Story: Banking and finance

Page 5. Bank profits

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Bank revenue

Customers deposit funds (savings) with banks, and banks generally pay interest on savings. Banks then lend that money to people who want to borrow. They charge the borrowers a higher interest rate, generating some net interest income. Banks also gain income from fees and from providing other services.

Out of their gross income they pay their operating expenses such as staff, premises and the technology that powers the payments system, write off any losses on loans (from borrowers who have been unable to repay them), and pay tax. At the end of this process they are left with a net profit after tax, which in a favourable economic environment should be at a little over 1% of the assets.

Competition

Competition in the banking industry, which followed deregulation in the 1980s, led to banks adopting user-pays pricing for their services. Fees for specific services more accurately reflected the actual cost of providing those services than previously, when cross-subsidisation (where a customer using services sparingly effectively subsidised a customer with high usage levels) was more common. However, the increased level of fee income was offset by a smaller margin between the average interest rate banks pay for deposits and the average rate they charge borrowers.

Increased competition impacted not only banks’ income, but also their costs. As well as improving their product range and quality of service to the customer, banks have reviewed the cost-effectiveness of every part of their operation. For some banks this has resulted in significant redesign and restructuring of both their corporate and retail operations to improve their competitiveness. Many banks closed branches, particularly during the 1990s, to reduce their cost levels.

No business like bank business

With a net profit after tax of over $1 billion in the year to 30 September 2008, ANZ National Bank group, which includes the ANZ Bank, the National Bank and UDC Finance, is one of New Zealand’s largest companies (based on profits and assets). However, in the nine months to 30 June 2009, in a time of economic recession, profit fell by 43% compared with the same period in 2007–8.

Bank capital

Banks need to make profits to sustain their business – without profits, banks will not have the necessary capital to lend, and they would not be able to support the payments infrastructure on which the economy depends. As households, farmers and businesses steadily increased their borrowings through time, banks have needed increased quantities of capital. The main channel by which they obtain this is through earning profits. Some of these profits are reinvested in the banks, while the rest are paid to shareholders as dividends, so shareholders can be persuaded to invest more capital in the banks when it is needed.

Capital is also needed to absorb losses in times of economic downturns such as in 2009. Profits that banks built up over the previous 15 years gave them sufficient buffers of capital to survive.

How to cite this page:

David Tripe, 'Banking and finance - Bank profits', Te Ara - the Encyclopedia of New Zealand, http://www.TeAra.govt.nz/en/banking-and-finance/page-5 (accessed 23 June 2018)

Story by David Tripe, published 11 Mar 2010