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Budget 2023 Tax Initiatives Information Release
July 2023
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Treasury:4746291v2
Treasury Report: Windfall gains in the New Zealand banking sector, and
responses
Date: Friday, 10 February 2023 Report No: T2023/53
File Number: 4742275
Action sought
Action sought Deadline
Minister of Finance
(Hon Grant Robertson)
Agree to your preferred
recommendations of this report
None
Contact for telephone discussion (if required)
Name Position Telephone 1st Contact
Dan Doughty Analyst, Tax Strategy N/A
(mob)
Stephen Bond Manager, Tax Strategy N/A
(mob)
Minister’s Office actions (if required)
Return the signed report to Treasury.
Note any
feedback on
the quality of
the report
Enclosure:
No
[39]
T2023/53 Project Cricket Page 2
Treasury Report: Project Cricket
Executive Summary
This report responds to your request for advice on the extent to which the New Zealand
banking sector is generating windfall or supernormal profits, and tax options for responding
to any windfall profits in the banking sector. You have also asked whether officials view other
industries as having experienced windfall profits.
The large New Zealand banks have persistently elevated levels of profitability relative
to comparators in other countries
Excess profits are defined as profits above the level that would be expected in a workably
competitive market. Evidence on the competitiveness of the New Zealand banking sector is
mixed. The large New Zealand banks have persistently elevated levels of profitability relative
to comparators in other countries, in part due to the relatively low costs of the large New
Zealand banks. It is possible that an enduring structural issue, such as weak competition
between the large banks, may be allowing excess profits to persist (referred to as ongoing
supernormal profits in this report).
The assessment of windfall profits involves subjective judgements, but should take
into account the scale of owners’ investments in the firm
Windfall profits are a form of temporary excess profit that arise from an extraordinary external
event (rather than an enduring structural issue) that the firm is not responsible for (i.e. the
firm did not anticipate the event, and the firm’s actions did not contribute to the windfall
profit). There is no standard definition of windfall profits, but it often carries connotations of
being unearned or undeserved. In practice distinguishing between windfall and non-windfall
profits is difficult because it involves subjective judgements about the degree to which a firm
anticipated the event, and whether profits were appropriate compensation for risk.
In Treasury’s view, the extent of windfall profits should be primarily assessed based on
whether the owners of the firm have made excessive returns on their investment. Relative
measures of profitability, such as return on equity or assets, are better indicators of
profitability as they account for the size of the firm (e.g. the assets employed, and the equity
invested). Rather than representing a windfall, an increase in the nominal profits of a firm
could result from an increase in the general price level, increased volume growth as a result
of rising customer incomes or wealth, or larger investments in the firm exposing owners to
greater risks.
Banks’ profits were likely supported by favourable economic conditions arising from
the fiscal and monetary response to the COVID-19 crisis, but there is no clear
evidence of windfall profits
Bank profits have increased in dollar terms since the early pandemic period (early 2020),
driven by the improving economic outlook allowing banks to reduce provisions for impaired
losses, elevated inflation, loan volume growth, and widening net interest margins. However,
we have not identified clear evidence for windfall profits, on top of the sectors usual elevated
level of profitability, given that the profitability of the banking sector relative to its size (return
on equity or assets) is around pre-pandemic levels and is not exceptional relative to typical
levels in recent decades.
T2023/53 Project Cricket Page 3
If windfall profits existed, they were not large enough to be apparent in sector-level
profitability measures or were offset by confounding factors that lowered profitability.
We also looked at whether banks may have made windfall profits in relation to specific
potential aspects of the COVID-19 fiscal and monetary response, including from the
reduction in impaired loan provisioning, the implementation of the additional monetary policy
tools, increased credit demand, and widening average net interest margins. While banks’
profitability was likely supported by the generally favourable economic conditions generated
by the COVID-19 fiscal and monetary response, this was also the case for other sectors, and
it is difficult to disentangle the impact on bank profits from any specific fiscal or monetary
policy.
We do not recommend a windfall tax in the banking sector given risks to confidence in
the certainty and predictability of the tax system and the effectiveness of future
monetary and fiscal policy responses to economic crises
Due to the risk of unintended consequences from introducing a tax on windfall profits, we do
not believe there is sufficient justification to recommend a windfall tax. A windfall tax may
undermine confidence in the certainty and predictability of the tax system, with potential flow
on impacts on investment decisions and long-term economic growth and wellbeing. The
incidence of a windfall tax is subject to elevated uncertainty, and there is a risk that the costs
are borne by depositors and borrowers rather than shareholders. Moreover, applying a
windfall tax on profits arising from the growth in bank lending risks undermining the
effectiveness of monetary and fiscal policy responses at influencing credit conditions and
growth in future crises.
