The picture was rosier for the skills shortages faced by Aotearoa also suggested that the OIO would in a market that already appears to election, seemingly while businesses households over the shorter term – i.e. mean that any proposed changes need to concentrate on achieving be cooling somewhat due to various adopt a ‘wait and see’ approach in the year ended June 2017, average It should be noted that, while these to immigration rules or a deliberate processing efficiencies or receive other reasons (based on median house to business. annual household income increased by were New Zealand’s lower scores, the restraint placed on immigration significant staffing increases to make prices (see Figure 4), sales volumes 9.06%, while average annual housing country was still within the top 17%. numbers would need to be carefully sure that a backlog is not created. (see Figure 5) and days to sell (see Restrictions proposed on costs declined by 0.33%, albeit at a deliberated in order to ensure that Figure 6)). Potential factors that could The survey also separately highlighted foreign home ownership or A slow moving backlog will be another fairly high level (historically speaking). economic growth is not compromised. further impact the housing market the ‘Most problematic factors for doing investment piece of the discouragement jigsaw As a percentage of household income, A number of survey participants are if the Labour Party’s policies business’. Of these considerations, facing foreigners. One important housing costs also reduced from an commented on their own reliance (and The new coalition government has to increase supply and moderate at least two of the top five concerns aspect of this issue is to make sure average rate of 17.3% (in the year the broader economy’s reliance) on created a great of clamour around demand-side price pressures from (those two concerns being the overseas investment rules. The that, against this backdrop, the new ended June 2016) to an average rate of skilled labour immigrants, especially foreign and tax speculators’ activities ‘Insufficient capacity to innovate’ Overseas Investment Amendment Bill government’s policies refrain from 15.8% (in the year ended June 2017), as the cycle of Kiwi emigration across are put in place. and the limitations on the ‘Access to the ditch and elsewhere increases as passed its first reading in Parliament discouraging the investment we need driven by rising household incomes financing’) might have a direct and global growth improves. in December, and has been referred to launch some of our infrastructure with fairly flat average housing costs. discernible effect on, and be reflective to the Finance and Expenditure projects. We should also remember It remains to be seen whether any In its published immigration policy of, the banking sector, amongst select committee. that, since New Zealand is a young future legislative change which curbs November 2017 FSR: A bit others. The remaining three matters statement, the Labour Party alludes nation without great pools of wealth, Associate Finance Minister, David immigration figures would result in a more rope to play with? in the top five on the list of concerns to the fact that they will continue to it needs capital and access to it from Parker, said the law “recognises and decrease in inflationary pressures. On 29 November 2017, the RBNZ were as follows: an ‘Inadequate supply welcome migrants to the country, other countries to help keep growing reaffirms that it is not a right for an released its semi-annual Financial of infrastructure’, the ‘Inefficient but has noted with concern that its economy. overseas buyer to purchase a house Stability Report (FSR). In this report, government bureaucracy’ and an the apparent level of investment in here”. The reforms would result in the RBNZ stated that New Zealand’s ‘Inadequately educated workforce’. housing, plus other infrastructure and Is housing still hot? Affording a ‘shoe in’ on the public services, has not kept pace residential land being classified as financial system still maintains a In the past few years, house price property ladder The ability of business leaders and with the migration level. The Labour ‘sensitive’ land under the Overseas steady footing and that, although the Investment Act, a classification which inflation (see Figures 4, 5 and 6) has For a market where most banks’ the government to both deal with Party stated that these changes have financial system remains exposed to would mean that the property could been predominately Auckland-driven, portfolios are dominated by mortgage these challenging problems, and to “contributed to the housing crisis, put a number of risks, these risks have only be purchased by citizens or with other regions, especially Tauranga lending, what is happening in handle each issue separately without pressure on hospitals and schools, and reduced over the past six months. The permanent residents of New Zealand and Wellington, picking up in the last the housing market is always a exacerbating the other issues, remains added to the congestion on roads”. 9 regulatory body noted that the key to be seen. or Australia; other buyers would need year or so. These regions were at least topical issue. For most banks’ retail risks affecting the financial system are the prior approval of the Overseas partially driven by a high net migration customers, housing affordability, housing market vulnerabilities, dairy Will we have the people Investment Office (OIO).10 inflow (see Figure 7) and demand especially in Auckland, is often a topic sector indebtedness and the banking to grow? that exceeds supply. Whether the of debate, as we saw in last year’s system’s exposure to volatility in What the new government needs high net migration figures we have election campaigns and coalition talks. international funding markets. To be competitive on the global stage, is to be careful not to overreact and, observed over the past few years will there is a need to embrace diversity. in doing so, reduce the positive continue is questionable, especially Time and again, the valuable benefits influences of immigration. given the policies discussed during the Housing affordability, especially in of diversity in the form of different election of the parties in the Labour-led Auckland, is often a topic of debate, perspectives and experiences have coalition government. as we saw in last year’s election. been lauded.

The RBNZ also performed a ‘Policy This development is clearly shown in The combination of these cost and The (uncertain) winds of In some pockets such as construction, As mentioned in the quarterly Assessment’ in relation to the mortgage growth rate percentages; supply pressures makes it appear political change property development and residential FIPS editions during the year, the loan-to-value ratio (LVR) restrictions growth in this sector of the market has as though the liquid cash of retail property prices, it seems as though ‘Dashboard’ approach to quarterly The lead up to and outcome of the imposed, and opted to (with effect reduced from 9.23% in 2016 to 5.54% depositors is the ‘kingmaker’ as far as growth and/or prices seem to have reporting remains a topical area. In election has led to uncertainty as well. from 1 January 2018) loosen these in 2017 ($241.62 billion in lending) as funding is concerned, especially in the either slowed down or reversed, a late 2016 the RBNZ floated the idea There are mixed views in the business restrictions somewhat by increasing shown in Figure 8. Personal lending current low-yield environment. phenomenon nowhere more observed by means of a public consultation. sector around the various impacts the the percentage of each bank’s new continues to grow for the banking than in Auckland. However, export- A ‘Dashboard’ approach aims to Many survey participants espoused new coalition government may have, mortgage lending to owner occupiers sector as the economic environment led industries, such as commodities, reduce the amount of information the notion that, since the historic love not only around immigration, but also at LVRs in excess of 80% (from 10% remains strong with low inflation, low remain relatively solid and are poised disclosed in off-quarter disclosure affair with looking after the borrower with respect to government spending to 15%), and allowing each bank to unemployment, and a housing market to benefit further from the recent NZD statements, thereby reducing costs may be over, depositors may be the and increases in lower decile incomes lend 5% of all new mortgage lending that is still close to cyclical highs, thus currency weakness. and driving the focus of content to ones that now start to ‘feel the love’. through changes to minimum wages at a higher than usual LVR of 65% helping consumer confidence remain information that would be most useful and student allowances. (currently 60%) to investors. On high. Business lending continues to NZ IFRS 9: Called up from to key stakeholders. Local economy: Steady as this point, the FSR noted that “LVR show strong growth (6.18% for the the bench restrictions will be adjusted gradually year ended 31 December 2017), but she goes? There are mixed views in the NZ IFRS 9 Financial Instruments over time, provided that financial at a slower rate compared to that of New Zealand’s Gross Domestic The ‘Dashboard’ approach to business sector around the (IFRS 9), with an effective date for stability risks remain contained. 2016. The major change was the major Product (GDP), and other macro quarterly reporting remains a various impacts the new coalition years beginning on or after 1 January Gradual adjustment to policy will banks’ slower lending growth over the fundamentals such as the Consumer topical area. government may have. 2018, is a big hitter to be called up this reduce the risk of resurgence in the year than it had previously experienced. Price Index (CPI) and unemployment, year. The impact of the standard on housing market and a deterioration in appear to be quite steady and results is expected to be significant lending standards.”12 optimistic. The IMF forecasts annual In 2017, the RBNZ released the This uncertainty is reflected in the as banks move from an ’incurred GDP growth for New Zealand for the finalised policy decision on the recent negative reading on the loss‘ to an ’expected loss‘ credit 2018 calendar year of 3.0%, down Dashboard approach, with the first business confidence index. The ANZ model. Survey participants are 50 bps from the forecast level of 3.5% ‘live’ dashboard completed with Q1 Business Confidence Index declined mostly well advanced in preparation Banks’ conscious moves towards and lower than the 2016 growth of 2018 data to be published at the end of to -38 in December, only slightly up to implement the new standard’s selective, sustainable lending and 3.6% (see Figure 2). May 2018.16 from -39 in November 2017, well down complex requirements. Since BNZ has Survey participants and market the LVR rules implemented in the from 0.0 in September 2017 and +22 transitioned early to the new standard, commentators have mixed views third quarter of 2016 has resulted in 13, 14, 15 in December 2016. it has felt the impact on its bottom around the impact of loosening the sluggish lending growth, compared line. The standard will have an effect LVR rules. to that of previous years. However, as shown in Figure 2, this on the comparability of provisioning The RBNZ also finalised the revised growth still compares favourably and provisioning-related numbers Outsourcing Policy in September 2017, going forward. This impact on survey which came into force on 1 October Survey participants and market with the average growth forecasts participants’ results will be noted and 2017. The revised policy sets out commentators have mixed views Funding the advance for advanced economies. The IMF expects New Zealand’s CPI for 2018 analysed, where possible, in future requirements that banks need to meet around the impact of loosening the Low cost, easily accessible funding to show a reading of 2.0% for annual editions of this publication. when outsourcing particular functions LVR rules. Some Executives of the has become scarcer than before, price growth, a result which is right and services to third party and related major banks were a little surprised as following revisions to Australian at the midpoint of the RBNZ’s target party service providers and seeks the relaxation had arrived sooner than Prudential Standards (APS) 110 Capital Regulatory microscope range and is down 20 bps from a to ensure the bank can operate in a expected. Most survey participants felt Adequacy and APS 120 Securitisation Regulation continues to be a key forecast level of 2.2% in 2017. As Further pessimism is reflected in stand-alone fashion in the event of that the impact on their current lending which resulted in a reduction in the area of focus for New Zealand banks. shown in Figure 2, this result is in line the current account deficit which is functional failures by these providers. mix would be minimal and that they funding able to be provided by the Whilst a number of consultations with the forecasts for other advanced expected to widen to 3.8% of GDP The RBNZ noted it will work with would continue to work according to big four Australian banks to their have now closed and policy decisions economies. The IMF have predicted in 2017, an increase from a projected banks to ensure compliance with the their current internal risk models which New Zealand subsidiaries. Funding are final, challenges remain over the that unemployment in New Zealand deficit of 3.6% in 2017 and a recorded policy within the five year deadline.17 set lower targets than the RBNZ’s. costs also may be pressured upwards coming years to implement these will decrease marginally, from a rate deficit of 2.8% in 2016. This sort of in the future given the inflationary policy decisions and grapple with of 5.1% in 2016 to 4.9% in 2017, and thinking seems somewhat contrary We are still making pressures across the globe and in new consultations which will also continue on a downward trajectory to the current currency weakness New Zealand, and a rise in interest take a number of years to finalise and mortgages in 2018.7 and visitor arrivals which are boosting rates probably will not come as transition in to. The combination of banks’ conscious returns from tourism. a surprise. moves towards selective, sustainable lending and the LVR rules implemented in the third quarter of 2016 has resulted in slower lending growth compared to that of previous years.

Turning to Anti-Money Laundering and Earlier this year the RBNZ issued its The Basel Committee’s work in this It will be interesting to see how Countering Financing Terrorism (AML/ Issues and Options Paper in relation area (recently finalised) forms the the introduction of ‘robo-advice’ in CFT) compliance, in April, the RBNZ to the review of the capital adequacy basis of the options laid out, alongside New Zealand changes the provision issued a Sector Risk Assessment framework, outlining the premise the preservation of New Zealand- of financial advice, and how good paper in which it noted that the of the review and its possible policy specific implementation points. Banks conduct and client-centric outcomes overall inherent money laundering options. This extensive review is are undertaking significant work to can be applied to an automated (ML) risk rating for banks was ‘High’ continuing, and will do for some time. ascertain the impact of the options service. This could come quicker than compared to the ‘Medium’ rating This initial Issues and Options Paper presented, but as with any regulatory we think, as FMA has released a draft assigned to non-bank deposit taking has been followed by two more change in this area, the devil will be in exemption to allow providers to enter institutions. The ‘High’ risk rating papers: Capital Review Paper 2: What the detail as the RBNZ continues to the market before FSLAB is passed assigned to banks is a result of the should qualify as bank capital? Issues consult with the sector and develop- into law. out its proposals. characteristics of the banking sector and Options in July 2017 and Review Lastly, with regard to changing OTC – i.e. the large number of customers, of the Capital Adequacy Framework derivatives margin requirements, the high frequency of transactions, and for locally incorporated banks: The twin policy objectives of FSLAB NZBA is working with its members and high value of transactions, combined calculation of risk weighted assets in are to improve the quality of and the New Zealand Financial Markets with the widespread exposure to December 2017. Association (NZFMA) on an issue that international transactions.18 accessibility to financial advice. Paper 2 was discussed in previous concerns reforms being made in G20 FIPS editions and the RBNZ has now countries in relation to requirements to post margin for derivatives that made ‘in-principle’ decisions around Another large area of review is are not centrally cleared (uncleared the definition of capital following public the Financial Advisers Act. As part derivatives). During the year the On 1 November New Zealand’s consultation. These are: of the regular statutory cycle, the RBNZ and Ministry of Business, Prescribed Transaction Reporting Financial Advisers Act is currently —— Proceed to remove contingent debt Innovation and Employment issued regime commenced requiring financial under review, which has resulted in and contingent preference shares a public consultation and the RBNZ institutions to report large cash and the drafting of the Financial Services from the definition of capital. is currently analysing responses with international funds transactions to Legislation Amendment Bill (FSLAB). a policy decision expected early this the New Zealand Police Financial —— Accept non-redeemable, non- FSLAB has had its first reading in year.22 Additionally, the RBNZ granted Intelligence Unit.19 contingent, perpetual preference Parliament and has started the Select the registration and operation of shares as Additional Tier 1 (AT1) Committee process. The proposal is China Construction Bank Corporation capital. that FSLAB is rolled into the Financial in New Zealand as a branch. This —— Accept redeemable, non- Markets Conduct Act (FMCA), which provides further evidence that RBNZ contingent preference shares and means all financial advice providers In December AML supervisors are looking to increase the competitive long-term subordinated debt as will need to be licensed by the updated several AML/CFT guidelines forces in the market and are open to Tier 2 capital. Financial Markets Authority like other 20 the registration of small foreign, non- to update on phase two reforms and market participants. in an attempt to bring clarity to areas —— Allow options for a Tier 1 capital systemically important banks. of regulation bringing particular pain to instrument that can be issued by Given FMCA’s and the FMA’s focus on organisations compliance efforts. mutual societies. conduct, it is not surprising that the regulation of financial advice activities These decisions will have a large should also be shifting in the same impact on New Zealand’s registered direction. Client-centricity and good banks’ capital structures should client outcomes are key areas for they proceed in the current form. A guideline around electronic FSLAB and also the Code of Conduct Banks will need to grandfather and verification of identity set out for financial advice activities that will replace contingent AT1 and Tier 2 supervisory expectations which, while sit alongside the legislation. The twin capital, a time-consuming and costly helpful, will make it more difficult for policy objectives of FSLAB are to exercise. The paper issued just before some institutions to move forward improve the quality of and accessibility Christmas is still under consultation with non- face-to-face verification.21 to financial advice in New Zealand. and presents the options the RBNZ are One of the most innovative aspects looking at for the calculation of credit, of the legislation is the removal of the market and operational risk weighted requirement for personalised advice to assets (RWA). be delivered by a human adviser.

© 2018 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. © 2018 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. 16 | KPMG | FIPS 2017 FIPS 2017 | KPMG | 17 Timeline of events23

• 22nd • 12th • 9th • Jan. 2017 Heartland Bank re-enters the • Apr. 2017 The Reserve Bank expects credit TSB Bank discloses having lent • Aug. 2017 • 17th mainstream mortgage market • 3rd growth to slow as banks fight more $50 million to date through peer-to- • 17th ANZ Bank New Zealand Limited by offering services on its ANZ announces that it will introduce aggressively for deposits to fund their peer (P2P) lender Harmoney. The Hongkong and Shanghai Banking online platform. voice biometrics by mid-2017; it Corporation offers a two-year names Stewart Taylor as their new expanding loan books. 11th Chief Financial Officer. intends this measure as a further • mortgage rate of 3.79% for premium According to global research firm element of security to help 30th customers. The bank states that, in • Forrester, New Zealand banks’ mobile 19th prevent fraud. The Reserve Bank confirms more than fifty years, this rate is the • • Mar. 2017 platforms are falling behind those of Heartland Bank names David Mackrell that Kiwibank’s two capital lowest residential mortgage rate in 10th 6th their Australian counterparts. as their new Chief Financial Officer. • • instruments no longer qualify as New Zealand. Kiwibank announces that Chairman New Zealand Post sells a collective regulatory capital under the capital 20th 31st Rob Morrison and Deputy Chair 45% of Kiwibank shares to ACC • 19th • adequacy framework. International ratings agency Moody’s • Rhoda Phillippo have resigned. Susan and NZ Superannuation Fund for Heartland Bank announces they will Investors Service downgrades TSB Bank purchases Fisher Funds, the Macken, a Director of the bank, is $495 million. be providing a facility to fund online 31st the credit ratings of the four big fifth largest KiwiSaver operation that appointed Kiwibank’s new Chair, with • lender Spotcap’s Australian growth 7th When releasing the Reserve Bank’s New Zealand banks in line with manages approximately $3.6 billion of plans. effect from 13 April 2017. • May Financial Stability Report, investors’ savings. The Reserve Bank releases an downgrades of their Australian Reserve Bank Governor, Graeme parents, citing concerns about the 16th update on its assessment of 22nd • Wheeler, said that New Zealand’s housing market across the Tasman as • SBS Bank announces that, in April, it money laundering and terrorism Kiwibank Chief Executive, Paul Brock, • Feb. 2017 financial system remains sound and a reason for doing so. will launch a mobile banking app for financing risks. 7th the risks facing the system have resigns after being with the bank for • customers. Grant Spencer is appointed as Acting • 26th reduced in the past six months. more than 17 years. Governor of the RBNZ to serve after • 17th SBS Bank launches a mobile banking • Jul. 2017 A former BNZ worker has been the conclusion of Mr Wheeler’s term In response to customers’ app for customers’ use. 8th charged with dishonestly using bank until a new Governor is appointed. • Jun. 2017 • preferences shifting towards digital As the big four banks continue to documents to secure more than 7th banking solutions, BNZ announces • close their doors to foreign applicants, $1.5 million in home loans. 14th ANZ spends $2 million to • a number of branch closures and • May 2017 finance companies, Chinese banks, The first bank to launch Android pay in compensate KiwiSavers for 29th reduced hours in other branches. 1st and other non-bank lenders remain • New Zealand is BNZ. Such technology • The Reserve Bank appoints Sean Mills The Co-operative Bank names its ’processing errors‘ as at least open to foreigners seeking mortgages allows anyone with an near-field as Assistant Governor and Head of 22nd General Manager of Customer 51,000 members did not receive full to buy New Zealand property. communication (NFC)-enabled • Operations. After AMP and Westpac confirm that Banking, David Cunningham, as its tax credits. Android device to pay in store with a 24th they have withdrawn investments in new Chief Executive. SBS Bank announces a new • tap of their phone. SBS Bank conditionally purchases The tobacco companies, ASB KiwiSaver partnership with Australian company Warehouse Group Financial Services 20th remains the last major KiwiSaver 10th Sandstone Technology to offer a new • • for $18 million. The Privacy Commission rules provider to continue holding The RBNZ announces that, as the digital banking service. against Westpac’s argument that investments in such companies. outlook for the dairy sector improves, 26th bank lending to the agricultural sector 8th • the bank does not need a legal order • The Co-operative Bank names 31st is shrinking. The Reserve Bank releases a before handing over customers’ • Bevan Miller as their new Chief Three of the big four Australasian consultation paper on debt to personal banking details to the police. banks lose a fight with Apple over 11th income limits. Financial Officer. Westpac had claimed that customers • Apple Pay in Australia. The ruling At a recent Blockchain New Zealand voided their rights to privacy when by the Australian Competition and conference, a visiting Blockchain they signed the bank’s ’terms Consumer Commission prevents expert posits that shutting down and conditions’. banks from passing on Apple’s fees cryptocurrency bank accounts to customers. is not the way to deal with competitive threats.

