“Banking was conceived in iniquity and born in sin,”  said Sir Josiah Stamp, a long-ago director of the Bank of England.

A good deal of the animus towards banks comes from their history of corruption.  You may have seen some ancient coins where the edges have been clipped off. This ‘bankers share’ was melted down to make new money, which they mostly pocketed. Ancient treasuries melted down gold and silver coins and mixed in some lesser metals, so that they could steal a portion of the precious metals.  

Eventually people concluded that walking around with bags of coins wasn’t safe and a systems of IOU’s developed. The banks held the physical money in a safe place and trading was done with paper – a ‘Letter of Credit’. The system worked until bankers issued more letters of credit than they had currency to back. When such rumours reached depositors, they quickly sought to withdraw their money.  We had our first recorded ‘bank run’ about 700 years ago.  

What was realised about this time, is that if you issued more credit than there was hard money, it was not only profitable but, if used wisely, caused economic growth. Inventing money out of thin air was good business.  

Today the creation of ‘money’ rests almost entirely in the hands of private sector banks.  They have the limited ability to create, say $100,000 debt for you and a $100,000 asset for them, out of thin air. What they’re really doing is extending credit, like they do with your credit card.  To do this they need a banking license; there are 10 of these in NZ. 

The banks are regulated by a Reserve Bank; the RBNZ in this country.  Initially private, it was shortly acquired by our Government. Bankers put forward the argument put that the financial system is too important to be in the hands of politicians. Central banks are supposed to act freely and without undue government influence. You are entitled to guffaw at this point as the Governor and Board are appointed by the Minister and they have ‘informal discussions’ quite regularly.  

The extension of credit creates significant risk as their reserves are only a fraction of the loans they have issued. In its latest annual report BNZ reports having almost $11b in capital reserves, while they have made loans of more than $100b.  

If there is a major economic shock, loans go bad and losses are made, the BNZ would take the hit on their $11b in capital reserves. If the depositors get nervous there could be a ‘bank run’ where everyone turns up tomorrow and tries to withdraw their deposits. In this case the bank would collapse, unless the taxpayer bails them out. In 1990 the government had to step in to ensure that the BNZ didn’t collapse. You’re probably still paying for it.

The Global Financial Crisis in 2008 almost brought down the entire global banking system.  

Governments responded by pressuring central banks to adjust their regulations. The objective was to prevent irresponsible credit growth and avoid another boom-bust cycle. This resulted in the Basel 1, 2 and 3  financial framework – a complex risk management framework intended to ensure banks are 99.9% confident that they won’t lose more than the value of their capital reserves.  

This modelling will be wrong. You can be quite accurate about fair to middling events, but absolutely hopeless at predicting rare events. We can roughly predict the rainfall in July but cannot predict Cyclone Gabrielle. The same is true of financial events and this is due to the connectedness of the financial world and the ‘madness of crowds’.  You can’t model panic.

What does this mean to a farming economy?

New Zealand is not part of the Basel Committee and doesn’t need to comply with Basel regulations. However, our big four banks are Australian-owned and Australia is part of the Basel Committee.

The new banking regulations try to relate a bank’s lending risk to their capital reserves. The required capital reserves to lend on housing might be 10%, to farms and businesses 15%, and if business loans become ‘non-performing’ it might pop to 20%. These figures are illustrative only, but not so far from the mark.

Superficially, this makes sense, if you’re a banker in Basel. Where it is irrational is in the blessed backwater of rural New Zealand. We are still an agricultural country. Farming businesses are inherently cyclical. 

For example, the dairy industry has been wildly successful over time, but has endured many downturns along the way. In 2014 and 2015 many dairy farms lost money. If the Basel framework was applied to such a downturn, the banks would have had to find a bucket of extra capital reserves to bank these businesses through. Essentially they would have reduce their ability to lend and reduce their profits. 

The Basel rules give strong signals – housing lending is safe and good; farming lending is risky and less desirable; loss-making farms with ‘non-performing loans’ are dangerous and bad. The problem with this logic is that it favours a strong banking sector over a stable economy.

Once it’s built, your house generates very little by way of PAYE, GST and income tax.  Most of all, it doesn’t create many jobs. Those dairy farms that lose money, 2 years in 10, are probably not ‘risky and bad’. In the old days a local banker would size them up and make a judgement call as to whether they should be backed. Now we are banked by machines who have limited knowledge, little nuance and no humanity.

You won’t be surprised to hear that the proportion of lending for home loans has gone up and proportion of lending to businesses has gone down. These business loans and their associated capital reserves have forced interest rates up. It’s common to see term business interest rates around the 10% mark.  

Finance Minister Nicola Willis has mentioned the high interest rates for business and farming to be a focus of a banking enquiry. What she has failed to acknowledge is that, it’s not the greedy banks but RBNZ regulation that is driving up interest rates. Technically Government shouldn’t wade into such matters but the RBNZ’s Governor, Adrian Orr, needs some pressure from all fronts.

These risk and interest rate dynamics have seen the rise of ‘shadow banks’, particularly in Australia. These are non-bank lenders that don’t have a banking license. Shadow banks lend ‘real money’ (it’s compicated) and for this reason the shadow banks typically charge about 3.5% more interest than the banks. This is a cost of capital that many farmers can’t bear, unless they become considerably more profitable. That can only happen if the price of food goes up.  

Banks need to be encouraged to support farming businesses though cyclical downturns. It would be perfectly reasonable to judge the performance of a farm on a rolling 7-year basis, rather than annually. A bad year does not make a farm a bad business.  

In the EU there are many farming enterprises that receive direct assistance from the EU and are somewhat insulated by cooperative structures to which they belong. They enjoy these protections for political reasons, but also to ensure food security, care of the land and their agrarian communities.  

We need something more commercial and robust that the EU bureaucrats have dreamt up. It starts with some heterodox thinking in Wellington and the rejection of banal banking regulations conjured up in Basel.

To be worth the journey, NZ’s forthcoming banking review must result in amendments to the Reserve Bank Act. At present the only RBNZ obligations are to control inflation and to protect the financial system. Neither of these ensure the underpinnings of economic growth. The business sector needs fairly priced and reliable access to credit or we risk becoming an economic basket case.