You have two main options if you wished to pursue a windfall tax on bank profits
We have identified two potential options, being:
a a one-off levy applied to windfall profits as assessed in prior periods; or
b a temporary top-up of the corporate tax rate.
Both of these options carry risks, and we have not expressed a preference for which would
be the preferred approach at this stage. There are several factors that would need to be
weighed against either potential option, on which we can provide further advice. There are
alternative options if you were interested in more permanent increases in the effective tax
rate applied to the banking sector.
There is limited evidence of windfall profits in other sectors, and a windfall tax on
those sectors also has significant downsides to confidence in the certainty and
predictability of the tax system and the Governments wellbeing objectives in those
sectors
Other sectors may have experienced windfall profits. Our initial review suggests that sectors
most likely to have experienced windfall profits where there is the strongest likelihood of
these gains targeting the relevant sectors may have undesirable consequences for the
Government’s wider wellbeing objectives.
T2023/53 Project Cricket Page 4
Next steps
If Ministers wish to progress a windfall tax on the banking sector, we will report back with
more detail on the design of the two tax options outlined in this report. This would include
more extensive consultation with Inland Revenue on the administrative complexities of
implementation, and mechanisms of applying the tax.
If Ministers wish to investigate ongoing supernormal profits in the banking sector, we
recommend you discuss initiating a Commerce Commission-led market study into the
banking sector with the Minister of Commerce and Consumer Affairs. A market study would
be the best avenue to identify the cause of, and solutions to, any enduring competition issues
that may be allowing ongoing supernormal profits, but it would need to be weighed against
other candidates for a market study. Following the findings of that report (expected to take 18
months from when it is initiated), we can investigate tax measures that better target the
factors of ongoing supernormal profits.
Recommended Action
We recommend that you:
a note the large New Zealand banks have persistently elevated levels of profitability
relative to comparator banks in other countries which may indicate enduring excess
profits (i.e. ongoing supernormal profits).
b note banking sector profits were likely supported by favourable economic conditions
arising from the fiscal and monetary response to the COVID-19 crisis, as were other
sectors, but we have not identified clear evidence for windfall profits (i.e. temporary
excess profits) above the sector’s persistently elevated levels of profitability given:
• the profitability of the sector relative to its size (return on equity or assets) is
around pre-pandemic levels, and
• it is difficult to disentangle the impact of specific fiscal or monetary policies on
bank profits.
c note that, although the assessment involves subjective judgements, there is no clear
evidence that banks made windfall profits during the recovery from COVID-19, on top
of their usual elevated level of profitability
d note we do not recommend a windfall tax in the banking sector given the risks to
confidence in the certainty and predictability of the tax system, the possibility of the tax
burden being borne by bank customers, and the effectiveness of future monetary and
fiscal policy responses to economic crises.
EITHER
e Agree to not progress work on a windfall tax on bank profits.
Agree / disagree
OR
f Direct officials to report to you with detailed options for a windfall tax on bank profits to
be progressed for announcement at Budget 2023.
Yes / no
T2023/53 Project Cricket Page 5
g Refer this report to the Minister of Revenue.
Yes / no
Stephen Bond
Manager, Tax Strategy
Hon Grant Robertson
Minister of Finance
_____/_____/_______
T2023/53 Project Cricket Page 6
Treasury Report: Project Cricket
Purpose of Report
1. You have requested advice on the extent of any windfall and supernormal profits
experienced by the New Zealand banking sector. You have also requested advice on
whether a one-off tax measure could be used to respond to windfall profits. Within this
report, officials have outlined:
a the extent to which the New Zealand banking sector continues to experience
supernormal profits (page 5);
b the extent to which the New Zealand banking sector has experienced windfall
profits (page 8);
c potential tax responses to windfall profits within the New Zealand banking sector
(page 10);
d initial indicative views as to whether other sectors have experienced windfall
profits (page 16).
2. Based on the findings of this report, you may wish to direct officials to commence
detailed design work on a tax response to windfall profits. If this is the case, the
findings of this report will inform the design of that response.