• 15th • 6th • 31st • Sep. 2017 • Nov. 2017 Westpac’s minimum regulatory capital Despite major upturns in dairy prices, • Jan. 2018 Global ratings agency Standard & • 20th • 1st requirements increase after Westpac there has been a noticeable lag in • 15th Poor’s has affirmed New Zealand’s The Reserve Bank introduces a China Construction Bank joins failed to comply with regulatory the flow through to income with ANZ’s deal to sell UDC Finance ‘AA’ sovereign credit rating, saying revised outsourcing policy. The revised New Zealand Bankers’ Association, obligations relating to its status as an farmers instead financing deferred to Chinese-owned company the new government’s plan to lift policy sets requirements that banks thus bringing the total membership to internal models bank. maintenance. This has caused an HNA is blocked by the Overseas spending will be a bigger contributor increase in industry debt. to growth in the future, but are funded need to meet when outsourcing seventeen banks. Rabobank announces the resignation Investment Office. particular functions and services, through cancelled tax cuts and won’t of its Chief Executive Daryl Johnson. 7th especially if the service provider is a • 2nd • • 16th undermine the outlook. Angela Mentis is appointed as While 10% of farmers in the dairy A Treasury-commissioned Reserve related party of the bank. 20th All 146 KiwiSaver products offered Managing Director and Chief • industry feel more pressure from Bank review finds ‘strong case’ for First NZ Capital agrees to buy by 16 providers generated a positive 22nd Executive of BNZ. their banks than they would like to, reform that would strengthen its • ANZ’s online trading platform for an return for their investors in 2017 as The FMA toughens its approach to the Federated Farmers notes that average decision making process and improve undisclosed sum. strong gains on equity markets with misuse of Financial Services Providers • 7th mortgages in the agri-sector have accountability. the local benchmark S&P/NZX 50 Register (FSPR), saying they will not The Hongkong and Shanghai Banking 23rd remained stable. • The New Zealand dollar climbs Index jumping 22%, Morningstar only target New Zealand directors of Corporation (HSBC) announces its Some banks lash out at the Reserve 11th above 73 US cents for the first time research shows. FSPR businesses who encourage or withdrawal from the South Island by Bank’s proposed debt-to-income • Adrian Orr, Chief Executive of in four months following a higher facilitate abuse of the FSPR but also closing its Christchurch branch by (DTI) ratio tool. The Co-operative New Zealand Superannuation Fund, euro on the back of an optimistic intends to hold them personally liable. the end of November. The Wellington Bank claims DTI is a ‘blunt, unproven is appointed as new Reserve Bank EU outlook. • Feb. 2018 office, however, will service South instrument’, ANZ declares it to Governor from March 2018. 2nd Island customers. be ’fundamentally flawed’, and 17th • • Oct. 2017 • Low business and consumer A review of the Reserve Bank is set HSBC says it is ’useful as indicative 12th Craigs Investment Partners says • confidence levels, coupled with 2nd to broaden its focus to a dual mandate tool, [but] shouldn’t be mandatory New Zealand’s first Bitcoin real-estate that shares in Australian banks are • the Government’s emphasis on TSB Bank announces that it has by targeting the control of both or decisive’. transaction sparks global attention. underperforming compared to those investment into rail over roading, rebranded itself as ‘TSB’. inflation and employment. in the rest of the market. 29th 14th will see economic growth begin to Barbara Chapman, ASB’s Chief • • 8th The Reserve Bank eases loan-to-value The Australian central bank considers In the wake of an easing in home-loan taper off in early 2019, say economist Executive, announces she will step • TSB announces that its Chief ratio (LVR) restrictions with effect establishing a digital currency. restrictions, mortgage brokers point Gareth Kiernan from Infometrics. down next year; she has functioned in Executive, Kevin Murphy, will retire from 1 January 2018. to early signs of the major banks this role since 2011. 15th 9th in January after almost a decade • opening their doors to more low- • ASB names Vittoria Shortt as their Mortgage fraudster, Kang (Thomas) 18th working in that role. deposit borrowers than before. • • Dec. 2017 new Chief Executive Officer. Huang, who dishonestly obtained Former Prime Minister, Sir John The big four banks sell their stakes $52 million of loans involving about TSB names Murray Bain as their new 1st Key, is named as Chairman of ANZ acting Chief Executive Officer. • 18th in Paymark to Paris-listed Ingenico 75 properties in Hamilton and BNZ announces the appointment of • New Zealand. Rabobank names Todd Charteris as Group for $190 million. Auckland, has been sentenced to 9th Mandy Rutherford as Chief Finance their new Chief Executive Officer. 23rd • 22nd four year and seven months in prison. • Heartland Bank seeks to raise Officer, effective 5 March 2018. • Analysts note that they are wary of the 21st Heartland Bank rekindles interest in $59 million of new equity through a Kiwibank names Mark Stephen • impact that a cooling property market China Construction Bank registers to the UDC sale. rights issue. as their new acting Chief will have on banks’ profits. provide banking services as a branch Financial Officer. ASB’s latest housing confidence in New Zealand. • 29th survey shows that house price David Hisco, ANZ’s Chief Executive, expectations have fallen for the fifth Internal models approach for says the New Zealand property quarter in a row to a six-year low. credit risk used by the big 4 banks market has peaked. will survive the RBNZ’s capital review, but increased transparency and heightened conservatism is foreshadowed.

© 2018 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. © 2018 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. 20 | KPMG | FIPS 2017 FIPS 2017 | KPMG | 21 Some of the significant management changes in the sector

This year, more than any other, we have seen the industry’s leadership change. Below we have captured the change at the CEO and CFO level. We welcome those new to their role and extend our gratitude to those who have departed for their contributions to the survey. It will be interesting to see what impact, if any, these changes have on the sector.

Entity Position As at January 2017 Changes up to March 2018 CEO David Hisco ANZ Bank New Zealand Limited CFO Antonia Watson Stewart Taylor CEO Barbara Chapman Vittoria Shortt ASB Bank Limited CFO Jon Raby Bank of Baroda (New Zealand) Limited Managing Director Prahlad Das Gupta Anupam Srivastava Bank of China (New Zealand) Limited CEO David Wang Bank of India (New Zealand) Limited Managing Director Ranjitkumar Amarendra Jha CEO Anthony Healy Angela Mentis Bank of New Zealand CFO Adrieene Duarte Mandy Rutherford China Construction Bank (New Zealand) CEO Li Xingyao Limited Citibank, N.A. New Zealand Branch CEO Derek Syme CEO Jeff Greenslade Heartland Bank CFO Simon Owen David Mackrell Industrial and Commercial Bank of China CEO Karen Hou (New Zealand) Limited JPMorgan Chase Bank, N.A. New Zealand CEO Mark Lawrence Branch CEO Paul Brock Mark Stephen (Acting) Kiwibank Limited CFO Gary Crawford Kookmin Bank Auckland Branch General Manager Yong Hun Song Rabobank Nederland New Zealand Branch CEO Daryl Johnson Todd Charteris CEO Shaun Drylie Southland Building Society CFO Tim Loan The Bank of Tokyo-Mitsubishi UFJ Limited, General Manager Mike Ryff Takamitsu Murakami Auckland Branch CEO Bruce McLauchlan David Cunningham The Co-operative Bank CFO Gareth Fleming Bevan Miller The Hongkong and Shanghai Banking CEO Chris Russell Corporation Limited, New Zealand Branch CEO Kevin Murphy Murray Bain (Acting)* TSB Bank Limited CFO Roddy Bennett CEO David McLean Westpac New Zealand Limited CFO Jason Clifton Ian Hankins (Acting) CEO Adrian Orr New Zealand Super Fund Chief Investment Officer Matt Whineray Reserve Bank of New Zealand Governor Graeme Wheeler Adrian Orr * New CEO will be announced any day

© 2018 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. © 2018 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. 22 | KPMG | FIPS 2017 FIPS 2017 | KPMG | 23 Sector performance

Interest expense fell by 7.37% Net profit after tax Net interest margin TABLE 2: REGISTERED BANKS – PERFORMANCE TRENDS The New Zealand banking sector ($918.39 million), while interest The banking sector saw net interest income fell by 3.67% ($806.86 million). Impaired asset produced a record profit result with margins (NIM) fall by 9 bps from Operating Net profit after expense/ an overall increase in net profit after Amongst the major banks, the big 2.17% to 2.08%, despite net Increase in total Increase in net expenses/ Year tax/Average Interest margin Average tax (NPAT) of 7.35% ($355.11 million) four (ANZ, BNZ, Commonwealth Bank interest income increasing by 1.17% assets profit after tax Operating total assets gross loans & to $5.19 billion, was the highest in the of Australia New Zealand (CBA) and ($111.53 million) for the year (see income survey’s history, completely reversing Westpac) collectively contributed Table 3). As mentioned in a number advances last year’s $316.38 million reduction. $451.00 million of the growth in of press releases, the decline in NIM 2017 1.42% 7.35% 1.04% 2.08% 39.46% 0.04% The current year’s result highlights the NPAT. Conversely, the fifth major for the banking sector was the result 2016 6.35% -6.58% 1.00% 2.17% 39.25% 0.12% relatively stable economy combined bank (Kiwibank) reported a 57.26% of volatile offshore funding costs with continued strong loan growth and ($71.00 million) decrease in NPAT and customer preferences shifting 2015 10.20% 6.94% 1.16% 2.28% 37.32% 0.12% improved asset quality, albeit with a which was significantly impacted by towards fixed rate loans. Out of the 2014 5.28% 20.41% 1.17% 2.24% 39.44% 0.08% continued decrease in margin. software impairment of $65 million twenty survey participants, seventeen (after tax). reported a decrease in their NIM 2013 1.15% 8.53% 1.00% 2.26% 42.05% 0.16% this year. The three Chinese Banks registered 2012 0.78% 14.12% 0.93% 2.26% 44.40% 0.22% the most impressive NPAT growth All five major banks reported The increase in profitability is in percentage terms, with increases reductions in their NIM for the year, largely attributable to the combined of 73.63% (Bank of China), 137.94% with CBA and Kiwibank showing an impact of a $281.93 million (61.34%) (China Construction Bank) and equally volatile change of 16 bps. TABLE 3: MOVEMENT IN INTEREST MARGINS 2017 2016 Movement reduction in impaired asset expense 138.97% Industrial and Commercial Although the big four banks managed Entity % % (bps) and a $268.66 million (10.05%) Bank of China (ICBC). to increase the total net interest increase in non-interest income. The income by $107 million, faster growth Australia and New Zealand Banking Group Limited – New Zealand Banking Group 2.17% 2.22% -5 JPMorgan Chase Bank and Southland reduction in impaired asset expense in interest-earning assets came at Building Society produced the Bank of Baroda (New Zealand) Limited 2.90% 3.48% -58 is largely a result of an improved dairy the expense of a decline in NIM. ANZ next largest NPAT percentage sector credit quality and a relatively continues to hold the top spot in the Bank of China (New Zealand) Limited 1.47% 2.21% - 74 increases of the non-major banks of stable economy over the past net income metric, recording a net 36.92% ($1.47 million) and 37.43% Bank of India (New Zealand) Limited 3.06% 3.67% -61 twelve months. Favourable gains on income of $3.08 billion with BNZ in ($7.48 million) respectively as fee and financial instruments further helped by second place at $1.79 billion. Bank of New Zealand 2.10% 2.19% -9 commission income increased for increasing non-interest income for the both participants, and SBS’s interest In 2017, Bank of China reported the China Construction Bank (New Zealand) Limited 1.38% 1.48% -10 majority of survey participants. largest decrease in NIM of 74 bps as expense dropped back down from a Citibank, N.A. New Zealand Branch 1.69% 1.69% 0 The gains mentioned above peak in 2016. net interest income rose by 75.47% were somewhat offset by an ($2.27 million) while interest earning Commonwealth Bank of Australia New Zealand Banking Group 1.98% 2.14% -16 The financial performance of the increase in operating expenses assets grew by a monumental survey participants can be summarised Heartland Bank Limited 4.45% 4.79% -34 (including amortisation) of 2.50% 148.19% ($305.55 million) as the as follows: ($127.44 million). The main contributors bank continues to establish a rung Industrial and Commercial Bank of China (New Zealand) Limited 2.19% 0.89% 130 on the sector’s ladder. Conversely, to this increase were Kiwibank’s —— Net interest income grew by an JPMorgan Chase Bank, N.A. New Zealand Branch 1.25% 0.85% 40 $90.00 million software impairment additional $111.53 million (1.17%) to Industrial and Commercial Bank of (which is discussed in more detail reach $9.66 billion; China (ICBC) witnessed a 130 bps Kiwibank Limited 1.91% 2.07% -16 increase in their NIM in 2017, largely later) and a $38.30 million (1.42%) —— Non-interest income increased due to an astronomical increase Kookmin Bank Auckland Branch 1.25% 1.24% 1 increase in personnel expenses. by 10.05% ($268.66 million) to in net interest income of 170.54% Even though banks continue to Rabobank Nederland New Zealand Banking Group 2.08% 2.30% -22 $2.94 billion; ($10.34 million), an amount which focus on containing costs and —— Operating expenses (including is the largest percentage increase Southland Building Society 2.49% 2.72% -23 improving efficiencies as loan books amortisation) rose by 2.50% amongst all survey participants. In The Bank of Tokyo-Mitsubishi UFJ Limited – Auckland Branch 0.33% 0.37% -4 continue to expand, 75% of survey ($127.44 million) to $5.22 billion; continuation from 2016, Heartland has participants experienced a rise in the strongest NIM of 4.45% due to The Co-operative Bank 2.39% 2.71% -32 operating expenses. —— Impaired asset expense reduced by 61.34% ($281.93 million) to the niche market in which it operates, The Hongkong and Shanghai Banking Corporation Limited – New Zealand Branch 1.60% 1.85% -25 Net interest income rose slightly $177.67 million; particularly in the areas of reverse by 1.17% ($111.53 million), which mortgages, asset financing and TSB Bank Limited 2.01% 2.09% -8 —— Tax expense grew by was attributable to interest expense working capital markets. $179.57 million (9.76% to Westpac Banking Corporation New Zealand Banking Group 2.02% 2.12% -10 decreasing proportionally more $2.02 billion). Sector Average 2.08% 2.17% -9 than the decline in interest income.

With respect to the results of the Of the twenty banks surveyed, sixteen TABLE 4: REGISTERED BANKS – ANALYSIS OF New Zealand New Zealand All banks smaller banks, consistent with reported a decrease in funding costs incorporated banks branch banks PERFORMANCE OF BANKS the prior year, the Chinese banks as interest expense for the sector 2017 2016 2017 2016 2017 2016 During our interviews, Executives of posted the largest percentage-based reduced by 7.37% ($918.39 million), Increase in total tangible assets 2.13% 8.26% -0.96% -60.15% 1.42% 6.35% the smaller banks noted that, in the increases in loan book growth as they despite interest-bearing liabilities first half of the year particularly, the all continue to establish a foothold increasing by 5.96% ($23.67 billion). Increase in operating income 3.48% -1.69% -11.22% -39.48% 3.12% -2.13% major banks had appeared to be less in the local market by following This year, Executives remarked on the Increase in net profit after tax 8.66% -6.94% -32.97% -31.35% 7.35% -6.58% competitive in the lending market. aggressive business development reduction in funding costs and noted Increase in gross loans and advances 5.44% 9.23% 3.59% -39.20% 4.68% 8.04% Empirical evidence supports this claim, strategies. China Construction Bank that they had observed less pressure Net profit after tax/Average total tangible assets 1.06% 1.02% 0.77% 0.65% 1.04% 1.00% with the major banks accounting for reported the largest percentage on the funding side of the equation increase of 142.75% to bring its loan compared with that of previous years, Net profit after tax/Average equity 13.08% 12.67% 24.90% 15.95% 14.43% 13.96% 82.34% of the total loan growth for the year compared to 92.24% in the book to $745.16 million, followed particularly in the second half of Net interest income/Average total tangible assets 2.03% 2.09% 1.14% 0.71% 1.93% 1.98% prior year. The slowing lending growth by Bank of China which reported a the year. Non-interest income/Average total tangible assets 0.56% 0.54% 0.72% 0.48% 0.59% 0.55% in these banks’ lending is likely to 138.32% increase to bring its loan Operating expenses/Average total tangible assets 1.03% 1.04% 0.84% 0.47% 0.99% 0.99% be driven mainly by the Australian book value to $345.92 million. ICBC, which has been in the local market Operating expenses/Operating income 39.79% 39.54% 44.97% 39.75% 39.46% 39.25% parent banks reducing the level of funding provided to their New Zealand for a few years now, nevertheless still Impaired asset expense/Average gross loans and advances 0.05% 0.13% -0.02% -0.36% 0.04% 0.12% subsidiaries due to the changes to achieved a massive 84.81% increase Collectively, the five major banks had Collective provision/Net loans and advances 0.40% 0.43% 0.02% 0.05% 0.39% 0.41% capital requirements as set out in in loans, lifting its loan book to a level a $767.00 million decrease in interest expense despite increasing their Total provision for doubtful debts/Gross loans and advances 0.49% 0.54% 0.04% 0.06% 0.48% 0.53% the amended Australian Prudential of $704.38 million. Other non-major interest-bearing debt by $21.52 billion. Standards (APS) 110 Capital Adequacy banks remarked on the intensity The major banks that led the charge and APS 120 Securitisation. with which the Chinese banks have been competing. in the falling funding costs trend were Although 2017 did not bring with Of the non-major banks, Bank of ICBC’s sharp decline was due to a All five major banks reported increases Kiwibank, Westpac, and ANZ; these it quite as severe a drop in NIM as China, China Construction Bank, positive result in 2016 reversing to a in their loan books of between 1.05% banks reported decreases of 53 bps, what occurred in 2016 (in which NIM and Rabobank achieved the highest negative result in 2017; this downturn and 7.57%. For the second year in 45 bps and 40 bps, respectively. reduced by 11 bps), the trend of percentage increases in non-interest was driven by losses on held-for- a row, CBA recorded the largest decreasing yields has continued as income, reporting exceptional trading derivatives. dollar-value increase in gross loans In terms of gross loans and advances, Our analysis of the smaller banks’ more and more customers switch to surges of 785.86%, 451.56%, and and advances of $5.74 billion (7.57%), all of the big four banks held onto their results revealed a mixed bag. Some lower margin fixed-rate loans. Many 118.77%, respectively. Total assets a result which was attributable to respective market share rankings. of the smaller banks, like the Chinese With a market share of 29.61%, ANZ banks (which are ICBC, Bank of China executives remarked that interest This year, total assets for the banking home loans increasing by 7% while These significant increases in non- continues to dominate the lending and China Construction Bank) reported rates remain close to cyclical lows. sector have continued to grow, reaching business, commercial, and rural interest income are due to these banks 24 space, down from last year’s 30.67%. substantial increases in interest a new high of $504.19 billion. However, lending was up by 11% . moving from negative revaluations in While Westpac followed suit with expense and interest-bearing liabilities. Non-interest income this growth rate of 1.42% or $7.06 billion the 2016 survey to positive revaluations a decrease of 37 bps to 18.85%, Bank of China’s funding costs climbed In 2017, fifteen of the twenty survey during the year is down from the high in the 2017 survey. An analysis of the CBA and BNZ saw increases of higher by 155 bps as interest expense participants reported increases in growth rates seen in previous years financial statements of Bank of China 53 bps and 39 bps to 19.70% and rose by an astronomical 1,253.23% of 7.03% in 2016 and 10.09% in 2015. non-interest income resulting in revealed that non-interest income was Following CBA, BNZ reported growth ($6.22 million) on the back of sharply Gross loans and advances for the 19.33%, respectively. non-interest income rising by 10.05% powered by lending- and facility-related of $5.10 billion (6.81%) driven by larger customer deposits and amounts sector grew by 4.68% ($18.50 billion) to ($268.66 million) to reach $2.94 billion. fee income and foreign currency housing and business lending. ANZ, payable to other financial institutions. $413.96 billion. This growth is relatively Funding costs Driving this increase was favourable exchange gains. Rabobank’s financials the leader in terms of market-share, The annual change in interest expense low compared to last year’s growth of Funding costs (interest expense as valuation adjustments on financial tell a similar story. We note that, since reported the most modest percentage reported by the remaining minor banks 8.12%, and 2015’s growth of 7.07%. a ratio of average interest-bearing instruments and higher trading Bank of China and China Construction increase (1.05% or $1.27 billion) of all was tamer than that announced by the Of the twenty survey participants, liabilities) for the banking sector income, which have almost completely Bank are relatively new registered the major banks and an $8.38 billion Bank of China. five participants reported decreases declined by 40 bps, decreasing from reserved last year’s 13.98% banks, these increases are off a (5.13%) decrease in total assets. The in total assets including ANZ (-5.13%), 3.22% to 2.82%, a result which is the contraction in non-interest income. relatively small base. decline in ANZ’s total assets was not Rabobank (-1.23%), and The Hongkong lowest ever recorded in the history of due to a change in gross loans and The increase in non-interest income In contrast, another Chinese owned and Shanghai Banking Corporation this survey. advances, which actually remained was driven by the five major banks. bank ICBC, and The Bank of Tokyo- (HSBC) (-9.05%). Rabobank and HSBC relatively stable, but was mainly due to These banks all reported increases in Mitsubishi recorded the largest were the only survey participants to a decrease in derivative assets. non-interest income and collectively declines (in percentage terms) in observe reductions in the size of their contributed $214.00 million of the non-interest income of 222.26% and loan books. $286.66 million total increase. 43.75%, respectively.

