Nicola Willis announced in June that the Finance and Expenditure Committee would be adding Rural banking to the inquiry into banking competition in New Zealand. In particular she noted that: "growing the rural economy is critical to rebuilding New Zealand's economy and with farmers satisfaction with banking services dropping in recent years, its critical we better understand the role of bank competition in that sector".

This followed an earlier process run by the Primary Production Select Committee to which NZAB was asked, among others, to provide a submission and subsequently present in person.

As part of this new inquiry, the New Zealand Government wants to delve deeper into the reasons why the cost of banking is much higher for business and rural borrowers and examine the effects it's having on the New Zealand economy.

NZAB recently made the below submission to the Finance and Expenditure Committee.  As this is a public process, we thought it would be useful to share our submission with our wider farming and farm professionals’ audience.

It covers a brief summary of some of the issues as we see them, but also offers some practical solutions that the committee might consider to improve farmers access to capital and have a positive impact on New Zealand’s ability to increase exports, close the current account deficit and continue to maintain New Zealand’s relative GDP vs its peers.  

If you have any questions on any part of our submission, please feel free to contact us.

The Submission:

From: New Zealand Agri Brokers Limited (NZAB)

Focus: Our submission focuses specifically on Rural Lending

Author: New Zealand Agri Brokers Limited (NZAB)

Request: We would appreciate the opportunity to present to the committee in person to discuss these issues in greater detail.

Executive Summary

This submission is laid out into two parts. ‘Part A’ covers the issues with Rural Banking and farmer access to capital and the impact of those issues. ‘Part B’ covers some proposed solutions that could be considered to mitigate the issues.

The agriculture sector will need increasing capital investment in the coming 10 to 15 years in order to ensure we:

• maintain our competitive advantage internationally,
• meet our environmental obligations, and
• enable the transition (sale) of farms between generations.
• Ensure regional New Zealand remains invigorated.

But alongside this, we have a heavily regulated banking sector that is resulting in the following:

• Higher interest rates charged to farmers to derive better bank capital ratios
• Reducing head count of bank staff
• Reduction in risk appetite for Agricultural loans
• Channeling of debt capital into easier home loans.

In addition, material limitations have been placed on farmers accessing foreign direct investment which has also led to capital constraints in the sector. These settings are at levels below our trading competitors, meaning the required investment into enhanced supply chains to access higher value revenue is not flowing to New Zealand and is instead going elsewhere.  This is a double-edged sword as it leads to a reduction in domestic capital that is competing and participating alongside one another.

The net result for farmers and farming businesses has been:

• Less bank competition, higher interest rates, decreasing viability, and an inability to access the right long-term capital for their business.
• Nonproductive assets classes such as housing have significant increased in value, but Farm business asset values have flattened, reducing the desirability of farming as an asset or investment class, leading to further investment reticence.

Without change, we see the potential for a significant ‘funding gap’ opening up over the coming years where farmers are unable to access the capital needed to meet these future needs. We consider this gap will grow to as much as $10-15bn over the next 5-10 years.

Failure to fill this gap with the necessary capital will have a significant impact on New Zealand’s ability to increase exports, close the current account deficit and continue to maintain New Zealand’s relative GDP vs its peers.

We recommend the committee consider the following solutions (or variations of such), which we address in more detail within this paper.

1. Consider changes to regulatory capital requirements for farm lending for existing deposit taking lenders to better reflect the actual lending risk profile versus other forms of lending like housing.
2. Consider capitalising Kiwibank with new capital, directed solely for Agri Lending.
3. Consider changes to regulatory capital requirements for farm lending for new deposit taking lenders to better reflect the actual lending risk profile versus other forms of lending like housing.
4. Encourage new lenders to New Zealand - both new mainstream bank and private capital lenders.
5. Encourage more foreign direct investment into the New Zealand agriculture supply chains by revisiting OIO settings and ensure they remain consistent over time.
6. Encourage farmers to continue to enhance their businesses to attract capital and adopt a competitive mindset when dealing with their banks.