3. Alternatively, you could direct officials to conduct additional research into specific
issues identified in the report. In this case, the findings of this report will provide scope
for any additional research, and whether alternative responses may be necessary.
Supernormal Profits in the New Zealand Banking Sector
4. The New Zealand banking sector is made up of four main banks (ANZ, BNZ, ASB, and
Westpac), referred to as the large New Zealand banks in this report, and several
significantly smaller banks, including Kiwibank, Rabobank, TSB, SBS, and Heartland
Bank. The four large New Zealand banks account for around 84% of total assets held
by New Zealand-registered banks.
5. The large New Zealand banks have had persistently elevated levels of profitability
compared to the rest of the banking sector, measured by return on equity and return on
assets.
T2023/53 Project Cricket Page 7
6. The large New Zealand banks are also relatively more profitable than key international
comparators. Reserve Bank analysis for the period 2016-2022 found the large New
Zealand banks’ return on common equity was generally the second highest of the
comparator group, after Canada.
7. The Reserve Bank found the large New Zealand banks’ revenues (net interest income
and other income) are close to peer country averages, when measured against the size
of their balance sheets, while expenses (operating expenses and credit impairment
expenses) are lower than peer country averages. By comparison, the small New
Zealand banks operate with higher cost structures than the large New Zealand banks,
leading to the lowest return on equity in the peer group.
8. The large New Zealand banks lower costs may be due to economies of scale (in
comparison to the small New Zealand banks) and cost-savings derived from being the
subsidiary of a larger banking group. New Zealand is the only country within the
comparator group assessed by the Reserve Bank where all the large banks are
subsidiaries of larger banking group businesses.
0
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0.6
0.8
1
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1.4
1.6
1.8
0
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4
6
8
10
12
14
16
Figure 1: Return on equity and assets
(average Mar 2018-Sep 2022, Source: Reserve Bank Financial Strength Dashboard)
Return on equity (LHS) Return on assets (RHS)
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
Figure 2: Average return on common equity for major banks in peer
countries
(Source: Reserve Bank analysis)
New Zealand Australia Canada Norway
Singapore Sweden Denmark Netherlands
T2023/53 Project Cricket Page 8
How do the large New Zealand banks generate persistently elevated profits relative to their
international peers? Are the large New Zealand banks making supernormal profits?
9. Excess or supernormal profits are defined as profits above the level that would be
expected in a workably competitive market. In a competitive market, an efficient firm
would achieve profits that, after covering its costs, are sufficient to compensate the
providers of debt and equity capital. The ability of firms to persistently generate
supernormal profits is often constrained in competitive markets by new players entering
and innovating, driving out excess returns, while firms that are operationally inefficient
or unable to innovate lose market share until they are no longer viable or are
purchased by the owners of more efficient firms.
10. It is unclear why the large New Zealand banks’ relatively elevated profitability has not
been eroded by competition between the large New Zealand banks (i.e. why haven’t
the large banks’ relatively low costs driven interest rate margins and fees down
further?). One possibility is that the large banks’ profits are not supernormal, if current
levels of profitability are necessary to compensate the providers of equity for an
elevated risk premium associated with general New Zealand equity investments. Credit
reporting agencies note the large New Zealand banks would have credit ratings 2-3
notches lower if not for the expectation of financial support from their parent bank. The
parent bank, therefore, may require a higher return on their New Zealand banking
operations to compensate for the higher risk.
1
1
Another possible driver of persistently high profitability for large New Zealand banks is
disproportionate risk-taking (high leverage) relative to international peers that is possible due to
unpriced, implicit government support. However, some degree of unpriced implicit government support
also likely to exist for the large banks in comparator countries, which does not explain New Zealand’s
disproportionate standing. Implementation of the RBNZ’s higher capital levels and the depositor
compensation scheme may reduce the contribution of this to profitability over time.
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
Figure 3: Operation expenses as a percentage of total assets
(average Dec-21 - Sep 22, Source: Reserve Bank Financial Strength Dasboard)
T2023/53 Project Cricket Page 9
Previous research has found mixed evidence of banking sector competition
11. In 2018 a Treasury review of the banking sector found mixed evidence on the level of
competition. On the information available, we concluded that there did not appear to be
significant issues with a lack of competition. For example, there were not any
significant concerns about anti-competitive conduct in the banking sector, barriers to
entry were considered low, and bank customer satisfaction was relatively high in New
Zealand. However, the report noted that the sector is relatively concentrated in four
large banks, measures of banking innovation were trending downward, customer
switching was lower than in the past, and it was considered possible that large, well-
resourced banks may not to enter the retail banking market due to New Zealand’s
relatively small size.