TABLE 5: REGISTERED BANKS – NON-PERFORMING LOANS 2017 2016 2015 2014 TABLE 6: MAJOR BANKS – PERSONNEL COST

Past due assets to gross loans and advances 0.14% 0.13% 0.19% 0.19% Entity 2017 2016 Cost/ Cost/ Gross impaired assets to gross loans and advances 0.33% 0.37% 0.48% 0.66% Personnel Personnel Employee average Employee average cost cost Total 0.47% 0.50% 0.67% 0.85% numbers employees numbers employees $Million $Million $000's $000's ANZ 7,565 856 112 7,655 894 117 Competition within the local deposit With the exception of BNZ, all the BNZ 4,787 493 101 5,019 476 95 market will likely continue to intensify major banks reported reductions in CBA 4,717 509 107 4,770 502 105 as banks look to pursue cheaper collective provisions, contributing funding sources. However, the Kiwibank reported a significant a total movement of $87.00 million Kiwibank 1,493 141 97 1,410 122 87 small size of the deposit market in improvement, with a 154.55% which was offset by BNZ’s Westpac 4,332 482 112 4,267 465 109 New Zealand means that most banks ($17 million) decrease in impaired $34.00 million increase in collective will still need to rely on external asset expense resulting in a $6 million provisions. BNZ’s increase was sources of funding to some extent. recovery. This amount stemmed from driven by higher provisioning in the Whether that funding comes from an a $10 million reduction in collective residential mortgage and corporate Operating expenses CBA also reported a decrease in its overseas parent or from the wholesale impairment, across all segments. books; however, we note that BNZ Investment in new technology and operating expense ratio, as operating market will depend on the individual When looking at the ratio of impaired have early adopted NZ IFRS 9, an increased regulatory and personnel income rose by 3.10% with operating bank’s support network and may asset expense to gross loans and approach which will have had an costs as loan books continue to Personnel expenses also grew expenses remaining relatively flat with be influenced by recent changes advances, the sector reported a impact on their provisioning levels. grow led to a slight increase in the by 1.42% ($38.30 million), thus an increase of 0.25%. The big four to Australian prudential legislation, decrease of 8 bps to 0.04% (the Rabobank achieved strong reductions banking sector’s cost to income contributing to the relatively high banks continue to hold some of the specifically for the big four banks. lowest since 2007), as gross loans in specific provisions of 61.24% (operating expenses versus operating increase in operating expenses. lowest operating expense ratios in the and advances rose by 4.68%, while which were offset by a $19.59 million income) ratio. industry, ranging from 34.70% (CBA) (130.36%) increase in collective to 38.91% (Westpac). impaired asset expenses reduced In 2017, the cost to income ratio by 61.34%. provisioning due to challenging increased by 21 bps from 39.25% to Rabobank and The Bank of Tokyo- dairy conditions experienced in the 39.46%. Overall, the sector enjoyed Of the twenty survey participants, Mitsubishi recorded the best operating Total provisions as a percentage of 2016 season.25 Asset quality average gross loans and advances a 3.12% ($381.04 million) increase eight participants recorded an increase expense ratios for the non-major banks at 38.17% and 18.01%, Although the banking sector has improved over the year, with a 5 bps in operating income. Nearly three- in their cost to income ratio. Kiwibank respectively. The impressive operating seen strong asset growth during the reduction to 0.49%. The overall quarters of this hike can be attributed reported the largest increase of all expense ratio realised by Rabobank year, Executives have continued to improvement in asset quality for the to the $268.66 million (10.05%) survey participants of 2,370 bps as is driven by the non-interest income stress that asset quality will not be banking sector is attributable to both increase in non-interest income. operating expense rose by 45.68% Conversely, operating expenses increase of $62.58 million, with a compromised to simply fulfil demand. specific provisioning, decreasing ($127.00 million). This increase was grew by 3.68% ($176.32 million), of by 15.18% ($58.18 million) to largely driven by the impairment predominantly recognised revaluation Asset quality for the sector has which a significant part correlate with discussed earlier while operating of hedging instruments. The Bank of $383.37 million; and collective There is an increase in past due assets significantly improved as evidenced Kiwibank’s $90.00 million impairment income rose proportionally less Tokyo-Mitsubishi continues to rely provisioning, reducing by 1.45% in the banking sector of 14.15% by the reduction in impaired asset loss relating to the information by 3.56% ($17.00 million). On the on its corporate-heavy client base ($23.79 million) to $1.61 billion. ($74.03 million) to $597.40 million. expense of $281.93 million (61.34%) technology (IT) modernisation project contrary, ANZ announced a 286 bps (who generate larger loans than retail Westpac recorded the largest While this is still relatively low to $177.67 million, as ten of the survey known as CoreMod. In a press release, (38.44% to 35.58%) decrease in clients) while also allowing the bank to decrease in specific provisioning of compared to historical levels, it is the participants reported reductions. the state-owned bank said that, due their operating expense ratio; they keep spending low. $57.00 million (118.75%) making up first increase since 2009, and may be a The big four Australian banks were to rapidly changing technology and noted that this decline was due to 97.97% of the total decline in specific lead indicator of increases in impaired The evolving technology required for key drivers for this movement. They customers’ preferences shifting their “strong team discipline, high provisioning, as corporate specific assets in the future. banks to stay competitive in a digital collectively reported a $336.00 million towards digital banking experiences, productivity and digital push”28, efforts provisions reduced by $59.00 million. market has affected the industry decrease in impaired asset expense, a review of the CoreMod project is which have ultimately decreased players in either two ways. Firstly, with with Westpac reporting a $149 million currently underway and that “while operating expenses (by 4.25%) while an increased level of cost developing reduction to reach a recovery of this review is being completed, a conserving customer satisfaction. the new technology required to $76 million. This result was aided by a decision has been made to impair the compete in the digital market; and recovery in the dairy sector together value of the work in progress which secondly, the efficiencies gained from with improvements in the corporate currently sits on the balance sheet as 26, 27 the lower variable costs involved in market segment. an intangible asset.” servicing the customer through the digital platforms.

Capital adequacy ratio Over the past year, we have seen TABLE 7: MAJOR BANKS – FUNDS MANAGEMENT ACTIVITIES In 2017, twelve survey participants some media attention around banks’ 2016–2017 capital adequacy ratios, specifically 2017 2016 reported increases in their total capital, Entity Movement in relation to Kiwibank and Westpac. $Million $Million and eleven banks reported increases % in their Tier 1 capital ratios. While the After scrutinising Kiwibank during the year, the RBNZ decided $250 million ANZ 28,490 7.57% 26,485 Chinese and Indian banks continue to establish a firmer footing in the sector worth of bonds issued by the bank BNZ 5,791 22.64% 4,722 than they previously had, leverage and did not qualify as capital, with the CBA 10,730 20.33% 8,917 liabilities will grow as loan books grow. subsequent adjustment impacting the bank’s capital adequacy ratios. Kiwibank 6,373 4.85% 6,078 As expected, the Indian banks, Bank of Baroda and Bank of India reported After the bank made changes to Westpac 11,979 11.27% 10,766 the largest reductions in their total address the RBNZ’s concerns, the Total 63,363 11.23% 56,968 capital ratios of 1,699 bps (to 77.21%) regulator issued a non-objection letter and 1,200 bps (to 58%), respectively. about the bonds. On the other hand, Despite these decreases, Bank of Westpac encountered some problems in relation to its capital modelling Return on equity/Return on The growth in ROE and ROA levels is Baroda and Bank of India continue to have the highest total capital which resulted in the bank breaching assets largely the result of NPAT increasing its conditions of registration and the by 7.35% ($335.11 million), while total adequacy ratios. The reductions of the The banking sector has enjoyed RBNZ embarking on an independent equity and assets grew proportionally capital ratios are driven by the banks growth in its return on equity (ROE) review of Westpac’s capital modelling. less at 3.17% ($1.12 billion) and continuing to lend out more of their in 2017 of 46 bps to 14.43%, thus How to deal with these types of 1.42%($7.06 billion) respectively. Going capital base. bouncing back from 2016’s drop of scenarios is discussed later in an forward, Executives have noted that 2.00%. Both CBA and ANZ increased Of the total capital ratios of the article from Ceri Horwill, a KPMG emphasis will be placed on continuing their ROE by 228 bps and 184 bps, major banks, CBA was the only bank Advisory Partner, on page 54. the improvement of the ROE and ROA respectively. ANZ’s press release to report a reduction of 10 bps (to by working to continue to clean up mentioned that “the strength in some 14.20%), while BNZ and Westpac loan books and contain costs. parts of the economy also meant saw the largest increases of 132 bps fewer bad loans”28, a development (to 13.36%) and 170 bps (to 14.80%). Despite this recent activity by the local which then resulted in a reduction in Funds under management Both ANZ and Kiwibank noted regulator, when comparing the capital impairment expense and provisioning The funds under management (FUM) increases of 50 bps to 14.80% and requirements imposed by the RBNZ levels. Whilst Westpac had a reduction of the major banks remained strong, 13.40%, respectively. to those imposed on Australian banks of 31 bps, three out of the biggest increasing by 11.23% ($6.40 billion) to New Zealand banks are still well by the Australian Prudential Regulation four banks experienced growth in their $63.36 billion (see Table 7). capitalised, as we expected. As Authority (APRA), the New Zealand ROE. Notably, HSBC and Kookmin Both BNZ and CBA continued to at 30 September 2017, RBNZ data capital ratios would be even higher Bank achieved the largest ROE ratios show the largest growth in FUM of shows that the locally incorporated if the calculations imposed by APRA of 116.60% and 103.99% as both 22.64% ($1.07 billion) and 20.33% banks common equity tier 1 (CET 1) were used showing the capital banks hold the lowest equity levels ($1.81 billion), respectively. capital ratio was 11.0%, and the Tier 1 position of the New Zealand banks is of all survey participants, noting that capital ratio was 13.26%, both figures even stronger when compared globally these banks are overseas branches ANZ still dominates the FUM being well above the minimum at face value. rather than locally incorporated subsector, and further increased their requirements of 4.5% for CET 1 and subsidiaries, and are thus not required managed funds by $2.01 billion to 6% for Tier 129. to hold capital. reach $28.49 billion this year. The key driver of the growth was attributed to ANZ’s own KiwiSaver fund, a fund which contributed $1.75 billion in FUM growth. In 2017, the return on assets (ROA) ratio for the sector increased by 3 bps Westpac’s FUM also grew by a to 1.04% off the back of a decrease of healthy 11.27% ($1.21 billion) as the 16 bps in 2016. bank’s retirement plans and its Term PIE Fund grew by $840 million and $381 million, respectively.

© 2018 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. © 2018 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. 30 | KPMG | FIPS 2017 FIPS 2017 | KPMG | 31 Analysis of annual results

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 2017 1 154,977 8,105 14.80 12.60 122,400 94,751 7,565 191 655 15.43 12.69 -5.13 Wellington Limited – New Zealand Banking Group 30-Sep 2016 1 163,358 7,819 14.30 11.80 121,129 89,768 7,655 215 666 -12.93 -10.19 7.35 31-Mar 2017 20 103 46 77.21 77.21 70 56 19 3 3 -34.48 -4.35 12.37 Bank of Baroda (New Zealand) Limited Auckland 31-Mar 2016 20 92 45 94.20 94.20 64 44 19 3 3 68.89 94.96 18.56 31-Dec 2017 17 515 55 12.74 12.74 346 214 36 0 0 73.63 73.53 146.95 Bank of China (New Zealand) Limited Auckland 31-Dec 2016 18 208 56 34.87 34.87 145 35 27 0 0 -655.08 -755.08 205.76 31-Mar 2017 19 121 53 58.00 58.00 88 24 12 3 0 23.72 24.37 18.96 Bank of India (New Zealand) Limited Auckland 31-Mar 2016 19 101 52 70.00 70.00 74 19 12 3 0 20.06 20.00 18.23 30-Sep 2017 3 95,038 6,664 13.36 12.41 79,920 56,131 4,787 160 548 2.63 3.84 2.94 Bank of New Zealand Auckland 30-Sep 2016 3 92,325 6,789 12.04 10.54 74,823 51,481 5,019 171 479 -12.04 -12.20 6.58 China Construction Bank (New Zealand) 31-Dec 2017 15 888 196 24.30 23.00 745 139 38 0 0 137.94 109.15 120.86 Auckland Limited 31-Dec 2016 17 402 53 14.00 14.00 307 97 32 0 0 -571.00 -572.97 335.24 31-Dec 2017 13 2,065 195 14.25 12.99 811 840 29 1 0 -2.46 -2.92 4.62 Citibank, N.A. New Zealand Branch Auckland 31-Dec 2016 13 1,974 195 15.44 14.17 755 1,064 29 1 0 -5.44 -3.91 -0.30 Commonwealth Bank of Australia 30-Jun 2017 4 92,505 4,679 14.20 12.10 81,494 54,713 4,717 124 440 10.24 9.97 7.81 Auckland New Zealand Banking Group 30-Jun 2016 4 85,804 5,174 14.30 12.30 75,757 50,892 4,770 134 431 4.25 4.57 6.90 30-Jun 2017 9 3,990 524 13.56 13.15 3,563 2,574 401 7 0 12.27 15.36 13.92 Heartland Bank Limited Auckland 30-Jun 2016 9 3,502 453 13.78 13.79 3,130 2,283 363 7 0 32.25 32.35 26.05 Industrial and Commercial Bank of China 31-Dec 2017 14 904 140 19.18 19.18 704 150 54 1 0 138.97 162.17 21.81 Auckland (New Zealand) Limited 31-Dec 2016 15 742 54 12.69 12.69 381 127 37 1 0 0.64 -0.82 10.63 JPMorgan Chase Bank, N.A. New Zealand 31-Dec 2017 16 845 0 14.62 14.20 101 236 15 0 0 36.92 34.28 -4.33 Wellington Branch 31-Dec 2016 14 883 0 14.12 13.54 93 193 11 0 0 -37.50 -34.65 -13.04 30-Jun 2017 5 20,616 1,380 13.40 12.30 17,849 15,904 1,493 253 237 -57.26 -49.47 6.50 Kiwibank Limited Wellington 30-Jun 2016 5 19,357 1,129 12.90 10.70 16,733 14,743 1,410 258 241 -2.36 -4.08 5.52 31-Dec 2017 18 394 3 16.32 14.83 169 190 14 1 0 11.11 10.92 -12.49 Kookmin Bank Auckland Branch Auckland 31-Dec 2016 16 450 3 16.01 13.74 122 207 13 1 0 -24.36 -24.78 20.19 Rabobank Nederland New Zealand Banking 31-Dec 2017 6 14,306 1,598 25.00 17.60 10,559 4,981 320 33 0 6.05 7.55 -1.23 Wellington Group 31-Dec 2016 6 14,485 1,480 23.20 16.40 10,642 4,767 319 33 0 -24.77 -23.87 6.86 31-Mar 2017 10 3,987 268 12.56 11. 74 3,429 2,945 480 16 0 37.43 32.18 17.02 Southland Building Society Invercargill 31-Mar 2016 10 3,408 235 13.76 12.50 2,889 2,703 447 16 0 2.76 0.32 19.13 The Bank of Tokyo-Mitsubishi UFJ Limited – 31-Mar 2017 11 3,560 143 15.28 12.70 3,113 219 17 1 0 -31.88 -34.39 12.36 Auckland Auckland Branch 31-Mar 2016 11 3,169 125 15.66 12.71 2,818 484 17 1 0 5,398.68 777.25 4.96 31-Mar 2017 12 2,363 171 16.90 14.00 2,107 2,035 313 34 0 0.74 10.52 15.80 The Co-operative Bank Wellington 31-Mar 2016 12 2,041 157 15.80 15.70 1,807 1,788 311 34 0 15.52 20.83 13.01 The Hongkong and Shanghai Banking 31-Dec 2017 8 5,071 10 19.00 17.20 3,448 3,118 214 1 0 -45.29 -44.96 -9.05 Auckland Corporation Limited – New Zealand Branch 31-Dec 2016 8 5,575 39 18.60 16.60 3,589 3,252 217 1 0 27.36 26.80 5.35 New 31-Mar 2017 7 6,803 588 14.60 14.60 4,680 6,157 440 26 40 -24.73 -23.80 5.84 TSB Bank Limited Plymouth 31-Mar 2016 7 6,427 554 14.52 14.52 3,848 5,813 388 26 45 141.26 152.81 8.71 Westpac Banking Corporation New Zealand 30-Sep 2017 2 95,141 7,306 14.80 12.70 77,983 58,405 4,332 169 611 9.97 10.71 2.49 Auckland Banking Group 30-Sep 2016 2 92,833 6,512 13.10 11.20 75,912 57,541 4,267 189 620 -4.27 -5.15 5.09 2017 504,192 32,124 n/a n/a 413,579 303,782 25,296 1,024 2,534 7.35 6.99 1.42 Bank Sector Total 2016 497,136 30,925 n/a n/a 395,020 287,303 25,363 1,094 2,485 -6.58 -5.74 6.35 * Total Assets = Total Assets - Goodwill - Other Intangibles