Part A: The Underlying Issues with Rural Banking and Wider Access to Capital for Farming Businesses

1. Overly onerous bank capital regulations for Agri lending are leading to higher interest rates and reduced credit accessibility.

• Fundamentally, The Reserve Bank of NZ (“RBNZ”) requires that the main banks hold more capital on Agri loans to protect the banking sector in the event of perceived wide scale defaults.
• These requirements were established post GFC in 2011 but were not fully embedded by the main trading banks until after the dairy downturn in 2015 and 2016 and subsequently RBNZ focuses on dairy risk.
• The RBNZ approach is based on their premise that Agri lending risk is significantly higher than home lending risk and therefore to ensure the New Zealand banking system is resilient towards volatility, a bank needs to “buffer” these loans with more of its own capital. The idea is that, in the event of a downturn leading to loan losses, the banking system would remain functional and capable of covering any resulting losses.
• In practice this means a New Zealand bank needs to hold at least twice as much of its own capital against an Agri Loan, than it does for a home loan.  
• Banks are a return focused business, with a strong interest in overall earnings, and with return on equity (tier 1 capital). Given that Bank equity is not infinite, decisions are made at treasury levels about where “bank capital is placed” to get the best possible return on its equity.
• This means that an Agri loan needs to earn at least double the margin of a home loan to achieve the same level of return on equity. In effect, it simply means the banks passing on the increased costs of this capital to the farmer by way of increased interest rates.
• This increased pricing is now also embedded in the origination standards for lending, leading to a lesser ability to borrow. Perversely, this actually increases the likelihood of loan default given the impact on viability. Which is magnified during cyclical (and regularly expected) commodity downturns.
• The result is that the RBNZ gets a stronger banking sector but passes all the risk onto the farmers, leaving them more vulnerable as their rates are higher and the access to capital is more difficult.
• Main banks that aren’t currently in the Agri sector, such as Kiwibank, have little incentive to grow into this sector given high capital hurdles to entrance.
• These rules are even harder for new Agri lenders. Whilst New Zealand has experienced a significant number of new lenders entering the home loan sector, the same has not occurred for Agriculture as the capital ratio requirements for “non-main bank deposit taking lenders”, when lending to Agri, are at significantly higher levels than main bank levels and versus home lending. This provides little incentive for these institutions to consider lending to farmers.
• This effect is also noticed with business lending. Collectively, it means that significantly more lending is going to the home loan sectors and not to the productive sectors.
• This reduction in availability of Agri lending is despite the Agri sector maintaining its relative contribution to GDP over the same period. In other words, the amount of bank debt available to the sector versus its GDP contribution is declining versus other sectors.
• Despite all of the perceived additional risk in Agri Lending, actual Bank losses in the Agri sector as a % of lending appear to be relatively low. This is a point that we would encourage the committee to explore with the banks themselves as the data is not publicly available.
• The graph below shows the significant increase in home lending from New Zealand registered banks versus Agri loans which have largely flattened off. Despite this over the same period, Agri’s relative contribution to GDP remains the same.

• The graph below highlights the sector lending data in a different way, again showing the growing preference of home lending versus both business and agri lending as a percentage of their overall portfolios.

• We’ve observed this impact between banks at market share level as well, with lenders who have previously held significant Agri exposures – such as ANZ via the acquisition of the National Bank- looking to reduce their Agri market share back towards the other banks over time. The graph below shows data from the last 5 years.