12. Conclusive findings have not been possible without more extensive research and
investigation, including information obtained internally from banks about their
profitability drivers, and the competition practices between the major banks.
Windfall Profits in the New Zealand Banking Sector
13. Windfall profits are a temporary excess profit that arises from an extraordinary external
event (rather than an ongoing structural issue like weak competition) that the firm is not
responsible for (i.e. the firm did not anticipate the event, and the firm’s actions did not
contribute to the windfall profit). As such, windfall profits draw connotations of being
unearned or undeserved. For example, an increase in a firm’s profits due to an
unanticipated increase in extractive prices may be described as a windfall profit,
whereas profits arising from productivity gains from an investment would generally not.
However, there is no standard definition of windfall profits. In practice distinguishing
between windfall and non-windfall profits is difficult because it involves subjective
judgements about the degree to which a firm anticipated the event, and whether profits
were appropriate compensation for risk.
The strong economic recovery from the early pandemic period, accompanied by strong
demand for lending and high inflation, has seen bank assets grow, leading to a rise in the
dollar value of profits
14. Bank profits have increased in dollar terms since the early pandemic period (early
2020). Nominal bank profits in the September 2022 quarter were the highest on record
(since 1991) and reflect an ongoing upward trend in nominal profits over the past three
decades.
T2023/53 Project Cricket Page 10
15. In Treasury’s view, the extent of windfall profits should be primarily assessed based on
whether the owners of the firm have made excessive returns on their investment.
Relative measures of profitability, such as return on equity or assets, are better
indicators of profitability as they account for the size of the firm (e.g. the assets
employed, and the equity invested). Rather than representing a windfall, an increase in
the nominal profits of a firm could result from an increase in the general price level,
increased volume growth as a result of rising customer incomes or wealth, or larger
investments in the firm exposing owners to greater risks.
16. Banking sector profitability, when measured by return on equity and return on assets,
fell during the early pandemic period but has returned to near average for the period
2013-2022. While nominal profits have increased recently, banking sector equity and
assets have also increased, meaning relative returns remain around pre-pandemic
levels. Equity and assets increased as banks have been increasing capital in
anticipation of the Reserve Bank increasing regulatory requirements. The fall, and then
recovery, in the return on equity and assets for the large New Zealand banks over
2020-2022 is consistent with international peers (see figure 2 above on average return
on common equity for major banks in peer countries).
0
200
400
600
800
1,000
1,200
1,400
1,600
1,800
2,000
Sep 2013
Dec 2013
Mar 2014
Jun 2014
Sep 2014
Dec 2014
Mar 2015
Jun 2015
Sep 2015
Dec 2015
Mar 2016
Jun 2016
Sep 2016
Dec 2016
Mar 2017
Jun 2017
Sep 2017
Dec 2017
Mar 2018
Jun 2018
Sep 2018
Dec 2018
Mar 2019
Jun 2019
Sep 2019
Dec 2019
Mar 2020
Jun 2020
Sep 2020
Dec 2020
Mar 2021
Jun 2021
Sep 2021
Dec 2021
Mar 2022
Jun 2022
Sep 2022
$m
Figure 4: Quarterly bank profits after tax
(Reserve Bank Income Statement Survey)
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
0.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
16.0
Sep 2013
Jan 2014
May 2014
Sep 2014
Jan 2015
May 2015
Sep 2015
Jan 2016
May 2016
Sep 2016
Jan 2017
May 2017
Sep 2017
Jan 2018
May 2018
Sep 2018
Jan 2019
May 2019
Sep 2019
Jan 2020
May 2020
Sep 2020
Jan 2021
May 2021
Sep 2021
Jan 2022
May 2022
Sep 2022
%
%
Figure 5: Banking sector return on equity and assets
(Reserve Bank Income Statement Survey)
Return on equity (LHS) Return on assets (RHS)
T2023/53 Project Cricket Page 11
Possible specific arguments for windfall profits in the banking sector
17. We also looked at whether banks may have made windfall profits in relation to specific
aspects of the COVID-19 fiscal and monetary response, including from the reduction in
impaired loan provisioning, the implementation of the alternative monetary policy tools,
growth in bank loans due to increased loan demand, and widening average net interest
margins. Profits from these events may not show up in the sector-level profitability
measure if:
a the windfall profits are too small to materially affect quarterly sector-level return
on equity, or
b the windfall profits are offset by reduced profits in another segment of the banking
sector (e.g. agricultural lending) or other banking businesses (e.g. smaller
banks).