© 2018 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. © 2018 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. 32 | KPMG | FIPS 2017 FIPS 2017 | KPMG | 33 Analysis of annual results

Analysis of financial statements Credit quality measures Profitability measures Efficiency measures Individual Total Impaired Net provision provision Net Non- Net Collective asset profit Underlying Operating for for interest interest profit Operating Impaired Gross provision/ expense/ Total Net after profit/ expenses*/ Past due doubtful doubtful income/ Interest Interest income/ after Underlying expenses*/ Survey asset impaired Net loans Average operating profit tax/ Average Average Entity assets debts/ debts/ Average margin spread Average tax/ profit Operating year expense assets and gross income after tax Average total total $Million Gross Gross total % % total Average $Million income $Million $Million advances loans and $Million $Million total assets assets impaired loans and assets assets equity % % advances assets % % assets advances % % % % % % % Australia and New Zealand Banking Group 2017 60 205 361 42.66 0.35 0.48 0.05 3,994 1.93 2.17 1.84 0.58 1,780 15.84 1. 12 2,513 1.58 0.89 35.58 Limited – 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 2017 0 0 0 0.00 0.41 0.41 0.04 4 2.81 2.90 1.63 1.81 1 2.00 0.94 1 1.33 3.26 70.60 Bank of Baroda (New Zealand) Limited 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 2017 1 0 0 0.00 0.27 0.27 0.20 9 1.46 1.47 1.09 0.95 -2 -2.93 -0.45 -2 -0.51 2.79 115.45 Bank of China (New Zealand) Limited 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 2017 0 0 0 0.00 0.39 0.39 0.05 4 3.00 3.06 1.06 0.52 1 1. 74 0.83 1 1. 16 2.32 65.97 Bank of India (New Zealand) Limited 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 2017 83 150 250 40.80 0.60 0.73 0.11 2,315 1.91 2.10 1.78 0.56 937 13.44 1. 0 0 1,353 1.44 0.94 37.97 Bank of New Zealand 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 China Construction Bank (New Zealand) 2017 0 0 0 0.00 0.10 0.10 0.08 11 1.37 1.38 0.85 0.26 2 1.45 0.28 0 0.07 1.50 91.71 Limited 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 2017 0 0 0 0.00 0.00 0.00 0.00 47 1.67 1.69 1.54 0.67 19 10.00 0.96 27 1.34 1. 0 0 42.67 Citibank, N.A. New Zealand Branch 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 Commonwealth Bank of Australia 2017 66 96 384 14.32 0.32 0.39 0.08 2,297 1.94 1.98 1.64 0.64 1,001 19.07 1. 12 1,434 1.61 0.89 34.70 New Zealand Banking Group 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 2017 15 36 25 34.06 0.49 0.72 0.45 169 4.35 4.45 4.00 0.17 61 11.39 1.62 84 2.24 1.89 41.70 Heartland Bank Limited 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 Industrial and Commercial Bank of China 2017 3 0 0 0.00 0.58 0.58 0.52 16 1.99 2.19 1.95 -0.10 1 1. 18 0.14 2 0.22 1.33 70.16 (New Zealand) Limited 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 JPMorgan Chase Bank, N.A. New Zealand 2017 0 0 0 0.00 0.00 0.00 0.00 21 0.69 1.25 1. 12 1. 74 5 n/a 0.63 8 0.91 1.52 62.39 Branch 2016 0 0 0 0.00 0.00 0.00 0.00 17 0.57 0.85 0.72 1.23 4 n/a 0.42 6 0.62 1. 18 65.62 2017 -6 7 12 50.00 0.19 0.22 -0.03 494 1.84 1.91 1.50 0.63 53 4.22 0.27 95 0.48 2.03 81.98 Kiwibank Limited 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 2017 0 0 0 0.00 0.19 0.19 -0.13 7 1.24 1.25 1.24 0.53 3 103.99 0.76 5 1.07 0.75 42.27 Kookmin Bank Auckland Branch 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 Rabobank Nederland New Zealand 2017 16 8 131 3.25 0.33 0.37 0.16 306 2.06 2.08 1. 76 0.07 118 7.65 0.82 173 1.20 0.81 38.17 Banking Group 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 2017 11 2 8 37.76 0.53 0.62 0.34 123 2.45 2.49 2.26 0.89 27 10.66 0.74 37 1. 01 2.03 60.93 Southland Building Society 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 The Bank of Tokyo-Mitsubishi UFJ Limited – 2017 0 0 0 0.00 0.00 0.00 0.00 24 0.32 0.33 0.28 0.38 18 13.48 0.54 19 0.58 0.13 18.01 Auckland Branch 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 2017 2 6 2 30.35 0.18 0.20 0.11 73 2.36 2.39 1.97 0.95 10 6.31 0.47 18 0.81 2.40 72.46 The Co-operative Bank 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 Hongkong and Shanghai Banking 2017 -1 0 3 40.52 0.04 0.07 -0.04 124 1.52 1.60 1.50 0.81 46 116.60 0.87 66 1.23 1. 12 48.22 Corporation Limited – New Zealand Branch 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 2017 4 8 9 12.76 0.47 0.50 0.09 149 1.99 2.01 1.64 0.26 46 8.11 0.70 66 0.99 1.20 53.23 TSB Bank Limited 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 Westpac Banking Corporation 2017 -76 80 173 27.75 0.39 0.45 -0.10 2,413 1.90 2.02 1.61 0.66 1,059 14.25 1. 13 1,550 1.65 1. 0 0 38.91 New Zealand Banking Group 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 2017 178 597 1,357 28.25 0.39 0.48 0.04 12,600 1.93 2.08 1.73 0.59 5,188 14.43 1.04 7,450 1.49 0.99 39.46 Bank Sector Total 2016 460 523 1,464 30.16 0.41 0.53 0.12 12,219 1.98 2.17 1.78 0.55 4,833 13.96 1.00 6,963 1.44 0.99 39.25 * Operating Expenses = Total Expenses - Interest Expense - Loan Write Offs and Bad Debts - Abnormal Expenses. n/a = not available

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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 and investment properties and investment Balances with other banks investments in subsidiaries in subsidiaries investments Perpetual preference shares shares preference Perpetual Cash on hand, money at call money Cash on hand, and money market deposits market and money Balances with related parties parties Balances with related Balances with related parties parties Balances with related and balances with other banks Other equity/Cash flow hedge hedge Other equity/Cash flow Trading, investment securities, securities, investment Trading,

2017 Australia and New Zealand Banking Group Limited 30-Sep 4,114 14,146 7,251 121,968 2,722 367 3,275 4,342 158,185 94,751 2,192 27,999 7,341 9,587 2,375 2,627 146,872 8,044 11 146,872 48 3,210 11,313 – New Zealand Banking Group Bank of Baroda (New Zealand) Limited 31-Mar 26 0 0 70 5 0 0 1 103 56 0 0 0 1 0 0 57 40 0 57 40 6 46 Bank of China (New Zealand) Limited 31-Dec 166 0 0 345 0 1 0 3 515 214 25 0 0 215 0 5 460 63 5 460 63 -9 55 Bank of India (New Zealand) Limited 31-Mar 30 0 0 87 2 1 0 0 121 24 0 0 0 43 0 1 67 50 0 67 50 3 53 Bank of New Zealand 30-Sep 4,453 5,778 3,805 79,441 677 173 277 711 95,315 56,131 1,594 23,938 3,219 1,799 544 1,149 88,374 2,351 1,075 88,374 52 4,538 6,941 China Construction Bank (New Zealand) Limited 31-Dec 132 0 5 74 4 2 2 0 2 888 139 28 293 5 226 0 1 692 199 1 692 0 -4 196 Citibank, N.A. New Zealand Branch 31-Dec 531 0 0 811 208 1 0 515 2,065 840 4 0 0 1,021 0 5 1,871 29 33 1,871 0 132 195 Commonwealth Bank of Australia New Zealand 30-Jun 3,085 6,003 856 81,232 613 186 453 400 92,828 54,713 416 21,273 1,251 2,294 7,181 698 87,826 667 462 87,826 461 3,412 5,002 Banking Group Heartland Bank Limited 30-Jun 57 319 0 3,546 0 8 71 34 4,035 2,574 0 856 3 0 0 32 3,465 473 22 3,465 -1 98 570 Industrial and Commercial Bank of China 31-Dec 159 41 0 700 0 1 0 3 904 150 0 137 0 467 0 8 763 145 8 763 -5 0 140 (New Zealand) Limited JPMorgan Chase Bank, N.A. New Zealand Branch 31-Dec 214 161 0 101 102 0 1 267 846 236 0 71 0 184 0 354 846 3 352 846 0 0 0 Kiwibank Limited 30-Jun 692 1,474 370 17,815 80 28 97 60 20,616 15,904 59 2,258 416 91 405 103 19,236 737 94 19,236 -8 651 1,380 Kookmin Bank Auckland Branch 31-Dec 7 0 0 168 218 0 0 0 394 190 58 0 0 141 0 1 390 0 3 390 0 3 3 Rabobank Nederland New Zealand Banking Group 31-Dec 518 724 13 10,524 2,495 5 0 27 14,306 4,981 0 2,652 34 5,027 0 14 12,708 551 232 12,708 1 815 1,598 Southland Building Society 31-Mar 101 418 5 3,411 4 21 7 29 3,994 2,945 401 259 27 0 39 49 3,719 2 47 3,719 -2 277 275 The Bank of Tokyo-Mitsubishi UFJ Limited – 31-Mar 298 26 12 3,113 77 0 0 34 3,560 219 0 0 11 3,167 0 20 3,418 0 83 3,418 0 59 143 Auckland Branch The Co-operative Bank 31-Mar 225 6 3 2,103 0 6 15 5 2,364 2,035 0 134 8 0 0 17 2,193 1 16 2,193 -1 172 171 The Hongkong and Shanghai Banking Corporation 31-Dec 606 487 117 3,447 391 2 15 22 5,086 3,118 232 331 44 1,293 0 42 5,061 3 23 5,061 2 23 25 Limited – New Zealand Branch TSB Bank Limited 31-Mar 144 1,970 0 4,658 0 18 8 4 6,803 6,157 0 0 8 0 0 49 6,215 10 40 6,215 12 566 588 Westpac Banking Corporation New Zealand 30-Sep 2,232 8,036 3,420 77,681 2,623 146 665 863 95,666 58,405 1,043 17,322 3,475 3,646 2,822 1,122 87,835 143 2,040 87,835 -64 5,712 7,831 Banking Group Bank Sector Total 17,791 39,588 15,857 411,966 10,219 965 4,885 7,321 508,592 303,782 6,052 97,522 15,843 29,204 13,366 6,299 472,068 13,512 4,548 472,068 648 19,665 36,524

© 2018 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. © 2018 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. 36 | KPMG | FIPS 2017 FIPS 2017 | KPMG | 37 Analysis of annual results

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

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 75,492 677 187 449 408 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 Heartland Bank Limited 30-Jun 84 236 0 3,114 4,903 9 58 46 3,547 2,283 2,053 717 6 13,614 2,336 43 3,049 421 1,296 155,539 -2 79 498 Industrial and Commercial Bank of China 31-Dec 353 5 1 380 3 1 0 2 742 127 0 85 9 461 0 5 687 60 0 47 -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 25 224 1 54 0 412 884 0 3 152 63 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 1 49 113 616 1,129 Kookmin Bank Auckland Branch 31-Dec 22 4,703 7,319 121 306 0 216 0 450 207 117 22,753 7,786 122 542 1 447 35 3 85,536 2,351 0 3 Rabobank Nederland New Zealand Banking Group 31-Dec 293 645 22 10,627 2,839 5 0 53 14,485 4,767 15 3,120 27 5,023 0 68 13,005 551 204 349 0 725 1,480 Southland Building Society 31-Mar 77 401 4 2,873 2 24 5 28 3,412 2,703 150 199 42 684 39 39 3,172 0 7 1,779 -13 253 240 The Bank of Tokyo-Mitsubishi UFJ Limited – 31-Mar 227 27 11 2,818 66 0 449 19 3,169 484 452 18,527 9 2,549 5,134 1 3,044 51 83 80,630 1 41 125 Auckland Branch The Co-operative Bank 31-Mar 198 9 4 1,804 0 8 13 6 2,041 1,788 0 65 15 0 0 16 1,884 7 36 3,049 -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 54 687 1 0 54 Limited – New Zealand Branch TSB Bank Limited 31-Mar 118 2,449 0 3,830 177 19 4 7 6,427 5,813 0 224 11 54 0 49 5,873 10 411 884 15 530 554 Westpac Banking Corporation New Zealand 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 18,228 -105 5,086 7,037 Banking Group Bank Sector Total 16,364 43,159 38,294 393,383 17,374 997 5,658 4,156 501,614 287,303 7,560 135,553 41,598 45,843 17,412 5,142 466,211 13,018 4,518 348,163 3,037 17,857 35,403

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Size & strength measures Profitability measures Entity Entity 31 Dec 15 31 Mar 16 30 Jun 16 30 Sep 16 31 Dec 16 31 Mar 17 30 Jun 17 30 Sep 17 31 Dec 15 31 Mar 16 30 Jun 16 30 Sep 16 31 Dec 16 31 Mar 17 30 Jun 17 30 Sep 17

Total assets34 ($Million) Interest margin (%) ANZ 152,289 160,801 163,538 163,282 159,861 157,717 160,788 154,910 ANZ 2.22 2.18 2.24 2.17 2.18 2.14 2.14 2.18 BNZ30 86,819 89,913 91,906 92,325 93,906 93,775 95,063 95,038 BNZ30 2.21 2.21 2.15 2.12 2.07 1.98 2.06 2.21 CBA31 81,785 86,012 85,678 88,764 90,827 91,625 92,375 92,344 CBA31 2.12 2.09 2.22 2.04 1.97 1.91 1.92 1.99 Heartland Bank 3,290 3,334 3,489 3,595 3,755 3,829 3,963 4,151 Heartland Bank 5.18 4.58 4.53 4.46 4.44 4.35 4.54 4.49 Kiwibank 18,858 19,227 19,199 19,372 19,834 20,247 20,519 20,364 Kiwibank 2.07 1.98 2.02 1.96 1.92 1.82 1.95 1.95 SBS Bank 3,286 3,408 3,506 3,543 3,740 3,987 4,053 4,229 SBS Bank 2.63 2.61 2.57 2.63 2.60 2.38 2.43 2.52 The Co-operative Bank 1,971 2,029 2,109 2,179 2,257 2,349 2,434 2,512 The Co-operative Bank 2.71 2.61 2.51 2.46 2.39 2.25 2.22 2.24 TSB Bank32 6,299 6,424 6,475 6,522 6,629 6,794 6,949 7,062 TSB Bank32 2.08 2.03 2.02 2.12 2.18 1.80 1.82 1.84 Westpac 88,416 90,309 91,518 92,708 95,903 91,883 93,564 95,001 Westpac 2.17 2.11 2.12 2.08 2.03 1.86 2.03 2.16 Total 443,014 461,455 467,418 472,291 476,711 472,206 479,709 475,612 Average 2.21 2.17 2.20 2.13 2.10 2.01 2.07 2.15 Increase in gross loans and advances (%) Non-interest income/Total tangible assets (%) ANZ 1.51 1.47 1.94 0.43 0.99 0.90 0.93 0.64 ANZ 0.33 0.77 0.62 0.37 0.48 0.63 0.46 0.73 BNZ30 2.35 2.24 1.80 2.46 2.08 1. 19 1.86 1.09 BNZ30 0.42 0.71 0.59 0.56 0.58 0.35 0.74 0.54 CBA31 2.53 1.87 2.38 3.43 1.58 1.06 1.37 0.82 CBA31 0.77 0.57 0.47 0.62 0.66 0.63 0.62 0.64 Heartland Bank 22.19 3.02 3.29 4.01 2.93 3.62 2.64 3.78 Heartland Bank 0.89 0.45 0.45 0.26 0.49 0.37 0.31 0.18 Kiwibank 2.51 0.53 1.55 1. 74 2.59 2.25 -0.08 0.21 Kiwibank 0.62 0.55 0.46 0.56 0.80 0.52 0.67 0.59 SBS Bank 2.04 2.67 3.19 3.15 6.06 5.10 3.45 4.53 SBS Bank 1.03 0.97 1. 0 0 1. 0 0 0.93 0.79 0.77 0.78 The Co-operative Bank 4.23 2.87 4.01 4.97 3.69 3.00 3.25 2.00 The Co-operative Bank 1.02 0.64 0.94 0.98 0.97 0.58 0.96 0.85 TSB Bank32 4.57 2.80 3.26 5.32 6.70 4.79 2.97 4.16 TSB Bank32 0.20 0.21 0.21 0.35 0.27 0.21 0.25 0.80 Westpac 1.38 2.22 2.88 1.86 0.71 1.03 0.69 0.20 Westpac 0.63 0.62 0.65 0.71 0.67 0.69 0.73 0.58 Average 2.09 1.85 2.22 1.91 1.48 1.19 1.18 0.77 Average 0.51 0.67 0.58 0.53 0.59 0.58 0.61 0.64 Capital adequacy (%) Impaired asset expense/Average gross loans and advances (%) ANZ33 13.30 13.70 14.40 14.30 14.00 14.50 14.20 14.80 ANZ 0.09 0.08 0.18 0.14 0.12 0.01 0.04 0.03 BNZ30 13.26 12.58 12.48 12.04 13.09 13.29 12.79 13.32 BNZ30 0.22 0.23 0.15 0.08 0.11 0.12 -0.01 0.21 CBA31, 33 14.10 13.70 14.30 12.70 13.70 13.80 14.20 14.10 CBA31 0.14 0.17 0.31 0.12 0.10 0.05 0.06 -0.08 Heartland Bank 14.46 14.01 13.78 12.71 12.96 13.19 13.56 13.04 Heartland Bank 0.34 0.41 0.63 0.49 0.36 0.46 0.47 0.56 Kiwibank 12.80 12.90 12.90 12.80 13.40 13.50 13.40 16.00 Kiwibank 0.07 0.10 0.02 0.00 -0.05 0.05 -0.13 0.25 SBS Bank 14.27 13.76 13.50 13.63 13.27 12.56 11.91 11.35 SBS Bank 0.33 0.67 0.21 0.44 0.40 0.33 0.30 0.32 The Co-operative Bank 15.80 15.80 15.50 16.10 17.50 16.90 16.60 16.60 The Co-operative Bank 0.08 0.05 0.08 0.16 0.10 0.11 0.11 0.10 TSB Bank32 14.86 14.52 14.62 14.59 14.65 14.60 14.85 14.55 TSB Bank32 0.08 0.31 0.07 0.12 0.13 0.06 0.08 0.06 Westpac33 13.90 14.00 14.00 13.10 13.40 14.00 14.00 14.80 Westpac -0.01 0.06 0.02 0.32 -0.19 0.01 -0.07 -0.14 Average 0.11 0.13 0.16 0.16 0.05 0.05 0.01 0.03 Net profit ($Million) Operating expenses/Operating income (%) ANZ 347 416 430 349 403 466 406 505 ANZ 43.30 42.41 36.61 43.98 38.24 35.67 39.28 34.30 BNZ30 192 259 229 233 223 193 276 245 BNZ30 42.26 34.94 39.69 40.28 42.11 42.91 38.65 37.99 CBA31 243 220 211 245 253 255 248 292 CBA31 36.76 37.98 37.66 36.03 36.32 36.25 38.02 35.00 Heartland Bank 15 14 15 14 15 16 16 16 Heartland Bank 49.59 43.96 42.55 46.95 43.43 41.23 42.93 43.70 Kiwibank 38 29 24 28 35 22 -32 14 Kiwibank 59.35 62.39 71.30 67.80 64.62 73.04 138.17 78.74 SBS Bank 5 6 7 7 6 6 7 6 SBS Bank 70.22 57.43 60.30 59.65 62.30 62.36 60.78 67.09 The Co-operative Bank 3 2 2 3 3 2 3 3 The Co-operative Bank 73.38 81.41 80.27 75.07 72.22 79.33 76.96 74.55 TSB Bank32 13 10 14 14 14 5 11 17 TSB Bank32 47.83 51.65 45.26 47.36 48.60 77.37 55.00 47.54 Westpac 251 239 249 224 285 237 255 282 Westpac 40.48 40.80 41.25 38.92 40.69 42.26 43.81 40.03 Total 1,107 1,195 1,181 1,117 1,237 1,202 1,190 1,380 Average 42.52 41.07 40.33 42.07 40.93 40.92 44.82 38.96