• Additionally, those banks that have been seeking to reduce market share have been more active with their market commentary about the need for sectors such as dairy to reduce debt levels and at times exerting credit pressure to achieve those outcomes.
• However, we also observe Banks competing quite intensely for certain Agri loans – those loans being the ones that require less capital. And the pricing outcomes for those loans are very good. But the farmers that fit into this theoretical credit criteria are now decreasing and the costs of this competition are borne by the borrowers who now find themselves now out of favour.  As each Agri loan is “risk rated” - meaning the higher the perceived risk, the higher the level of “theoretical capital” that needs to be allocated to that particular loan- these loans require a higher margin to meet bank return on equity hurdles.  
• But in practice, where an Agri loan meet bank criteria, banks compete fiercely for these loans resulting in better margins, often below normal bank “return on equity hurdles”.
• However, the decrease in risk appetite has seen a material increase in farmers who are ”stranded” with their current bank - meaning they are unable to be refinanced to another bank as long term stress testing metrics are not met. This means they can’t negotiate more favourable terms, conditions and price.    
• So, in practice, these stranded loans are “priced to the risk curve (* see a directive example in the graph below)” resulting in materially higher margins, making deteriorating economic position even worse.  

• Given these loans are “stranded”, a single bank has effectively a monopoly on this type of loan, even though they will never face a loss on them.

2. Restrictions on other forms of new capital entering New Zealand agriculture, including foreign direct investment.

• Overseas Investment office (“OIO”) regulations that govern Foreign direct investment (“FDI”) into New Zealand agriculture undertook significant restrictive changes in 2017/18 which materially restricted incoming FDI into New Zealand farmland.  
• Whilst regulations restricting any investment into New Zealand land that was >5ha in size, (with exceptions carved out for minority stakes in entities that hold land (<25%)) had been in place from some time, the criteria for meeting any exceptions to those rules was tightened significantly, effectively disincentivising any FDI participant from going through the process.  
• FDI investment into New Zealand has lagged some of our most important competitors. For example, In Australia, since 2010, they have averaged incoming FDI of 3.36% of their GDP versus New Zealand’s 1.74%. Translating those percentages into investment dollars for the New Zealand economy, that is the difference between receiving a further $145bn of investment over that period (at 3.365%) verse the amount we actually received - $75bn (at 1.74%).
• This is made it more difficult as New Zealand is already well known to have a shallow capital base plus a perceived “risk premium” that New Zealand has traditionally had to bear.  
• The restriction of FDI into New Zealand farming businesses has been a contentious political debate, with often emotive discussion focused on the apparent loss of control, profit repatriation to offshore entities, New Zealand farmers inability to compete for the same resources and impact on local communities.
• Conversely, there has been less discussion on the benefits, being the increase in revenue generation, diversification into new markets with higher value products, increased productivity, stimulus for R&D initiatives, facilitation of new market access and trade and wider contribution for regional development and job creation.  

3. The impacts on agriculture as an investment class.

• When regulations that govern the access to capital are more “open”, asset values correlate more closely to macro-economic performance and trends as capital is allowed to follow the sectors that are performing better (or in the case of poor performance, away from that sector).  
• The converse is true too – with restricted new investment capital, Agri investment capability generally can only be derived from retained earnings (which is fine, but it’s not that quick) or by debt via the established channels (New Zealand main banks, which are currently restrictive).
• With the current restrictive settings, investment capital is currently directed to places where it is easy to place debt (i.e. houses).  It’s a significant reason why New Zealand experienced a material spike in house value during Covid as the extra liquidity created at the time flowed into the banking system which in turn led to increased flow of credit into the less restricted home lending sector.  
• The graph below shows the impact of the preferred flow of capital into the less restricted housing sector. It is a graph of REINZ house price index compared to the REINZ farmland median price per hectare (turned into an index for comparable purposes). Given the median price per hectare is impacted by the size and nature of the farms sold and by volume, we’ve added some trendlines to both sets of data. Up until 2015, both asset classes increased at a similar pace, but since 2015 a divergence emerged as greater bank capital went towards housing loans and FDI restrictions were enacted.

In summary, farmland has suffered as an investment class due to the impact of these regulatory settings.  This in turn has led to the following:

• • reduced confidence in the sector
  • less investment into technology for innovation (both on farm and at processing level)
  • less appetite for generational succession
  • less new entrants into the sector (new talent and new investors) and;
  • less domestic capital exploring farming as an investment class.