18. The main potential arguments we have identified for windfall profits, and our
assessment on whether they are a windfall profit, are summarised below. Further
information is set out in Annex 1.
a Lower than expected impaired losses in 2020 due to the improved economic
outlook in late 2020 and 2021 are arguably not a windfall profit because the
majority of loans on issue during the early pandemic period had been issued
before March 2020. This means the improving economic outlook in 2021 would
have restored some of the profitability banks had anticipated at the time they
issued the loans (i.e. the improved economic outlook softened the windfall loss
from the pandemic).
b There is not sufficient information to draw firm conclusions about the degree to
which alternative monetary policy (Large Scale Asset Purchases (LSAP) and the
Funding for Lending Programme (FLP) contributed to bank profits. The extent of
any windfall profits from LSAP depends on whether banks changed their balance
sheet structures to benefit from rising interest rates, taking on interest rate risk
(i.e. risk of losses if interest rates fell). Regarding the FLP, as a subsidy for
lending, it likely supported bank profitability, but it appears there was a
reasonable degree of pass-through of lower lending costs to borrowers.
c While the COVID-19 fiscal and monetary response likely supported increased
loan volumes, increased loan volumes have not translated into returns on assets
or equity above pre-pandemic levels. In addition, total bank lending as a
proportion of GDP is also roughly equivalent to pre-pandemic levels suggesting
bank lending has grown largely in line with the wider economy.
d Increased net interest margins due to the rising interest rate environment from
the second half of 2021 has likely supported bank profits but we expect this to be
temporary as depositors shift their money from low or zero interest transactional
accounts to higher interest term deposits in response to higher interest rates.
19. Overall, while bank profitability was likely supported by favourable economic conditions
created by the COVID-19 fiscal and monetary response, it is difficult to disentangle the
impact on bank profits from any specific fiscal or monetary policy, and the broader
economic conditions that benefitted many sectors. Further investigation of the drivers
of increasing net interest margins and the impact of the LSAP would be needed to draw
clear findings of windfall profits.
T2023/53 Project Cricket Page 12
Tax Responses to Windfall Profits in the New Zealand Banking Sector
20. We have identified two potential options if you wish to consider a tax on any windfall
profits in the banking sector, being:
a a one-off levy applied to windfall profits as assessed in prior periods; or
b a temporary top-up of the corporate tax rate.
21. The costs and benefits of these options are assessed below, but both options carry
significant risks. In the absence of clear windfall profits, a windfall tax may undermine
confidence in the certainty and predictability of the tax system, with potential flow on
impacts on investment decisions and long-term economic growth and wellbeing.
Additionally, the favourable conditions for bank lending, and the associated lending
growth was one of the intended channels through which monetary and fiscal policy
supported the economic recovery from the COVID-19 crisis. Applying a windfall tax on
profits arising from the growth in bank lending risks undermining the effectiveness of
monetary and fiscal policy responses at influencing credit conditions and growth in
future crises.
22. Overall, we do not recommend a windfall tax in the banking sector given risks to
confidence in the certainty and predictability of the tax system and the effectiveness of
future monetary and fiscal policy responses to economic crises.
23.
If you wish to proceed with a windfall tax, we will provide further information on both options. We
have not made a recommendation between these options at this stage.
Option one (one-off
levy) better targets windfall gains, but in the absence of clear evidence of those gains,
it will be difficult to design in a way that is meaningfully targeted. However, a one-off
levy design has lower administrative implications compared to an adjustment to the
annual income tax rate for a very small subset of taxpayers.
24. In contrast, option two would treat all income earnt as having a windfall component,
though it could be narrowed to a specific subset of banks over a certain income
threshold. This approach intentionally abandons targeting windfall gains in favour of a
more simplistic design. However, this design would require additional work to
determine the secondary impacts on broader tax administration – which may be
significant depending on final design decisions.
Definition of a windfall tax
25. As discussed in the earlier sections of this report, windfall profits are an increase in
profits that arise from an unanticipated, extraordinary and external event. A windfall tax
is a tax that is levied specifically on profits that can be attributed to those windfall
profits. Typically, these are one-off taxes that are imposed retrospectively, and often
take the form of a levy; being a charge on a taxpayer that is above and beyond their
normal tax obligations.