MAJOR BANKS: NET PROFIT $MILLION MAJOR BANKS: % 23 600 26 NON-INTEREST INCOME/ 0.90 TOTAL ASSETS 0.80 500 ANZ ANZ 0.70 BNZ 400 BNZ 0.60 CBA CBA 300 0.50 KIWIBANK KIWIBANK

WESTPAC 200 WESTPAC 0.40

0.30 100 0.20 0 0.10

-100 0.00 DEC 15 MAR 16 JUN 16 SEP 16 DEC 16 MAR 17 JUN 17 SEP 17 DEC 15 MAR 16 JUN 16 SEP 16 DEC 16 MAR 17 JUN 17 SEP 17

MAJOR BANKS: INTEREST % MAJOR BANKS: % 24 MARGIN 2.50 27 OPERATING EXPENSES/ 150 OPERATING INCOME 2.40 130 ANZ ANZ 2.30 BNZ BNZ 110 CBA 2.20 CBA

KIWIBANK KIWIBANK 2.10 90 WESTPAC WESTPAC 2.00 70 1.90 50 1.80

1.70 30 DEC 15 MAR 16 JUN 16 SEP 16 DEC 16 MAR 17 JUN 17 SEP 17 DEC 15 MAR 16 JUN 16 SEP 16 DEC 16 MAR 17 JUN 17 SEP 17

MAJOR BANKS: INCREASE % MAJOR BANKS: IMPAIRED % 25 IN GROSS LOANS AND 4.00 28 ASSET EXPENSE/AVERAGE 0.40 ADVANCES GROSS LOANS AND ADVANCES 3.50 0.30 ANZ ANZ 3.00 BNZ BNZ 0.20 2.50 CBA CBA 2.00 0.10 KIWIBANK KIWIBANK

WESTPAC 1.50 WESTPAC 0.00

1.00 -0.10 0.50 -0.20 0.00

-0.50 -0.30 DEC 15 MAR 16 JUN 16 SEP 16 DEC 16 MAR 17 JUN 17 SEP 17 DEC 15 MAR 16 JUN 16 SEP 16 DEC 16 MAR 17 JUN 17 SEP 17

© 2018 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. © 2018 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. 42 | KPMG | FIPS 2017 FIPS 2017 | KPMG | 43 Getting practical with blockchain

There are two blockchain Bill Gates is attributed with the quote, These issues are valid but should be 2. Commercial phase: There stories. The first, is the “We always overestimate the change There has been significant hype considered in context. For example, have been extensive pilots that will occur in the next two years around blockchain. where the use case delivers benefits and continued development cryptocurrency story. The and underestimate the change that will in process improvement within the during 2017, and over the next media focus has been on occur in the next ten. Don’t let yourself organisation, it is likely that DLT is 12 to 24 months this work will be lulled into inaction.” There are DLT implementations that not required or the best fit. That said, move into the commercial and the highly volatile values for are extending beyond the pilot phase, there are multiple use cases where production phase. Respected IT Analyst, Gartner Inc., has Bitcoin, Ethereum, Ripple with perhaps the highest profile is the the benefits can only be delivered a model which supports the Bill Gates 3. It can enable future competitive Australian Stock Exchange (ASX) plan through DLT. and others. Cryptocurrencies quote. It is the Gartner Hype Cycle for advantage: Blockchain investments to replace CHESS with a DLT post- Emerging Technologies which tracks The performance and resource issues may not be paying massive returns can be seen as the first trade settlement and clearing system new technology through five stages relate more to public blockchains yet, but they are allowing some from Digital Asset. blockchain application including Inflated Expectations and where anyone can join or run a node firms to create the right platform and their evolution will a period of Disillusionment. The In the Media Release announcing the and anyone can participate in the for future growth. The adoption of be fascinating. hype around emerging technology decision, the ASX Managing Director consensus process. The majority of blockchain and DLT should unlock is often about creating media and CEO Dominic Stevens is quoted commercial applications will run on a unprecedented business flexibility, interest and developing funding for as saying “we believe that using DLT permissioned blockchain, operated by improved efficiency and new The second story is the capabilities that could be leveraged Mike Clarke start-up organisations who work in to replace CHESS will enable our known entities, with the capability to identify the nodes that can control and to rapidly respond to changing Partner – Head of IT Advisory use of blockchain (or these technologies. customers to develop new services update the ledger, and even have ways market dynamics and competition KPMG other Distributed Ledger and reduce their costs”. to control who can issue transactions. in the future. The cost reduction theme is Technology, or DLT) as Permissioned blockchains will reduce 4. It is likely to disrupt the value supported by a research paper issued the performance and resource issues, chain: Blockchain has the potential the core tech of industry by Accenture in conjunction with There has been significant hype and ongoing development is underway to add significant value – by applications. The difference McLagan, a business unit of Aon around blockchain, with the majority of from technology, commercial and improving confidence between PLC35. The research shows significant between these new media and BBQ conversations being academic organisations. parties, reducing friction in the value cost reductions from use of DLT in applications and traditional around cryptocurrencies, particularly chain and speeding up complicated Bitcoin. Less publicly, there has been Investment Banks across middle and While organisations seek competitive back office functions. advantage, there is significant inter-party processes. But it will legacy applications is that industry hype around commercial also mean the disintermediation applications built on blockchain. collaboration in the blockchain DLTs provide a trustworthy space with more than 30 banks (or, more likely a refocusing) of service to a group of There are examples of pilots in participating in the R3 Consortium, certain players in the value chain. multiple industries including: other banks in the Digital Trade Chain, Players should be sizing up their computers (nodes) that do Critics of DLT will point to the following future position and managers —— Freight and Logistics (covering Bills and up to 20 insurance companies not fully trust each other. issues as reasons to stand back: participating in the B3i Blockchain should be reassessing their value of Lading and Trade Finance); chains. Certain players, such as the With DLT, several users can —— The same benefits can be delivered Insurance consortium. —— AgriBusiness (Product Provenance transfer agents and the clearing from traditional systems and do write entries into a block or a and Traceability); Five reasons to consider expanding and settlement houses, will need not need DLT. record of information, and a —— Insurance (Automated Claims your blockchain and DLT initiatives to address their future in the value —— With the required consensus through Smart Contracts); in 2018. chain and migrate to a new model. community can control how mechanism, the solutions are too 5. Involvement: Some emerging the record of information is —— Utilities (peer-to-peer power slow for real-time transactions. 1. It is rapidly becoming the trading); and underlying approach of the global technologies are developed by —— The consensus mechanisms modified and updated. —— Government (Identity, Asset system infrastructure: More than a small number of organisations consume significant computing a single solution or technology, whereas blockchain has Tracking and the potential for and electricity resources which are eVoting). blockchain and DLT technologies widespread involvement from difficult to justify. essentially connect together to form technology, commercial and In the Financial Services sector, there —— To be effective, DLT is a network a new type of market infrastructure academic organisations. The are also a number of advanced pilots solution and organisations will be that sits in top of – and integrates Banking and Insurance consortia including automating bank guarantees reluctant to work together. into – existing systems and include the largest global players as used in commercial property —— The tech talent is scarce. processes. And in doing so, it is from those sectors. The Open leasing, and cross-border payments quickly penetrating and changing Source nature of blockchain using Ripple Labs network as an the way firms, regulators, investors developments means that there alternative to SWIFT. and managers communicate and is more collaboration, resulting in share data. rapid enhancement.

Some definitions Distributed Ledger Technologies (DLT) Distributed Ledgers are basically decentralised, shared, distributed and synchronised databases spread across multiple locations. DLTs leverage the cloud to allow parties in a value chain or ecosystem to share data securely in near real-time, thereby opening up new opportunities for peer-to-peer collaboration and transactions.

Blockchain Blockchain shot to fame as the distributed database behind the digital currently, Bitcoin. But it is just one of many different types of DLT platforms now in operation. While people tend to use the term blockchain as a synonym for DLT, it is important to remember that the DLT ecosystem is much broader than one technology or platform.

Smart contracts Smart contracts are standardised, fully- automated, and autonomous financial instruments that facilitate, verify and enforce attributes of a contract according to predetermined scenarios. Underpinned by DLT technology, smart contracts ensure that agreements are fulfilled by all parties, automatically and in near real-time.

© 2018 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. © 2018 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. 46 | KPMG | FIPS 2017 FIPS 2017 | KPMG | 47 Conduct, robo-advice and good client outcomes

No matter how financial A new code of conduct for FMA exemption available for advice is delivered, all financial advice activities early adopters good conduct principles A new universal code of conduct Prior to the start of the new regime will be developed that will apply and the publication of the new code apply. Although robo- to all financial advice provided to of conduct, FMA has also recently advice will improve the retail clients (the current code of consulted on an exemption to enable conduct applies only to Authorised firms to offer personalised financial access to financial advice Financial Advisers). advice or an investment planning for New Zealanders, service to retail clients using a digital To expedite development of the new advice service. The exemption and providers will need to code of conduct, a Ministerial working application process are expected to be group was appointed to develop the design their service to finalised in the first quarter of 2018. consistently support good code before the new regime comes into effect allowing the code of client outcomes. conduct to be developed in tandem Robo-advice brings benefits with the legislative process. While this and opportunities for approach is innovative, given the tight providers and consumers Beckie Vanderbom legislative timetable, it means that This new distribution channel provides Associate Director, firms are developing new technologies an excellent opportunity for providers Financial Risk Management Why now? to provide financial advice without to connect with prospective clients KPMG In late 2014, as part of the statutory knowing what the future code of for whom their branding or services review cycle, the Ministry of Business, conduct will require. may not have previously appealed. Client preferences are changing, a Innovation and Employment (MBIE) See Table 8 on page 49. began a review of the Financial phenomenon which presents new Advisers Act 2008 (FAA). As part of the opportunities to rebrand, or create new process they consulted with industry, The robo-adviser will be subject to or sub brands to appeal to different consumers and other stakeholders, the same standards as a human. demographics. This is particularly true a process which culminated in for firms who wish to grow their client the Financial Services Legislation base across client segments. Robo- Amendment Bill (currently at select The working group is expected to have advice is likely to be most popular with committee stage). produced a draft code of conduct by Millennials who have grown up with, August 2018 which will be delivery and generally express a preference for, Here is a list of the following key digital engagement. Baby Boomers, on changes in the proposed regime: agnostic – i.e. it will apply equally no matter what the delivery method of the other hand, are more familiar with, —— the definition of financial advice the financial advice is. Put another and arguably feel more comfortable has been broadened; way, the robo-adviser will be subject with, face-to-face business interactions with a trusted human adviser. —— the categorisation of products has to the same standards as a human. been removed; This development is interesting as traditionally, conduct is associated —— the distinction between Baby Boomers … arguably feel with human behaviour. Good conduct personalised and class advice has more comfortable with, face-to-face is the essence and spirit in which a been removed; and business interactions with a trusted provider or adviser interacts with their human adviser. —— the requirement for personalised client. It is driven by sound intentions financial advice to be provided and a desire for a good client by a human adviser has been outcome. However, since conduct is Robo-advice also offers the benefit of removed; this removal allows the difficult to measure because, by its a cost-effective, lean operating model. introduction of robo-advice into nature, it is not simple to quantify, So long as the service is meeting all New Zealand. robo-advice providers will need to regulatory requirements, robo-advice design and maintain their services to can be provided with fewer resources, consistently deliver a positive human thus reducing set-up and ongoing behavioural trait. operational costs.

This benefit potentially allows for Since digital advice will be a new TABLE 8: MBIE – CONSULTATION PAPER – NEW FINANCIAL ADVICE REGIME36 firms to offer lower-cost services than —— How do we deal with ongoing concept for most consumers, when possible under a traditional advice client relationships? developing their robo-advice services, Code of Conduct 2017 model. A further gain for consumers —— Is the solution likely to expose firms will need to consider where, and —— Code Working Group appointed in early-mid 2017 to develop a Code of of a lower-cost model is that advice the firm to future risk? How how, appropriate disclosures should Code Working Group appointed Early- Conduct before the Act comes into force. can be offered in areas where it can this be mitigated? be made to ensure clients understand mid was previously not cost effective for all aspects of an automated service, Bill introduced —— Will provide industry with more certainty about the requirements sooner, providers, notably for KiwiSaver. and the nature and scope of the advice Mid alleviating anxiety about any changes. Despite the potential opportunities they are receiving. —— Means most elements of the new regime will be able to take effect sooner. The introduction of robo-advice into offered, there is uncertainty in 2018 New Zealand will also increase choice rolling out a new distribution channel Those designing their services with Transitional licensing for consumers, not only because without a clear understanding of all conduct principles front of mind it encourages domestic fintech the regulatory requirements in the will be considering how they can Code of Conduct approved Aug —— All existing industry participants innovation, but also because we new regime since the new code of challenge a client when necessary to Transitional licence applications must be licensed within are likely to see overseas entities conduct is still under development. ensure the client has an appropriate open six months of the approval of the accessing the market. In a more Being first to market can provide understanding of, and is engaged with, 2019 Code of Conduct. competitive market, good client a competitive edge, which means the advice process. A human adviser —— Relatively easy process vis-á-vis experience acts as a differentiator that entities taking advantage of the has the benefit of being able to detect Existing industry participants Feb the full licensing requirements. must be transitionally licensed to retain existing clients and attract proposed FMA exemption will need changes in tone of voice, hesitation, —— Brings existing industry New regime takes effect new ones. to consider whether their robo-advice or body language that may indicate a participants into the new regime offerings are likely to meet the new client does not understand or needs (including new Code of Conduct Full licensing and new adviser designations) quickly – subject to new Code code of conduct, and how they might further explanation. How will a provider Care, attention, and planning with a competency safe harbour of Conduct and enforcement —— Existing industry participants be able to introduce some future in the design stage of the deal with clients for whom robo-advice Full licence applications open measures. will have two years from the proofing to minimise the number of is either not suitable, those with a time transitional licensing takes robo-advice solution are —— Option of competency safe changes required. lower level of financial literacy or those effect to be operating under a full crucial harbour but must limit their that vulnerable? licence. Given FMA’s focus on improving the services to those they are Key conduct considerations for conduct of the financial services Capability is an important currently able to provide. —— Full licensing will be a more robo-advice solutions 2020 comprehensive process than the providers it regulates, robo-advice consideration. Providers will need —— Gives FMA and education transitional licensing process, but services will need to be designed to to have people with the right skills providers time to better will also be flexible and depend —— Is robo-advice suitable for our be able to demonstrate not only that and experience to ensure clients anticipate licensing, training and on factors such as the nature and company’s client base, product they consistently support and deliver are receiving consistently high compliance requirements. range and service proposition? good consumer outcomes, but also quality advice that provides them size of the firm and the services 2021 —— Will make transition to full licence that the client’s interests are actively with a suitable recommendation. it provides. —— Layout and design are smoother and more manageable taken into account. Firms will need to Well prepared firms will be giving Transitional licences expire Feb —— Competency safe harbour appropriate for the target for industry. market. Attention has been be able to articulate how they know thought to the robustness of testing, Everyone must be fully licensed will cease and all industry Competency safe harbour ceases given to textual statements that their service is fulfilling good monitoring and quality assurance. participants will be required to and language used is well conduct principles. The approach They will also be considering how meet the competency standards worded, clear and suitable for taken by a vertically integrated firm the application of competence, in the Code of Conduct. to conduct principles will be different knowledge, and skills might be applied the typical investor profile. Key from one employed by a provider who to an automated service, and whether —— Has adequate consideration only offers robo-advice. it will need to change under the Code of Conduct been given to how and when new regime. Legislation and regulations disclosure is made? Vertically integrated firms will have Transitional licensing the additional challenges of potentially Given the pace of technological —— How do we ensure that clients Full licensing are sufficiently engaged conflicted conduct and conflicted change, and the generational remuneration to turn their minds to. movement in client engagement with the solution to support SOURCE: MBIE – CONSULTATION PAPER – NEW FINANCIAL ADVICE REGIME (PAGE 54) consistently good outcomes Conflict management procedures preferences, we expect to see digital for them? will need to be designed to show strategy becoming an important consideration for client interests. consideration for financial advice —— How can risk profiling be Providers will need to think about providers. Conduct that supports tailored for an automated how to design advice processes and good consumer outcomes and client- experience? any incentives for partially automated centricity will need to be integral parts services appropriately. of that strategy.