Part B: Potential Solutions to the Underlying Issues with Rural Banking and Wider Access to Capital for Farming Businesses

1. Consider changes to regulatory capital requirements for farm lending for existing deposit taking lenders:

• RBNZ currently argues that by increasing the capital held by banks, this will further safeguard the banking system and instead, banks should simply “lower their margins”. New Zealand banks then counter that because of the extra capital, margin costs now need to be higher.
• Some consideration could be given to changing the relative differential of the amount of regulatory capital between each lending class (reflected by the Risk Weighted Assets “RWA” settings between the lending classes) so that they were closer in quantum versus current settings.
• Lowering the RWA settings for Agri Lending to better reflect their actual loss rates would immediately result in the following three things:
  • The interest rate required on an Agri loan to meet bank return on equity “hurdles” or “comparisons” (versus their other lending sectors) would drop. Under competition, interest rates for Agri lending would then go down. This has the impact of increasing profitability in the sector further, freeing up capital for further investment or to strengthen farmers balance sheets further.
  • The lowered regulatory capital requirement would then allow for an expansion in Agri lending capacity – both by virtue of more advantageous bank capital leverage ratios and also by lowered stress testing criteria for farm loan viability. This has the impact of greater access to debt capital to the sector as a whole, in turn encouraging further investment.
  • Additionally, better incentives for Banks to lend more to a sector is self-de-risking. Historical results show that better access to capital encourages asset value growth, competition for farmland purchase (and hence better farm sale liquidity) and greater investment into productivity or higher profit land use change - all things that lead to less lending losses.
• These changes may also encourage existing registered banks who don’t currently lend to Agri, to begin doing so.  Aside from the four main banks (ANZ, ASB, BNZ & Westpac), plus Rabobank & Heartland Bank who all lend to Agri, there are a further nine other registered Banks that don’t lend to Agri (Kiwibank, TSB, SBS*, BOC, Co-op, CCB, ICBC, BOI & BOB). *SBS did but have been exiting all Agri Loans. 

2. Consider capitalising Kiwibank with new capital, directed solely for Agri Lending.

• As above, capital regulations are preventing Kiwibank from becoming a meaningful player in Agri lending. Kiwibank has a limited amount of its own equity capital, and the capital adequacy rules (i.e how much of its own equity it needs to place against each loan) means that it’s more incentivised to lend on houses than it is to an Agri or business customers.  
• The Government could consider widening Kiwibank’s mandate to become a genuine capital provider in the primary sector, and to do this, could mandate that any extra capital it provides Kiwibank, needs to be explicitly for new lending to the Agri and/or the business sectors.
• Broadly applying standard bank capital requirements for lending to Agri this means that if the government advances $200m of new capital to Kiwibank with this specific mandate, it would lead to a c. $1bn of new capital for Agri. Increasing this to $500m could corelate to a further c.$2.5bn of new competition to the sector. 

3. Consider changes to regulatory capital requirements for farm lending for new deposit taking lenders to better reflect the actual lending risk profile versus other forms of lending like housing.

• Whilst there is a growing list of deposit taking non-main bank lenders that are active in the home loan space, these emerging lenders are discouraged to lend to farmers by even higher Agri lending capital ratios than what the main banks face.
• As an example, a non-bank lending institution may be required to hold ~ 25% of its own capital when lending to housing, but for Agri lending, they may be required to hold ~100% of its own equity capital for the same dollar extended as a loan.
• This means the new lender is able to write four times the amount of new home loans than they could for one dollar of Agri Lending which is not particularly incentivising for these lending businesses as they look to scale.
• These rules, designed to make the system less vulnerable for depositors are creating an effective oligopoly for the main banks as new entrants can’t enter and compete.