26. Windfall taxes are distinct from similar taxes that target specific industries. For
example, officials note that various jurisdictions impose taxes on banking sectors
where the stated intention is to extract some of the sectors apparent ongoing
supernormal profits.
Option one - Year-on-year profit levy
27. A levy on year-on-year profits directly targets one-off windfall profit events by
comparing the assessment year against the prior year (or an average of prior years).
Where profits have grown by a proportion greater than an implied natural rate of
growth, that growth would be deemed to be a result of a “windfall” event and would be
levied at a special rate.
T2023/53 Project Cricket Page 13
28. In the New Zealand banking sector this could take the form of a levy on the net
reported profit as stated for a given income year. The reported growth in profit over the
period would then be compared against a predetermined implied natural rate of growth
for profits in the banking sector (e.g., 5%). For example, a bank that had experienced
profit growth of 9% for the year would be levied on the difference between the actual
profit growth and the implied natural rate of profit growth (i.e., 4%).
29. Recent international comparisons include:
a Netherlands – a special levy of 33% is imposed on “excess profits” earned by
energy producers in the year ended 2023; being net profit that is more than 20%
above the average level of net profit in the 2018 – 2021 years.
b The Czech Republic – a special levy of 60% is imposed on the difference
between net profits earned by energy producers in the year ended 2023, and net
profits averaged across the prior five years.
30. Of note is that both examples were introduced in response to European energy
producers experiencing relatively clearer windfall profits due to the war in Ukraine and
subsequent supply disruptions. While the cause and severity of windfall profits in the
New Zealand banking sector are not directly comparable, officials consider the core
design could be replicable.
31. Additional work would be required to appropriately set the rate of growth over which the
levy would be collected. As discussed in prior sections, it is not clear that recent growth
is as a result of a windfall event. Therefore, setting that rate too low risks capturing
non-windfall growth; effectively penalising the banking sector for its risk-weighted profit-
making decisions. Additionally, setting the rate too high risks collecting a minimal
amount of revenue and making the levy redundant.
32. Officials also recommend that the design use average growth over various prior years,
as opposed to a direct year-on-year comparison. As evidenced in the sections above,
COVID had a significant distortionary impact on growth margins, and measuring from
that depressed position may attract significant criticism as an artificial measure of
growth. As such, officials recommend any design specifically exclude the COVID
period to best model growth under more normal conditions.
33. Overall, officials consider that there would be significant complexities in designing an
effective year-on-year profit levy. Specifically, the balancing exercise needed to set the
rate of growth over which the levy would apply would be complex and controversial. If
this balance is not achieved, the negative economic impact of option one is likely to be
significant.
Option two - Top-up of corporate tax rate
34. The second option is a top-up of the corporate tax rate applied to the net profit of banks
who are considered to have experienced a windfall gain. Unlike option one no
comparison is made to prior periods to determine a natural rate of growth, and instead
the top-up tax is levied on the entirety of the net profit reported for the period.
35. For example, when a bank has reported a net profit of $1b for the 2021/22 income
year, that bank would have a normal income tax obligation of $280m. A top-up windfall
rate of 5% would generate an additional $50m tax obligation for the bank.
36. It would be possible to design the levy to only apply to the largest banks on an income
threshold basis. This may be desirable if there were concerns with levying smaller
banks, or an expectation that only the largest banks operating in New Zealand had
experienced a windfall gain.
T2023/53 Project Cricket Page 14
37. Option two would likely be easier for officials to design than option one as it would
apply to the entirety of a bank’s net profit and would not need to account for the
differences in rates of growth between banks. However, officials would need to
consider several factors to ensure the rate was commensurate to the average windfall
profit experienced by the banking sector.
38. Recent international comparisons include:
a The United Kingdom – two recent examples - an 8% (soon to be 3% for an
effective 28% tax rate) top up of the corporate tax rate for banks, and a 25% top-
up for oil, gas and energy companies to apply until “prices normalise”; initially
intended until the 2025 year.
b Canada – a one-off 15% levy on banks and insurers with profits over $1bn (CAD)
for the 2021 tax year.
c Spain – a one off-tax of 4.8% on the net income derived on interest and fees (but
exclusive of other income types) in the 2019 financial year by banks with greater
than €800m net income.
d Hungary – a levy of 10% on net income in the 2022 year, and 8% levy in the
2023 year for all banks.