© 2018 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. © 2018 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. 50 | KPMG | FIPS 2017 FIPS 2017 | KPMG | 51 Revolutionising the banking eco ‑system

The Open Banking Implementation A world in which What is Open Banking and Banks Consumers Other Providers why now? Entity, created by the CMA (and organisations share customer funded by industry participants), Open Banking is a collaborative model —— Speed and efficiency —— More effective —— Better and more cost information with one another has been working with industry in which consumers are able to have in serving its use of financial effective data access stakeholders to create software securely and with ease is greater access and control over their customers; for management apps has the potential to standards and industry guidelines to own banking data. Consumers will example, on-the-spot with real-live data decrease barriers on the horizon. You will have enable Open Banking to be rolled out be able to direct banks, through lending approvals and the ability to to entry for new from early 2018 (on a managed roll seen the myriad of news giving explicit consent, to provide —— Provide support obtain financial providers out basis). items in 2017 talking to information directly to them or to share for embedding advice to help better —— Opportunity to this very development and the information with third parties in a Closely coupled with the UK’s Open responsible lending manage your money partner with standardised and secure way. Banking Standard is the European practices with —— Ability to assess incumbent banks to how this will change the Union’s Second Payment Services access to all financial options when provide innovative landscape for customers Directive (PSD2). This new legislation relationships, looking at new solutions, obtain in choice and control. And Open Banking is a collaborative came into force in January 2018, spending patterns financial products investment for model in which consumers are able mandating for more open data – that and financial and understand future development where is this change first to have greater access and control is banks must provide access to behaviour which one works and access to a over their own banking data. Nicola Raynes going to land? Given the customer information to other financial —— Ability to innovate best for you wider population of Director – Financial Services quantum of information and payment institutions. more products —— Having a single- consumers KPMG and services that view platform and data the banking An Open Banking regime paves the Closer to home, the Australian government announced in its 2017- consumers want of all financial sector holds as custodian way for a new eco-system in financial and need; for relationships services, one that transcends the 2018 budget the introduction of . of consumer finances, it Open Banking, following a number of example, budgeting —— Access to debt traditional banking and payments and financial is the first logical place to infrastructure. Disrupters in the market reviews undertaken in previous years management tools into data access and competition. management tools that will help you start. We are talking about and global technology companies will exist alongside and in competition An independent review is being —— Opportunity to get through paying ‘Open Banking’ – a phrase with traditional banks through undertaken to assess the best partner with creative off your debt and you will hear more and more integrated application programming approach for implementing the regime. and disruptive avoid unnecessary Here in New Zealand, the government technology partners charges frequently as jurisdictions interfaces (API), ultimately providing consumers with more choice, control is yet to decide what path it will take, to really be more —— Cash flow get to grips with what the and efficiency. with the government asking Payments customer centric management for regime can do and how to NZ to report on how the industry will and tailor offerings businesses and But why is Open Banking getting so progress Open Banking. Payments to consumers potentially better approach its development much air time now? It centres on NZ is currently working on the API with predictive unsecured loan and implementation. increasing competition in banking, that connects organisations’ systems analytics and artificial terms allowing consumers greater control and will be running a pilot programme intelligence over their finances and improving for the API during 2018, of which the —— Lower cost of consumer inertia. banks are likely to participate. An distribution through update is required from Payments digital presence What have we seen so far? NZ in April 2018 and it is anticipated The United Kingdom (UK) has led the that Commerce and Consumer Affairs way. The Competition and Markets Minister Kris Faafoi will seek to move Authority (CMA) undertook a review quickly to establish a way forward. (beginning in 2013) into the supply of retail banking services to personal The potential impact customers and to small and medium- Just what Open Banking will mean for sized businesses, which concluded you will depend on whether you are that there was a need to improve a bank, a consumer or an alternative competition in retail banking and financial service provider. We have financial services. Open Banking outlined below just a few of the was one of the changes proposed to expected benefits this regime may increase competition. provide to each of these stakeholders.

And we cannot forget the real benefits —— Silo approach to implementation —— Targeted consumer campaigns this could create for improving – an industry-wide collaborative – there are concerns that with New Zealanders’ financial literacy. approach is required when the enhanced data sharing, There are concerns in New Zealand at New Zealand seeks to implement some parties may target certain the levels of financial literacy amongst Open Banking. It cannot just be the customers, e.g. those who take the population, and programmes large multi-national and challenger a long time to pay debt providing throughout the country, run by banks driving the regime approach, the potential for higher interest organisations community-wide, are with fintech companies, consumer income. This risk would be driving financial literacy initiatives. groups, regulators, government, mitigated by the Responsible Any tools that enable New Zealanders etc. also needing to be involved. Lending Code, financial markets to manage their money better are This will ensure that a standardised legislation and Conduct Risk welcomed, to help ensure people approach is developed for the principles banks are required (or are making appropriate financial entire eco-system. encouraged) to abide by. choices and planning for their and their —— Transparency for consumers – family’s future. the terms and conditions of data Open Banking will revolutionise the sharing need to be well developed provision of banking products and to ensure consumers understand Any tools that enable services. exactly what they are allowing to New Zealanders to manage their take place and are in a language money better are welcomed. that all consumers can understand. —— Scale of regulation – in developing It’s only the beginning an Open Banking regime, Open Banking will revolutionise the Real concerns with Open consideration is required on the provision of banking products and Banking scope and scale of regulation for services by breaking down consumer An Open Banking regime brings with all parties within the Open Banking inertia on changing banking service it a number of risks and challenges eco-system, particularly in respect suppliers and intensify competition that need to be fully mitigated and of providing financial advice, for customers. We already have addressed. We look at some of responsible lending, etc. comparison websites for insurance these below. —— Taking a pure compliance companies. Banks are already approach – ensuring compliance providing alert services for bill —— Data privacy and security – this with the new Open Banking and payments or potential limit breaches risk is not to be underestimated data privacy/cyber-standards is and are developing apps for financial and must be front and centre in paramount, but there is a risk management (think Westpac’s any development plan put in place. that banks do not adequately CashNav). But imagine a society Cyber risk is a ubiquitous risk that strategise for how they will defend where these services and more are is here to stay, thus data privacy their market positions from new the norm! and security protocols need to be competitors or innovate new well developed and maintained for This is only the beginning – the products and services alongside all parties in the Open Banking eco- opportunity for this type of data the compliance and technology system to adhere to. sharing across the entire economy development activity. There is a risk is exponential. Not only within —— ‘Turning off’ data – further to the that banks may lose their place in the financial services sector with above, there is real concern around the customer experience journey insurance and wealth management how consumers can ‘turn off’ their and the opportunity to be in front sectors – but utility companies, approval for data sharing (i.e. at the of consumers, and therefore this logistics, etc. … the opportunity is end of a contract or relationship) strategising is essential. and what happens to that data at endless. But it will be the banking the end of that relationship. sector that will lead the way.

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In the middle of a serious We frequently see banks using When done well, by someone —— Was there a single point or multiple They have experience of previous an ‘increasing concentric circles’ independent of the problem, with no points of responsibility? remediation, and build a pool of compliance breach, it’s hard type approach at the first stage of vested interest and the remit, ability knowledge to keep improving Building maturity around future to look beyond the immediate responding to an incident. Initial and appetite to ask the hard questions, responses and ensure that responses remediation response is equally efforts are focussed on remediating root cause analysis can offer real are consistent and proportionate. response to ‘fix the problem’. important, as not all incidents can be the immediate issue – i.e. the circle insight into your business. Most importantly, where relevant, prevented and incident frequency But, given the volume and at the centre, but banks who do this they function as a customer advocate, The third stage, future proofing, can is increasing. At the lower end of complexity of compliance is well will then expand the circle and to give the customer the best vary extensively in scale and has two the maturity curve is the heroics/ look at possible wider impacts of the remediation experience so that they only heading in one direction main aspects; prevention of future firefighting approach, where immediate issue and identify and fix become an endorser of the bank’s incidents and moving up the maturity remediation is reactive. Costs are high, – it’s time to accept that there any issues in those. Finally, they will response, not a detractor. curve of remediation. methodology is manual and frequent extend the circle wider again and will be a ‘next time’, and rework required. Customer experience Even if you don’t take it as far as consider areas not impacted by the work out how to get beyond is poor and detracts from trust. At a remediation hub, its worthwhile immediate issue, but facing the same Future proofing, can vary the other end of the spectrum is a taking the time out to regroup after an crisis management. challenges or using similar approaches, extensively in scale. proactive approach, using standardised incident and consider what you could or systems or shared resources. policy tools and approaches, do differently or better next time. For Lateral thinking to bridge the gap automation and leveraging previous example, you could consider whether Ceri Horwill between circle two and three is where Thinking about prevention of future knowledge and experience. the following are appropriate: Partner – Advisory the smarts are. The idea is to figure out KPMG Our banking industry is facing ongoing incidents can feel intangible and challenges around compliance. what areas could have a similar issue futile when the energy is needed in —— Develop a policy on incident Whether that’s compliance with and extend the review into that area the immediate incident response, The theory is that if you invest time response and put your learnings prudential requirements, Commerce without taking it too far and looking for and money into fixing a problem into it. . so is generally thought about shortly Commission, AML, internal limits, problems which don’t exist. Areas to afterwards. A good start is to identify once, then can’t you learn from —— Identify and make accessible the policy or methodology, or compliance be considered might be similar areas the learnings from the root cause what you did and apply it next time. people who gained the knowledge with general laws and regulation. run by the same team, areas of similar analysis and look for factors that this time and look at making them complexity, similar data or models could have stopped the current available as a ‘support group’ for being used, similar history or a build-up incident or identified it earlier had The epitome of this approach, being future incidents. Our banking industry is facing of minor incidents. they been in place. Consider the developed by large banks in the —— Identify the early warnings ongoing challenges around During the second stage, the root following questions: UK and Australia, are remediation indicators that first alerted you to compliance. centres of excellence. These teams cause analysis, the bank needs to —— Did the incident occur when this issue, or that should have been have a clear mandate to proactively get behind the current view of the the business operated outside spotted, and share these to help incident and identify the layers upon identify and focus on resolving issues, people develop a sense for when In the middle of a response to an a framework or policy? If yes, layers of decisions that have led to the particularly resolving customer issues might need to be escalated. incident it feels like there is very little how was it circumvented; if no, incident. Most people follow an ‘ask issues and allowing customer trust positive that can come from it, and why wasn’t the risk captured by —— Identify the key dates, deadlines, why five times’ type approach and try to be regained. The theory is that very few decision points you have the framework? reporting and stakeholder not to jump to conclusions or become if you invest time and money into control over. Typically, the whole expectations that drove the wedded to one theory or solution that —— Had this area been looked at fixing a problem once, then can’t you team up to Executive level is caught majority of the effort. might not necessarily address the by second or third line? If not, learn from what you did and apply it up in reporting deadlines, regulator —— Develop some decisioning criteria whole problem. The other temptation why not; if yes, why wasn’t the next time. response and developing robust issue identified? for issue criticality and identify the solutions, with nobody truly free is to skip doing root cause analysis These centres of excellence are —— How familiar were your team right communication channels for to focus on what is actually a good at all because it seems obvious what essentially a group of people and with the legislation or regulation raising and resolving future issues. opportunity to learn. For example, went wrong, and there is a reticence resources that form a central hub for once you got into it? Do they risk appetite – is your compliance to start going over the area again with remediation. They build, collate, share For all the hard work and effort during need to be more familiar – is more risk appetite really as you’ve stated more people. This is an easy trap to and importantly re-use knowledge. an incident, there is a silver lining, training needed? it or has the incident challenged fall into, but causes of incidents are They are efficiently, expediently and which is that a successful response that? Are there opportunities to learn rarely what they most obviously look —— What is the rest of the world doing flexibly mobilised. They have the to an incident should bring your from mistakes or to identify areas like. Root causes can be a combination in the area where the incident right mandates already set up to team insight into how to respond to that are not working as well as they of cumulative decision making over occurred? Are you applying process and resolve issues quickly. future incidents and the foresight to should? Lastly, if the breach impacted many years, policy choices, investment best practice? They have strong visibility and prevent as many incidents as possible decisions (or lack thereof), cultural customers in some way, can you —— Are there others in the market recognition internally and ready-to-go in future. or behavioural norms or area of use the opportunity to communicate experiencing similar challenges – governance structures. weakness in the risk management proactively and turn the incident into a what can be learned from them? positive in your customer relationship? approach, among others.

© 2018 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. © 2018 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. 56 | KPMG | FIPS 2017 FIPS 2017 | KPMG | 57 New Zealand declares war on multinational financing arrangements

The winds of war —— require ‘exotic’ terms and conditions Those of us who thought the (including subordination and loan terms greater than five years) crackdown on multinationals was to be ignored when pricing something viewed only on our laptops an intercompany loan, unless and iPhones involving belligerents in these are features evident in the faraway jurisdictions like the US and borrower’s third party debt, or are Europe will be interested to learn that required for regulatory purposes. New Zealand has now joining the fray. During last year’s election campaign, The effect of these measures will be both Labour and National were clear to materially reduce the interest rate on that they would be tightening up acceptable on such borrowing for on the perceived avoidance of taxes many taxpayers. The new measures by multinational companies operating are intended to commence on in New Zealand. The Labour-led income years beginning on or after Government has made good on this 1 July 2018. Further, there will be no promise by introducing a Tax Bill in grand-parenting of existing loans – all cross border loans in place on or after Bruce Bernacchi Jordan Taylor December that will enact a range of measures aimed at shoring up the effective date will be impacted. Partner – Taxation Senior Manager – Taxation New Zealand’s international tax laws. The interest rate charged on every KPMG KPMG related party cross-border loan into Squarely in the firing line is the amount New Zealand therefore needs to of interest that multinationals can be re-evaluated to see whether charge on intercompany loans to the New Zealand borrower will risk their New Zealand operations. The having a portion of their interest proposed law contained in the Tax Bill deductions denied. are largely consistent with discussion papers released in February and Rebuttable presumption – a September 2017, despite a number bridge too far? of stakeholders raising a litany of The presumed credit rating of concerns. Multinationals now find New Zealand borrower (other than a themselves sitting on the cusp of financial institution) can rebutted, but significantly reduced levels of tax only if three criteria are met, which the deductible interest payments on Government views as being indicative intercompany borrowings by their of whether or not ‘tax structuring New Zealand operations. elements’ exist with the lending into New Zealand. If the presumption can Battle lines drawn be rebutted then a taxpayer is allow The Tax Bill will bring into force a to determine the interest rate under ‘restricted transfer pricing rule’ that a more traditional transfer pricing will significantly impact the amount of analysis (which allows taxpayers to interest that can be charged on related make interest deductions based on party debt for many multinationals. their standalone credit rating, and not the usually stronger parent rating). The Broadly, the new rules will: three criteria are: —— have a rebuttable presumption —— the interest income on the loan that a New Zealand borrower has a must be subject to tax in the credit rating one notch lower than lender’s jurisdiction at a rate the highest rated member of the greater than 15% (unless the multinational group; lender is the global parent entity); —— deem financial institutions (i.e. —— there must be a reasonable both bank and non-bank lenders) expectation that the New Zealand and insurers to have a credit rating borrower’s interest coverage ratio equal to the highest rated member (i.e. EBIT-to-interest expense) will of the multinational group; be above 3.3x; and

—— there must be a reasonable —— ignoring any other unusual terms, Also of concern is that the rules will expectation that the New Zealand such as deferral of interest leave New Zealand out of step with borrower’s thin capitalisation ratio payments, options which give rise international consensus. While the will be less than 40% or less than to premiums on interest rates and New Zealand side of the transaction 110% of its parent’s worldwide convertibility into equity. will mandate a much lower interest group’s ratio. rate, the lender jurisdiction will still The only exceptions are where such (reasonably might we add) expect You would be right to view this features are present in the borrower’s their taxpayer to return an arm’s presumption as hardly ‘rebuttable’ third party debt or are required for length level of interest income While the 15% tax requirement is regulatory purposes. reasonable, for many organisations the based on a traditional transfer pricing second and third criteria will be difficult principles. This of course raises the to meet. In our view these strict “The supreme art of war is to spectre of double taxation and trying criteria simply go too far. subdue the enemy without fighting” to resolve the issue via the multi- jurisdictional vortex that is Mutual ‘Talk to the hand’ Agreement Procedure. The situation for financial institutions All of this begs the question as to Finally, the Tax Bill also contains a and insurers is even tougher. Where a why these rules are being introduced. number of drafting weaknesses, which New Zealand entity is a New Zealand Fundamentally it all boils down to the will make applying the rules in practice registered bank, a licensed insurer, a fact that the Government believes that very difficult (if not impossible) for non-bank deposit-taker or a member in the majority of cases multinationals some taxpayers. For example, the of a corporate group whose main should not be able to charge more rules are unclear on what to do where business is the lending of funds, they than their global cost of funds to the an offshore parent company does not are simply deemed to have the credit New Zealand operations. The restricted have a formal credit rating and it is not rating of the highest rated member transfer pricing rule will achieve this for clear when to calculate the interest of their corporate group. There is no many taxpayers. New Zealand believes rate cap figure for loans already in ability to rebut this presumption. this is the way most of the world is existence when the new law comes headed and that the restricted transfer into force. Given that many New Zealand pricing rule is therefore consistent with subsidiaries of foreign banks have global trends. their own formal credit ratings than Getting ready for action can differ from those of their parent We disagree. Our primary concern Times are changing, and company, it seems unfair to simply is that this has the potential to be New Zealand’s reputation as an easy assume a credit rating equal to their a blunt instrument, for what will no place to do business will be impacted foreign parent. doubt be widely varying circumstances by the complexity these rules create. across taxpayers. It assumes that Submissions on the Tax Bill were New Zealand operations have the See no evil received on 8 February and it will be same assets, risk and functions as The other significant area of concern interesting to see whether any of the their parent. Transfer pricing analysis is that once a credit rating for the types of concerns raised in this article is complicated and time consuming, New Zealand borrower has been lead to any watering down of these as the Government has acknowledged established (i.e. using the presumed proposals. We are not hopeful. rating or via orthodox transfer pricing itself. But it does eventually produce analysis if the presumption can be outcomes which Governments should The most important thing taxpayers rebutted), certain ‘exotic’ terms of an be happy with, as demonstrated by can do at the moment is to ready intercompany loan must be ignored in the Full Federal Court of Australian themselves by conducting an initial pricing it. These will include: in the recent Chevron decision. By gap analysis, and comparing their introducing this rule, the New Zealand interest rates under the current and —— ignoring the effect of any Government is seeking to legislate the proposed rules to determine any subordination of the intercompany view they maintain in many transfer potential exposure. Not only will this loan to third party senior debt; pricing disputes, without giving quantify the size of the problem, but it —— ignoring any loan terms in excess taxpayers a chance to argue back. can kick-start the process of putting in of five years (i.e. a loan must be place a revised financing arrangement pricing assuming that it only has a to ensure taxpayers are in compliance five year term even though legally with the rules when they commence. in may be in place for longer); and