 4. Encourage new lenders to New Zealand - both new mainstream bank and private capital lenders to New Zealand.

• There is a vast amount of private credit funds around the world, accumulating on the back of growing super funds and other private capital collecting in funds.  In the US, more cash deposits now flow into these funds than regulated banks.  In turn, these funds now lend directly to individuals, businesses and agri as they look to capitalise on this straightforward type of capital placement and return.
• There is a heightened awareness from these funds about the need to invest in Agriculture around the world given the real asset base and long history of stable returns - matching perfectly the funds need to invest for long periods of time at stable returns, with low risk of default.
• This is largely a role for the private sector, but the government might consider new initiatives for encourage the establishment of either new banks or new private credit funds in New Zealand. 

5. Encourage more Foreign direct investment into the New Zealand agriculture supply chains by revisiting OIO settings.

• As highlighted in section A, the current FDI settings discourage new investment into New Zealand.
• New Zealand needs to create a consistent and enduring framework so that investors feel comfortable that New Zealand is a sustainable place to invest and have the ability to both invest and extract their capital, if they wish to.   Fear of subsequent policy changes creating regulations that results in their capital becoming “captive” will detract from investment in the first instance.
• A very simple, yet highly effective shift would be to increase the maximum offshore ownership in New Zealand farming companies to 50%.   Sophisticated offshore investors would be more interested in the genuine partnership that metric (50%) provides for as opposed to the “minority” 25% setting.
• To enable this, a wider conversation needs to be led, avoiding the emotive conversations of and re-framing this discussion to be one of genuine partnerships. The collaboration of an innovative and low-cost New Zealand farming technique, processing and marketing talent, with offshore business and investors that have similar values and attributes, all against a backdrop of an investment ready New Zealand will create significant new revenue streams for New Zealand Farmers and invigorate regional New Zealand.
• We note the government’s already indicated willingness to smooth the process for overseas investment with a new directive issued recently to the OIO, detailing a clear shift in policy to encourage overseas investment via a greater focus on economic benefits, and a general streamlining of the OIO application process with applications to be considered in under of the statutory timeframes.  Precedents created by this directive will encourage others to participate. 

6. Encourage farmers to continue to enhance their businesses to attract capital and adopt a competitive mind frame when dealing with their banks.

• Whilst there is a capital gap in New Zealand agriculture, the banking environment is still quite competitive for the right type of Agri transaction. For Farmers to get a competitive banking solution, their business needs to be positioned as one that a new bank wants to acquire or one that their existing bank doesn’t want to lose.
• The credit process is equal parts objective (projections, values and results) and equal parts subjective (judgement on ability to perform, people, past performance and strategy). A farmer’s business performance, on farm resources, future strategy, decision making experience, skill and past financial history can be open to a very wide range of interpretation unless it has the required analysis, justification and narrative.  These are just some of the factors in a credit decision that leads to either a “yes” or a “no” plus a wide range of interest rate outcomes and differing lending conditions.
• Farmers need to continue to grow their understanding about their business credit/ risk position, the factors that will influence this (and which can be improved). Equally, presenting this well to a bank or source of capital is important. Too often, farmers have not been able to present this well enough to their bank, or at times are uncomfortable pushing for what they might deserve in an interest rate sense.
• Speaking “bank” isn’t easy these days, nor is understanding what a competitive rate looks like so getting a professional to help in this process is important.

Supporting Information

1. Our website - https://nzab.co.nz/
2. Our Articles on Banking and Farming https://blog.nzab.co.nz/.   Relevant articles:
   1. https://blog.nzab.co.nz/any-change-to-kiwibank-needs-to-address-agri-lending
   2. https://blog.nzab.co.nz/the-nzab-banking-dashboard-to-june-2024
   3. https://blog.nzab.co.nz/you-are-paying-too-much-interest.-who-is-to-blame
   4. https://blog.nzab.co.nz/with-bank-profits-falling-be-very-wary-of-the-2024-response
   5. https://blog.nzab.co.nz/a-further-look-at-agri-interest-rate-margins
   6. https://blog.nzab.co.nz/why-doesnt-kiwibank-lend-to-nz-farmers 

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