39. International evidence suggests that many comparable jurisdictions have favoured a
windfall tax designed like option two. It is expected that these jurisdictions have also
acknowledged the design complexity inherent in option one and have favoured a
broader base response as a result. However, comparable jurisdictions do not have
imputation regimes, which (in the New Zealand context) is expected to significantly
complicate the detailed design process.
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Assessment criteria for both options
40. Officials have considered both options below
Criteria Assessment
Efficiency and
Growth
International evidence suggests that windfall taxes, when applied
retrospectively and as a one-off response to a specific event, are relatively
non-distortionary. To the extent that impacted taxpayers understand the
rationale for the tax, and that it will not be repeated (without similar
circumstances), these taxpayers and their investors are unlikely to
significantly alter their behaviour. This suggests that the proposals are
unlikely to significantly negatively impact New Zealand’s financial capital.
Given the lack of evidence of windfall profits noted in earlier sections of
this report, there is a risk that impacted taxpayers will not accept the
rationale for imposing either option. In this case, these taxpayers may
change their future behaviours in anticipation of other levies.
Additionally, the introduction of either levy may have a downstream impact
on the international competitiveness of the New Zealand banking sector
and lower the availability of international capital. This could undermine the
banks’ role in safeguarding and building wealth and overall wellbeing.
Equity and
Fairness
The fairness of a given windfall tax rests primarily on whether a clear
windfall profit has been earned. As discussed in prior sections the
evidence does not suggest a clear windfall profit event has occurred.
As a result, the imposition of a windfall tax on the banking sector risks
being viewed as arbitrary, and otherwise reduces the fairness of the tax
system. Specifically, to the extent that increased bank profits are taxed
more highly than other sectors that have also earned increased profits,
this reduces the horizontal equity of the tax system.
Revenue
Integrity
As one-off retrospective measures targeted at a small number of
taxpayers, neither options come with any significant integrity concerns.
However, revenue generated from the levy would be in one fiscal year
only and should not be relied upon as a sustainable revenue base.
If either of the options was made permanent, there may be significant
integrity concerns that would need to be considered when designing the
full proposal.
Fiscal impact Either option would be fiscally positive, though exact modelling would be
required if Ministers decided to progress either option. The fiscal impact
would be highly dependent on the final design of a proposed levy.
Compliance
and
Administrative
Cost
As a one-off levy, compliance costs should be relatively low for taxpayers.
Inland Revenue officials have advised Treasury that, depending on the
design of the levy, the administrative costs of option two are likely to be
greater than option one.
Coherence There are no significant coherence concerns to the extent that the levy is
applied as a one-off and no other proposed measures are introduced.
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Administrative complexities to be addressed
41. If Ministers wish to pursue a windfall tax, additional consideration will need to be given
to the administrative impacts of that tax. Specifically, officials anticipate that either
option will need to account for impacts on the imputation credit regime (i.e., will the levy
give rise to imputation credits?) and the provisional tax regime (i.e., will the current year
provisional tax obligation need to retrospectively account for the levy?).
42. If these and associated questions are not resolved before the implementation of a final
design officials are concerned that adverse impacts on confidence in the tax system
could be exacerbated. This is likely a greater concern under option two than under
option one.
Recommendations
43. If Ministers decide to pursue a windfall tax on the banking sector, officials view the
choice as between minimising negative impacts on confidence in the tax system and
minimising negative impacts on the administrative coherence of the tax system.
44. Option two does not attempt to limit the levy based on a specific area of income
growth. However, as a flat increase to the corporate tax rate for banks, the top-up tax
does not limit itself to windfall gains explicitly; every dollar earned by affected taxpayers
would be subject to the higher rate. This approach risks being considered arbitrary
where affected taxpayers disagree that the entirety of their taxable profits are as a
result of windfall events.
45. Officials consider it would be worthwhile pursuing a more targeted option if there was
clear evidence that growth was (either partially or wholly) a result of windfall gains. In
the absence of that evidence attempting to design a targeted tax is likely to be complex
and may not result in a materially more equitable tax than the broader approach of
option two. To the contrary, officials believe that a more targeted levy under option one
is open to more criticism as it would be arbitrary if the selected target cannot be
coherently explained by evidence.
46. Weighed against this, officials acknowledge that there are significant administrative
complexities in adjusting the corporate tax rate per option two. Associated regimes
such as the provisional tax and imputation systems will need to be carefully
considered, with potential implications branching off further depending on decisions
made. This will be complex for taxpayers to administer, and for officials to effectively
design.