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Reducing customer friction is Startups are also acting as a catalyst Regtech startups and solutions have The New Zealand ecosystem is With the rapid rise of ICOs there is for corporate innovation as both banks the potential to impact the customer relatively immature in comparison an increasing focus from regulators. fuelling innovation across the and insurers look to improve their experience through predictive analytics to some of the global eco-systems In China, ICOs have been banned Fintech industry, as we seek digital performance and capabilities. and artificially intelligent solutions. counterparts, but no doubt we will entirely, while a number of smaller This technology monitors and identify see a notable increase in activity jurisdictions like Malta, Mauritius, to become a more consumer Changing the customer experience issues for the customers in real time. in this space in the near term, the Switzerland, and Gibraltar have set offered by traditional financial service centric society. Many Customers will begin to be serviced FMA permitting robo-advice being their sights on becoming leaders in providers who are challenged by companies have succeeded by faster as Regtech solutions transform an example. ICO-related innovation. legacy processes is providing the labour-intensive manual compliance focusing on improving a single opportunity for fintech disruption. The processes through automation. 2. The rising tide of Initial 3. Partnering in Fintech area of a customer experience use of emerging technology in AI, chatbots, robo-advice and blockchain is Organisations are also waking Coin Offerings (ICOs) In the future, the customer front- (e.g. payments, lending). supporting this innovation. to the opportunities for business An ICO is a sale of tokens by a end user interface of traditional These areas have either transformation provided by agile blockchain company looking to financial service players may yield The emerging trends discussed below regtech solutions. Regtech is raise funds to create a currency of to technology players (e.g. Amazon been slow or cumbersome are likely to shape New Zealand’s particularly well-positioned to exchange in a decentralised network entered the lending market with Fintech sector. The following emerging to deal with – traditionally contribute to productivity by helping of applications. These tokens allow Amazon Lending in 2011. Since then, trends in technologies are building more than $3 billion has been lent to Lauder Erasmus structure and draw meaningful, the owners of the applications to code subjecting its customers to consumer ecosystem in an effort to actionable information from large the token on its blockchain. This code small businesses in the US, the UK Partner – Private Enterprise a certain amount of friction reduce customer friction: and Japan, who sell on the Amazon volumes of data. Once integrated is called a ‘smart contract’. Coupled KPMG platform.). Large e-commerce and frustration. into business processes, advanced with its ability to incorporate complex companies have shown increasing 1. Regtech evolution regtech solutions may begin to provide code, tokens provide access to a interest in providing traditional financial Regulatory technology (regtech) has the capability to deliver a better decentralised network of computers services. By creating their own become a hot subsector in nearly customer experience, more robust to run applications on. Tokens allow the algorithms and verification processes, every major region worldwide. consumer protections, improved holder to purchase a service or product We are starting to see a number these companies can achieve greater Consumer experience has been transaction monitoring and real-time from this network. However, many of Fintechs moving into vertical efficiency while reducing costs directly impacted by the explosion fraud detection. of these applications are still building markets to meet the needs of their compared to obtaining these services of regulatory compliance traditional their functional networks. customers across a wide range from a third-party provider. financial institutions are having to products. This ultimately creates digital Instead of going the traditional VC deal with. The myriad of local and The New Zealand ecosystem is E-commerce giants already hold ecosystems which are designed to route an application will announce it’s international financial regulations and relatively immature in comparison and process significant volumes reduce customer friction. This trend of issuing a token. Virtual funds in the reporting requirements has left many to some of the global eco-systems of customer data. The focus of creating a lower friction environment form of tokens (e.g. Bitcoin or Ether) financial institutions overwhelmed counterparts. technology giants is on developing through developing one-stop-shops promise consumers a frictionless by the amount of effort required to and enabling consumer data-centric for digital financial transactions is alternative to the traditional banking maintain compliance. This has flowed business models. Technology giants driving innovation via the use of system. Consumers are lured by directly back onto the customer 2016 saw over $994 million in global also offer advantages of increased new technologies. lower transaction fees, greater control experience because the design of venture capital (VC) investment across speed to market, inexpensive and and greater flexibility. These tokens internal processes lack consideration 91 deals. Regtech startups in the US scalable infrastructure, and modern make digital transactions between Changes in the way fintech for being customer centric. and the UK are taking an early lead data analytics capabilities, including in the industry due to the regulatory two parties possible without the bank access to proven machine learning companies interact with customers The considerable increase in pressures in local markets, as well as an intermediary. and cognitive technologies. These is a key source of innovation. regulatory requirements for financial as alignment with broader industry Recently, there has been an explosion are all areas in which technology institutions is a direct consequence drivers. While much regtech startup in interest in ICOs as an alternative and e-commerce giants excel, of the global financial crisis (GFC). and VC activity is centred in these means of raising funding – particularly unencumbered by legacy technology. Changes in the way fintech companies This is forcing the industry to respond areas, activity continues to increase for blockchain-based companies. interact with customers is a key source through new Fintech solutions. The E-commerce players are investigating in other locations around the globe. Initial investors in ICOs speculate in of innovation (for example, the coming increased regulatory complexity and how to use customer data to better Regulators in areas like Singapore making gains by buying early access to wave of AI-driven banking chatbots). ever-changing regulatory environment, manage credit risk, working capital and and Australia have been working potentially foundational decentralised There is also an increasing trend in requires more sophisticated and liquidity. Though the focus is currently to encourage regtechs through applications, just as early investors corporates who are creating platforms digitised products that are simple for a on creating an exemplary experience use of regulatory sandboxes and into Bitcoin and Ethereum did. Locally, to connect back-office legacy systems consumer to use but are compliant. for customers within their ecosystem, to customer-facing systems and apps. targeted funding opportunities for an Auckland blockchain company there is the potential for such services regtech startups. Centrality issued US$80 million to be offered as a white label product tokens in January 2018 when its in the future, further disintermediating ICO tokens sold out in six minutes. traditional players.

The focus of technology giants like Google, Apple and Microsoft’s on developing and enabling data-centric business models provide threats from another front. While banks hold and process significant financial data, the speed and efficiency with which a data-centric business can achieve these same tasks is accelerating. In the future, the front-end user interface and data processing elements of traditional banking players may eventually yield to technology players that can deliver reliable results on a more expedient timescale. Facebook is an example of a non-fintech player expanding into what is currently fintech-dominated space: digital payments. Coming from a social media background, Facebook’s driver is the ability to monetise social communities as an integrated part of their ecosystem. While Facebook’s strategy is not new, the size of its existing, engaged customer base offers opportunities unmatched by fintech or traditional payments firms. Partnerships with technology giants may provide significant advantages to banks and other financial services firms currently hobbled by legacy systems, processes and people. Increased social engagement, and technologies to better manage customer relationships in the digital sphere, offer other opportunities. With this wave of advancements in innovation in response to existing legacy infrastructure, continued increases in the development of complex regulation and the building of integrated consumer digital eco- systems – Fintech is certain to provide a very different consumer experience in the future. If customer centricity continues to drive this innovation then the prospect of vertically integrated digital eco-systems will become very real.

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The Reserve Bank plans to The Dashboard will be an interactive Market discipline refers to the The Reserve Bank has been working online tool that will provide a central The Dashboard will be an way market participants influence to bring this digital innovation from unveil an innovative online repository of key information about interactive online tool that will a financial institution’s behaviour finalised policy to reality as quickly as information disclosure tool the prudential and financial condition provide a central repository of key through monitoring its risk profile and possible. While originally floated in this year. Its Bank Financial of New Zealand incorporated banks. information about the prudential financial position. 2015 as part of a regulatory stocktake The underlying data will be updated and financial condition of undertaken by the Bank, the decision Anybody providing funds to a financial Strength Dashboard aims to quarterly and hosted on the Reserve New Zealand incorporated banks. to produce a Dashboard followed institution is considered an investor, make it easier for investors, Bank’s website. The information will an iterative and robust consultation from depositors banking $100 to be drawn from data that banks provide process. A public consultation was including the public, to professional investors in sophisticated to the Reserve Bank and presented in As far as the Reserve Bank is aware, undertaken in 2016, feedback from debt instruments or equities, so assess the financial stability an accessible and user-friendly format. a digital interface of bank disclosures which was built into the final proposal. the effects of market discipline can Importantly, the new Dashboard will – combining timely data with an Relevant industry stakeholders have of banks by enhancing the be considerable. Public scrutiny of allow users to make side-by-side approach accessible to both the also helped shape the Dashboard, disclosure and accessibility of bank disclosures could be expected comparisons of banks in an `apples- general public and more sophisticated and engagement with Government to incentivise banks to improve the key financial information. This with-apples’ scenario on seven key investors – will be something of a agencies has also been significant. quality of their disclosures and thus subject areas. These are: credit world first. As such, the Reserve Bank We expect that the firstBank Financial will give greater transparency bolster the self-discipline pillar. ratings, capital adequacy, asset quality, recognises that this is an ambitious Strength Dashboard will ‘go-live’ Geoff Bascand about banks’ financial health profitability, the balance sheet, liquidity, project and anticipates that the The quarterly Dashboard replaces the toward the end of May 2018. Deputy Governor and and performance, and more and credit concentrations. Dashboard New Zealand public and the market need for banks to prepare off-quarter Head of Financial Stability informed investors should users will be able to interact with the will benefit from having easier access disclosure statements, but banks will Reserve Bank of New Zealand information and drill down for more to a range of bank financial and continue to publish annual and half- The Dashboard itself will be a help promote a sound and details on each of the subject areas. prudential information. yearly statements. Compared to the dynamic tool. efficient financial system. More use of bank disclosures will help status quo, the Dashboard will improve to improve investor decision-making the timeliness, comparability and and incentivise banks to prudently accessibility of bank disclosures. The release of the Dashboard will be Financial System manage their risks. accompanied by a public awareness and education campaign to ensure The Reserve Bank sees the it encourages wide access for both as an exciting Self Dashboard technical and lay audiences. This will

Market

Discipline

Discipline Regulatory development in the evolution of its include a series of educational videos, prudential regime. explaining the seven key metrics and their related subject areas, as well as carrying out on-going financial The Dashboard builds on the three- The Dashboard’s success will depend education with industry and public pillars approach that the Reserve on the integrity of the data behind it users in the interests of further Bank’s prudential regime is built on: and this will be a shared responsibility enhancing market-discipline. market, self- and regulatory discipline, between the retail banks, which The Reserve Bank sees the Dashboard with the Dashboard helping to bolster are expected to provide high quality as an exciting development in the market-discipline in particular by reporting to feed into the Dashboard, evolution of its prudential regime. The providing a tool to help investors and the Reserve Bank, which will Dashboard itself will be a dynamic assess the financial strength of manage the publication process. tool, with the Bank intending to work their banks. Another ingredient for success is behind the scenes beyond the `go-live’ the important role that users have to date to ensure the Dashboard keeps play in terms of scrutinising the data, The Dashboard builds on the three- which will contribute to data integrity pace with industry developments and user needs. pillars approach. and ultimately help make Dashboard disclosures effective. Given the range Depending on the success of the of stakeholder perspectives, the policy Dashboard there may be scope development process included a public to broaden the approach to other consultation, and has involved working regulated institutions in the future closely and collaboratively with banks as the Bank seeks to promote a to help configure theDashboard with sound financial system in the modern their current reporting processes in digital world. order to create a workable proposition.

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Implementing conduct Benefiting consumers We have enabled digital advice by using Where necessary we have intervened regulation is an incremental Our frontline teams will be talking to There is always a tension in regulation our exemption powers to bring it into to prevent initial coin offerings that did those we regulate and asking them between ensuring licensing conditions the existing framework of products and not comply with market regulations in process. Over the last two to show us how their conduct is and standards are met, alongside services we regulate. This decision has relation to the offer of financial products years, we’ve licensed around benefiting their customers. working with the industry to benefit been supported by many providers, from to the public. major institutions to small start-ups. 200 firms across various parts consumers. While the requirement to Our guidance to consumers is clear: support and promote investor capability of financial services, and Innovations bring opportunities and can this is a risky, unregulated sector. Be Transitions are rarely smooth initiatives is part of the conditions also pose risks. Both when innovation is prepared to lose money if you decide to have begun to build critical of an instrument of appointment for misused to circumvent or ignore rules buy or sell cryptocurrencies. Investors Transition to a new regime is rarely KiwiSaver default providers, we are still designed to protect New Zealanders should also understand that using intelligence about the sectors smooth. Conduct regulation means we seeing a range of responses from the and also when exuberance about the cryptocurrencies may make you a target not only seek to respond to instances of we regulate. From a standing default providers. latest product obscures risks inherent for fraud, cyber-theft or businesses potential misconduct but to guide and start, businesses have grasped in it. Cryptocurrencies offer both these selling high-risk investments. encourage providers to improve their While we accept some providers have opportunities and risks. the requirements to ensure focus on customer outcomes before made efforts to reach their customers, the results remain patchy. However, we they have systems, controls something has gone wrong. Our guidance to consumers is clear: also continue to work with the default Liam Mason Throughout last year we saw examples Innovations bring opportunities and this is a risky, unregulated sector. and governance processes to providers in behavioural insights trials to of businesses doing the right thing, can also pose risks. Director of Regulation meet their obligations and the understand how simple changes to the ensuring they understand our Financial Markets Authority way information is communicated can terms of their licence. expectations and talking to us about have a big impact. Focus in 2018 issues or concerns. Our recently To address this, we have published published Conduct Outcomes Report guidance for both consumers and A regulator cannot be everywhere all the time. We take a risk-based, intelligence- covers the enforcement action we While we accept some providers industry. We want to strike a balance – encouraging and accommodating led approach to meeting our objectives. In 2014, when we began this process, have taken when we are required to have made efforts to reach innovations that support financial With over 200 firms having made the we said it would take at least five years hold firms and individuals to account. their customers, the results markets, while helping consumers effort to gain a financial services licence, for industry and consumers to These cases also demonstrate our remain patchy. understand the risks. The rise of a particular focus for us in 2018 will be experience the difference and benefits of expectations to the market. cryptocurrencies is a global challenge, to take action where we see unlicensed conduct regulation. We’re now halfway Our teams also saw examples where a so we are working with colleagues at firms engaging in an activity requiring through. Over the next two years will Conduct regulation is not just designed provider made a mistake, the business Australian Securities and Investment a licence, or otherwise operating be focused on whether businesses are to impose rules and compliance accepted it, made good, and focused on Commission (ASIC) and other market on the perimeter of our regulation moving from a ‘checking-off’ process on standards to prevent misconduct. It ensuring it wouldn’t be repeated. For the regulators around the world. to the detriment of New Zealand’s their compliance systems to a broader has a broader goal of expanding the most part we engage with and monitor market integrity. focus on how their conduct impacts willing compliers, market participants capacity of financial markets, allowing We are continuing to engage with the customer outcomes. who understand our role and their better and cheaper allocation of capital. sector as entrants develop ideas for the For our regulated firms, we will continue We believe raising the overall standards local market. As a minimum, we have to use thematic reviews to evaluate Our frontline teams will be talking to obligations. The industry as a whole can of conduct within the financial services stated that cryptocurrency exchange standards of conduct. We will take those we regulate and asking them to see and understand the benefits of an industry, and enforcing the law where businesses must be on the Financial action where we see shortcomings, show us how their conduct is benefiting active regulator engaging closely with we see potential breaches, supports Service Providers Register and provide and use what we find to improve our their customers. How has the provider the sector. our mandate to increase investor consumers access to an independent understanding of current risks and dealt with any issues that have arisen There are a small number of providers confidence and encourage participation dispute resolution scheme. identify areas for future monitoring. leading to poor customer outcomes? We where this willingness to engage is in financial markets. do not want providers to tell us they are lacking. These businesses will be subject delivering quality customer outcomes. to an increased level of scepticism Encouraging innovation while We want them to show us how they about whether their conduct meets mitigating risks know they are. This was set out in our the objectives of our financial markets Statement of Intent 2017-2020 and is the regulation. They are likely to receive a We also have a mandate to encourage next natural step in conduct regulation. firmer response when issues arise. innovation. New Zealanders will soon be able to access digital advice, or robo- advice, for the first time. We believe this innovation has the potential to broaden access to financial advice, particularly for KiwiSaver members and those with small sums to invest.

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Trust and confidence are The Code has played an important The new Code will more easily keep While the Ombudsman is more likely part in maintaining customer trust up to date with banking innovation. these days to deal with complaints watchwords for the banking and confidence since it was first For example, the current Code has a about mistaken online payments than industry the world over. introduced in 1992. As the relationship whole chapter on cheques and only a problems with cheques, the point The banking environment between banks and their customers couple of clauses on mobile banking. of the disputes resolution service has matured over the years, the time That doesn’t make sense in a world remains the same as when it was in New Zealand is different seems right to break new ground and where cheque use is declining year- established 25 years ago. from other countries. We did bring the Code into the 21st century. on-year, and mobile banking is hugely All the evidence suggests that increasing. A higher level principles- not experience bank failures The new Code states what customers the Ombudsman scheme has based approach avoids the Code quickly can expect from their bank in a simple worked as its architects intended. or bailouts in the GFC, nor getting out of date in light of changes to way. It is high-level and sits above the New Zealanders rate their banks highly the way we prefer to do our banking. the conduct scandals seen detail of bank terms and conditions. in customer satisfaction surveys. That’s in other countries. We have The new Code also fits better with not just because banks are providing The Code clearly sets out five the changing regulatory environment. the kind of experience customers a strong, stable and well- commitments that banks will make to Consumer law and regulations have want. It’s also because banks operate their customers. regulated industry, which been enhanced over recent years, in a very competitive environment and Karen Scott-Howman benefits our economy, It says banks will treat their customers and there are more changes on the work hard to keep their customers Chief Executive, households and business. That fairly and reasonably. They’ll way. For example, we now have the happy. That includes putting right any New Zealand Bankers’ Association communicate clearly. They will protect Responsible Lending Code under problems quickly and fairly. said, we’re very conscious of customer privacy and security. They’ll the Credit Contracts and Consumer The new Code will provide the Banking be responsible lenders. And they’ll deal Finance Act. We’re also looking the world around us and we’re Ombudsman with more flexibility effectively with customer complaints. at changes coming in through the not sitting on our laurels. in determining what good banking Financial Advisers Act, which propose These few words say a great deal practice is. As well as looking at the new customer-first obligations for about what customers can expect principles set out in the Code, the financial advisers. from their bank. While the new Code Ombudsman will continue to take is shorter and easier to read, in no into account the relevant law, and Building on our reputation and way does it reduce what banks will do bank terms and conditions. She may constantly looking to improve The new Code also fits better for their customers. In fact, it raises also consult other banks to determine customer experience is an important with the changing regulatory the bar. what good banking practice looks like driver for all banks in New Zealand. As environment. in particular cases. That’s important part of that, the New Zealand Bankers’ because customer expectations may Association will this year publish a new While the new Code is shorter and change over time. This flexibility will Code of Banking Practice. We’re taking Our new approach is quite different easier to read …it raises the bar. help keep minimum standards in line a fresh approach to the Code that from other countries, including with those expectations. aims to boost its relevance and make Australia. There they have a different framework for their Code of Banking it easier for customers to understand These principles avoid the old rules- Practice that involves regulator- what they can expect from their bank. based approach. This means banks Customer trust and confidence in approval and requires a more have to think carefully about how their banks are essential to the industry’s prescriptive approach. It’s a legal conduct meets the commitments ongoing success. We’re taking a fresh approach to document that focuses on what banks in the Code. Following prescribed the Code that aims to boost its need to do. By contrast, our new Code rules doesn’t always result in the best relevance and make it easier for will focus on customers and what they customer outcomes. The principles- Customer trust and confidence in customers to understand what they can expect from their banks. based approach we’re proposing banks are essential to the industry’s can expect from their bank. means banks will work even harder to We’ve consulted closely with the ongoing success. For the last 25 years get the right customer result. We think Banking Ombudsman on the new the Code of Banking Practice has it’ll be great for customers, and much Code because it goes hand-in-hand played a crucial role in improving The Code of Banking Practice has better aligned with how we now do with the Ombudsman’s role. If you’re customer outcomes by setting been around for over 25 years. It things in New Zealand. not happy with the way your bank minimum standards in what people can sets out what banks will do for their has responded to your complaint, expect from their bank. The new Code customers as a minimum standard, the Code says you can take it to the aims to build on that solid foundation. and helps ensure customers get a fair Ombudsman to sort out. The service It will create a simpler, more easily go from their banks. is independent of the banks, and free understood and relevant framework for to customers. even better banking in New Zealand.

© 2018 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. © 2018 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. 70 | KPMG | FIPS 2017 FIPS 2017 | KPMG | 71 Massey: Banking industry forecasts

As the savings on expenses and loss Lending in 2017 was around 5% higher The unwinding of the Canterbury Although the unemployment rate “There are two kinds of forecasters: reversals have now been absorbed, than anticipated, with a total lending earthquake reconstruction in 2019 is expected to rise slightly to about those who don’t know, and those before tax banking profits in the volume of $481 billion in 2017 (Q3). and the intention of the government 5% in the next two years, overall who don’t know they don’t know.” fourth quarter of 2017 (actual data Total lending is expected to increase to slow down house price increases unemployment is low, providing a not available yet) are expected to at a similar rate as in the past two could intensify competition, leading to stable platform for lending by banks. John Kenneth Galbraith dip slightly. The outlook for 2018- years from $498 billion in 2018 (Q1) to slightly lower profit margins. As the OCR remains at record 19, however, is very positive, with $560 billion in 2019 (Q4). Investments For 2016 (Q4) and 2017 (Q1), the Credit lows, borrowing is cheaper, which profits anticipated to rise gradually to and exports are projected to increase Loss Rate (CLR) hovered around contributes to the anticipated increase $2.09 billion. This is due to an expected and residential construction should 0.1% as predicted. In 2017 (Q2 and in lending volume. Another factor that In this section, we forecast increase in lending volume, steady net soon rebound from a recent drop. The Q3), however, the CLR fell to a record will likely exert a positive influence on the key performance drivers interest margins and a very low and RBNZ’s Official Cash Rate (OCR) has low of 0.02% as a result of several the lending volumes of banks is the stable credit loss rate. been progressively cut to record lows for the New Zealand banking credit loss reversals. We anticipate growth in New Zealand’s population. in recent years, stimulating not only the CLR to remain this low as banks In 2017, net migration surged to a industry, namely lending, net economic activity but also housing continue to implement stringent record high (in the year to 31 March demand. Add to this strong net interest margin, and credit lending policies. 2017 net gains from migration immigration numbers, and demand for loss rate. were 71,932 up from 71,333 in the Christoph Schumacher Let’s now take a closer look at the loans continues to be strong. industry performance drivers. In year ended 28 February). Including Professor of Innovation and Economics our model, we use the collection of natural increase, our population Massey University grew by 100,400 people, the largest As in previous years, this FIPS past values of our drivers and before ever increase. article reviews and forecasts the tax profits; that is, a vector of time key performance drivers for the series, in order to predict future Net Interest Margins (NIM) were Inflation can have an impact on NIMs New Zealand banking industry, namely values. The key benefit of the VAR marginally lower than expected, as environments of higher inflation model is its ability to rely not only on despite a reduction of OCR in Changes in our macroeconomic lending, net interest margin and credit indicators can impact the industry often entail greater credit risk, which loss rate. Based on these drivers, I previous values of past drivers but 2016 (Q4) from 2% to 1.75%. This banks need to offset with higher also on previous values of profit, thus shows that banks pass on OCR drivers used in our model. The provide an outlook for the industry’s regression results suggest that margins. After very low inflation rates profit before tax. To produce quarterly providing a two-way interaction within changes to customers and that there of around 0.4% in 2016, inflation rose the model. is healthy competition in the banking changes in lending volume are forecasts for the next two years ending inversely related to changes in to over 2% in 2017 and is currently sector. NIM are expected to remain in December 2019, I use a combination The definitions of industry drivers are: unemployment. New Zealand’s sitting at 1.9%. This rate is in line with fairly constant over the next two years of macroeconomic variables and time- unemployment rate fell to 4.6% inflation in the majority of Organisation —— Lending – the total volume of at around 2.2% with a possible small series analysis. Specifically, I employ in 2017 (Q3) from 4.8% in the for Economic Co-operation and lending broadly defined, that is, all reduction to 2.1% in the second half a vector autoregressive model (VAR) previous period. This was the third Development (OECD) countries. interest-earning assets. of 2019. as it enables me to investigate how straight decline and the lowest interaction between the variables —— Net interest margin – the unemployment rate since 2008 (Q4). changes the forecast. The results of difference between interest my analysis are displayed in Table 10 income and interest expense, on page 72. I also revisit the forecast expressed as a percentage of TABLE 9: LIST OF MACRO-ECONOMIC INDICATORS supplied in last year’s FIPS to see lending. Macro variable Description Units Source how accurate it was, review the —— Credit loss rate – provision for performance of the New Zealand Gross Domestic Product credit impairment, expressed as gdp $mn, nominal index RBNZ economy in 2017 and provide an a percentage of lending. (expenditure based) economic outlook for 2018. bankbill90 90-day bank bills rate %, annualised RBNZ govbond10y 10-year government bond yield %, annualised RBNZ The banking sector finished 2017 very Number of registered strongly with higher than anticipated unemployed Number RBNZ unemployed profits of over $2 billion. This was Average number of home loans driven not only by an increase in avgqhouseloancount Number RBNZ approved lending volume, but also the result Estimated population of of banks reducing their operating estpop Thousands Statistics NZ New Zealand expenses and several loss reversals. 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

There is an expectation that inflation See Table 10 with Forecasting We now take a closer look at the For the year that ended in March will sit around the 2% mark for most Results VAR. performance of the New Zealand 2017, New Zealand’s exports were of 2018 and possibly rise to 2.4% in economy in 2017 and identify $70.4 billion, while imports were There are three things to note 2019. The impact on NIMs should be challenges that lie ahead. The economy $67.4 billion (figures from the Ministry about our model. First, although minimal, as possible increases in profit grew by around 2.7%, which is solid in of Foreign Affairs and Trade). The macroeconomic indicators are not margins to compensate banks for terms of global growth rates. However, New Zealand dollar is expected to stay explicitly used in the VAR model, increased risks could be offset by the growth was lower than in 2016 (3.6%) strong; indications are that it will trade the impact of these indicators is competition within the industry. caused by a contraction in utilities and a little lower in the near future. already factored into past values of a slower than anticipated growth of Interest rates are low at the moment, the performance drivers. Secondly, In 2017 we saw fairly steady and services. The expectation is that the reducing pressure on borrowers and despite their obvious importance, we reasonable global growth. Major economy will grow by around 3% over resulting in a lower number of defaults do not attempt to take into account shocks to the global economy as a the 2018-19 period, reflecting a positive and a low CLR. However, house prices regulatory changes in this analysis. result of the political changes in the outlook for the construction sector and household debt have soared in This is a limitation, since regulatory US and Britain, ‘Brexit’ and looming (we have seen a rebound in building recent years in relation to income. This changes can clearly have an impact elections in Germany didn’t happen. permits) and stronger investments high exposure to interest rate risks on our key industry drivers. Fiscal The economies of the European and exports. might impact on the CLR if interest policy is expected to become more powerhouses France and Germany rates were to rise. In 2017, household expansionary in the next two years In 2017, the New Zealand dollar have stabilised and so has China. debt as a percentage of disposable based on the new government’s plans weakened marginally from the Overall the New Zealand economy income was 167.8%, a further rise to raise spending, investment and elevated 2016 levels but remained is still in good shape, although 2017 from a high of 165% in 2016. Although transfer payments. Although there is strong. The demand for our dollar lagged a bit behind expectations. The the present levels of household debt an expectation of monetary tightening is backed by high interest margins forecast for 2018 is similar to that of aren’t particularly alarming compared from late 2018 onwards, there are compared with the G10, demand for 2017. Solid economic growth of around with other countries, the rate at which no indications that the economic primary products and a continued rise 3% driven by high tourist numbers, households become increasingly landscape of the banking sector will of tourism numbers. The strong dollar strong construction and building leveraged is a factor to watch. change dramatically in the near future. is still putting pressure on exports. activity, solid inward migration and Another related factor that deserves Finally, forecasts for periods after a However, after declining terms of government monetary policies that consideration is rural debt-to-income change of government can be tricky trade in 2016 (-1.8%), we have seen support growth. Fiscally, New Zealand ratios. Last year, commodity prices as the impact of new policies creates a constant increase throughout is in a sound position with a balanced improved after weaker values in 2016. uncertainty. Specifically, policies on 2017, reaching an all time high in budget and low public debt. As in However, the cyclical upturn matured new government spending, increases September (+0.7%). This is due to a previous years, the major vulnerability in the second half of 2017 and markets in the minimum wage, tighter drop in import prices that was greater is the high level of household debt are looking tentative heading into 2018. visa restrictions and the KiwiBuild than the decline of exported goods. fuelled by the house price increases, programme might affect the economy especially in Auckland. more strongly than anticipated. An interesting finding by the OECD Economic Survey 2017 is that New Zealand’s productivity levels TABLE 10: FORECASTING RESULTS VAR remain well below that of leading VAR industry driver 2017 Q1 2017 Q2 2017 Q3 2017 Q4 2018 Q1 2018 Q2 2018 Q3 2018 Q4 2019 Q1 2019 Q2 2019 Q3 2019 Q4 OECD countries. It attributes this to Actual Actual Actual Forecast Forecast Forecast Forecast Forecast Forecast Forecast Forecast Forecast a lack of international connections, Upper CI 502 517 531 544 558 572 587 601 616 missing economies of scale, weak Lending Forecast 469 476 481 489 498 507 516 524 533 542 551 560 competitive pressure, low rates ($Billion) of capital investments, and weak Lower CI 477 480 484 488 492 497 501 505 509 research and development activity. This Upper CI 2.33% 2.37% 2.38% 2.39% 2.39% 2.39% 2.38% 2.38% 2.38% Net Interest suggests that New Zealand could do Forecast 2.02% 2.07% 2.10% 2.13% 2.13% 2.14% 2.14% 2.14% 2.13% 2.13% 2.13% 2.12% Margin (%) even better by addressing its labour Lower CI 1.94% 1.92% 1.92% 1.91% 1.91% 1.90% 1.90% 1.90% 1.89% productivity issues. Upper CI 0.10% 0.14% 0.17% 0.19% 0.21% 0.22% 0.23% 0.23% 0.24% Credit Loss Forecast 0.09% 0.05% 0.02% 0.02% 0.02% 0.02% 0.02% 0.02% 0.01% 0.01% 0.01% 0.01% To conclude, the banking industry Rate (%) Lower CI -0.07% -0.11% -0.14% -0.16% -0.17% -0.19% -0.20% -0.21% -0.22% seems to be in even better shape 2.50 2.54 2.58 2.61 2.64 2.67 2.69 2.72 2.74 than the New Zealand economy. The Profit Before Tax Forecast 1.75 1. 74 2.01 1.93 1.95 1.97 1.99 2.01 2.03 2.05 2.07 2.09 industry finished the year with record ($Billion)* profits and this trend is expected 1.36 1.36 1.37 1.38 1.39 1.40 1.41 1.43 1.44 to continue. * 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.

© 2018 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. © 2018 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. 74 | KPMG | FIPS 2017 FIPS 2017 | KPMG | 75 Ownership and credit ratings Descriptions of the credit as at 8 February 2018 rating grades

Long-term credit rating 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. Registered banks Ultimate shareholding % Standard & Poor’s Moody’s Fitch Ratings assigned by Standard Australia and New Zealand ANZ Bank New Zealand Limited 100 AA- Negative A1 Stable AA- Stable & Poor’s Banking Group Limited Commonwealth Bank of AAA Extremely strong capacity to meet financial commitments. Highest rating. ASB Bank Limited 100 AA- Negative A1 Stable AA- Stable Australia AA Very strong capacity to meet financial commitments. Australia and New Zealand Australia and New Zealand A Strong capacity to meet financial commitments, but somewhat susceptible to adverse economic conditions Banking Group Limited – 100 AA- Negative Aa3 Stable AA- Stable Banking Group Limited and changes in circumstances. New Zealand Branch37 BBB Adequate capacity to meet financial commitments, but more subject to adverse economic conditions. Bank of Baroda (New Zealand) Bank of Baroda (India) 100 n/a n/a Baa3 Stable BBB- Stable Limited38 BB Less vulnerable in the near-term, but faces major ongoing uncertainties to adverse business, financial and Bank of China (New Zealand) Limited39 Bank of China Limited (China) 100 A Stable A1 Stable A Stable economic conditions. Bank of India (New Zealand) Limited40 Bank of India (India) 100 BB+ Stable Baa3 Stable BBB- Stable B More vulnerable to adverse business, financial and economic conditions, but currently has the capacity to Bank of New Zealand National Australia Bank Limited 100 AA- Negative A1 Stable AA- Stable meet financial commitments. China Construction Bank China Construction Bank CCC Currently vulnerable and dependent on favourable business, financial and economic conditions to meet 100 A Stable A1 Stable A Stable (New Zealand) Limited41 Corporation financial commitments. Citibank, N.A. New Zealand Branch CC Citigroup Inc. 100 A+ Stable A1 Positive A+ Stable Currently highly vulnerable. Default has not yet occurred but is expected to be a virtual certainty. and Associated Banking Group42 Plus (+) or Minus (-) The ratings AA to CCC may be modified by the addition of a plus (+) or minus (-) sign to show relative standing Commonwealth Bank of Australia – Commonwealth Bank of 100 AA- Negative Aa3 Stable AA- Stable within the major rating categories. New Zealand Branch43 Australia BB, B, CCC, and CC Borrowers rated BB, B, CCC and CC are regarded as having significant speculative characteristics. BB Various investment/nominee indicates the least degree of speculation and CC the highest. While such borrowers will likely have some Heartland Bank Limited companies; various private 100 n/a n/a n/a n/a BBB Stable quality and protective characteristics, these may be outweighed by large uncertainties or major exposures to shareholders adverse conditions. Industrial and Commercial Bank of Industrial and Commercial Bank 100 A Stable A1 Stable A Stable China (New Zealand) Limited44 of China Limited (ICBC) 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 JPMorgan Chase Bank, N.A. JPMorgan Chase & Co. 100 A+ Stable Aa3 Stable AA- Stable modifier 2 indicates a mid-range ranking and the modifier 3 indicates the lower end of that generic category. New Zealand Branch45 Assigned by Fitch New Zealand Post 53 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 NZ Super Fund 25 Kiwibank Limited A Stable A1 Stable AA- Stable higher level of credit risk or that a default has already occurred, Fitch Ratings applies a ‘BB’ to ‘D’ rating. The Accident Compensation modifiers ‘+’ or ‘-’ may be appended to a rating to denote relative status within the major rating categories. Corporation (ACC) 22 Credit ratings express risk in relative rank order, which is to say they are ordinal measures of credit risk and Kookmin Bank Auckland Branch46 KB Financial Group Inc. 100 A+ Stable A1 Stable A Stable not predictive of a specific frequency of default or loss. Rabobank Nederland New Zealand Coöperatieve Rabobank U.A. 100 A+ Positive Aa2 Negative AA- Stable Banking Group47 Rabobank New Zealand Limited Coöperatieve Rabobank U.A. 100 A Positive n/a n/a n/a n/a Southland Building Society Mutual 100 n/a n/a n/a n/a BBB Stable The Bank of Tokyo-Mitsubishi UFJ The Bank of Tokyo-Mitsubishi 100 A Stable A1 Stable A Stable Limited – Auckland Branch48 UFJ, Limited The Co-operative Bank Mutual 100 n/a n/a n/a n/a BBB Stable The Hongkong and Shanghai Banking Corporation Limited – HSBC Holdings plc 100 AA- Stable Aa3 Stable AA- Stable New Zealand Branch49 TSB Bank Limited TSB Community Trust 100 n/a n/a n/a n/a A- Stable Westpac Banking Corporation Westpac Banking Corporation 100 AA- Negative Aa3 Stable AA- Stable New Zealand Banking Group50 Westpac New Zealand Limited Westpac Banking Corporation 100 AA- Negative A1 Stable AA- Stable n/a = there is no credit rating available for this entity from the rating agency indicated.

© 2018 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. © 2018 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. 76 | KPMG | FIPS 2017 FIPS 2017 | KPMG | 77 Definitions KPMG’s Financial Services Team

Terms and ratios used Definitions used in this survey John Kensington Jamie Munro in this survey Head of Banking and Finance Partner – Head of Insurance +64 (09) 367 5866 +64 (09) 367 5829 Includes all impaired assets, restructured assets, and assets acquired through the enforcement of security, Gross impaired assets [email protected] [email protected] 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 Ross Buckley Brent Manning sundry debtors and prepayments. Executive Chairman Partner – Audit +64 (09) 367 5344 +64 (04) 816 4513 Gross revenue Includes gross interest income, gross operating lease and net other income. [email protected] [email protected] Impaired asset The charge to the Profit and Loss Account for bad debts and provisions for doubtful debts in relation to gross expense loans and advances. This is net of recoveries (where identifiable). Godfrey Boyce Paul Herrod Interest bearing Customer deposits (including accrued interest payable where identifiable), balances with banks, debt Chief Executive Officer Partner – Audit liabilities securities, subordinated debt and balances with related parties. +64 (04) 816 4514 +64 (09) 367 5323 [email protected] [email protected] 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. Graeme Edwards Gary Ivory Interest expense Includes all forms of interest or returns paid on debt instruments. National Managing Partner – Audit Partner – Corporate Finance +64 (04) 816 4522 +64 (09) 367 5943 Difference between the average interest rate on average interest earning assets, and the average interest Interest spread [email protected] [email protected] rate on average interest bearing liabilities.

Net assets Total assets less total liabilities. Jack Carroll Ceri Horwill Net interest income Interest income (including net income from acting as a lessor) less interest expense. National Managing Partner – Advisory Partner – Advisory +64 (04) 816 4516 +64 (09) 367 5348 Net interest margin Net interest income divided by average interest earning assets. [email protected] [email protected] Net loans and Loans and advances, net of provision for doubtful debts. advances Ross McKinley Mike Clarke Includes all expenses charged to arrive at net profit before tax (excluding interest expense, impaired asset National Managing Partner – Tax Partner – Head of IT Advisory Operating expense expense, subvention payments, direct expense related to other income (where identifiable), depreciation of +64 (09) 367 5904 +64 (09) 363 3507 leased assets where a lessor, and amortisation of goodwill and other intangibles (including software)). [email protected] [email protected] Net interest income, net operating lease income and net other income (where direct expense related to Operating income other income is identifiable). Kay Baldock Rachel Piper Includes any asset which has not been operated by the counterparty within its key terms for 90 days and Past due assets Partner – Head of Financial Services Partner – Tax which is not an impaired or restructured asset. +64 (09) 367 5316 +64 (09) 363 3525 [email protected] [email protected] Provision for doubtful Includes both collective and individual provisions for bad and doubtful debts. debts

Total assets Excludes goodwill assets (unless specifically defined). Matthew Prichard Bruce Bernacchi Partner – Head of Funds Management Partner – Tax Ultimate shareholding Identifies the ultimate holding company rather than any intermediate holding companies. +64 (09) 367 5846 +64 (09) 363 3288 Operating income less operating expense and impaired asset expense. Items of a non-recurring nature, [email protected] [email protected] Underlying profit unrelated to the ongoing operations of the entity, are excluded.

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