47. Inland Revenue anticipates that administering a change to the corporate tax rate for a
limited number of taxpayers within their system will be significantly complex regardless
of final design decisions. This complexity is minimised (though not altogether
eliminated) by pursuing option one as a one-off levy would not have as many
administrative interdependencies.
48. On the basis of the above, officials cannot, at this stage, make a recommendation
between the options presented. If Minister wish to pursue a windfall tax under either
option, officials can explore the associated costs in more detail.
49. Inland Revenue agrees with the conclusions and recommendations in this report and in
particular does not recommend a tax on windfall profits in the banking sector. If
Ministers seek to progress a windfall tax on the banking sector Inland Revenue
recommends that, if designed as a one-off tax on a small number of banks, the
proposal be integrated into existing income tax filing requirements as much as possible
to minimise administrative costs.
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Fiscal considerations
50. As officials have not designed a windfall tax at this stage, there is no reliable way to
model the potential fiscal impact of any of the options contained in this paper. Officials
anticipate that any revenue generated by a windfall tax is likely to be in the order of
tens to several hundred million dollars, though this is highly variable depending on
design decisions. This would also be a one-off sum if imposed as a one-off measure
(as recommended below), and should not be expected beyond the year it is collected
in.
Recommendation for retrospectivity and timing
51. Officials consider it important that the design of either levy be based on retrospective
windfall profits to avoid income structuring that might otherwise occur. For example, if a
levy were imposed on profits earned in the 2023/24 income year, it would be possible
for affected taxpayers to shift profits to future years to avoid the additional tax
obligation. If obligations were instead measured from prior income years taxpayers
would be limited from structuring out of the levy, as these profits would already have
been reported.
52. Additionally, officials recommend that either option be designed as a one-off measure.
If continued for more than one income year officials would need to address several
potential integrity concerns. If Ministers were to pursue a multi-year solution for banks,
it is recommended that Ministers instead consider a flat corporate tax rate increase for
banks. This would mitigate the integrity concerns with an indefinite windfall tax,
although it would be a highly distortionary and inequitable approach once windfall
profits decline.
53. Lastly, officials consider it necessary that, either the levy or the top-up tax rate, be due
prospectively (i.e., due in the 2023/24 income year or later) so as not to have serious
unanticipated cashflow impacts. If the tax obligation were due retrospectively the actual
cost to the affected taxpayers will be increased and will have secondary impacts on
their reporting obligations. Given the concerns raised on the introduction of a windfall
tax generally, officials strongly recommend against retrospective tax payments.
Incidence of windfall taxation on banks
54. Officials can complete further analysis if Ministers wish to understand where the
incidence of taxation will lie if a windfall tax is imposed. There is mixed evidence: for
example, RBNZ research indicates banks passed through the benefits of the FLP
programme (a lending subsidy to banks). However, the general incidence of company
taxation is usually primarily on a combination of shareholders or employees. The
incidence would likely be influenced to some extent by the competitiveness of the
market, and therefore how much market power individual banks have in different
markets. Furthermore, a windfall tax in the context of increasing bank capital
requirements may also influence the incidence of the tax if banks were relying on
retained earnings to build capital.
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Possible responses to supernormal profits or competition concerns.
55. As noted above, there is some evidence ongoing supernormal profits are occurring
within the banking sector – rather than one-off windfall profits.
56. If Ministers wish to investigate ongoing supernormal profits in the banking sector, we
recommend you discuss initiating a Commerce Commission-led market study into the
banking sector with the Minister of Commerce and Consumer Affairs. A Commerce
Commission-led market study would have the resources, expertise and information
acquisition powers to identify the cause of, and solutions to, any weak competition and
elevated profitability in the banking sector. Similar studies in other countries (e.g.
Australia) have yielded useful information in recent years. A banking sector market
study would need to be weighed against other potential candidates for a market study.
57. Following the findings of that report (expected to take 18 months from when it is
initiated), we can investigate tax measures that better target the factors of ongoing
supernormal profits.
Additional Sectors Examined for Windfall Profits
58. Ministers have asked for advice on whether there are any other major sectors where
further investigation of windfall profits might be warranted. Officials have previously
examined changes in profitability for the energy, construction and aged-care sectors in
an Aide Memoire provided 16 September 2022 (T2022/2068), and summarise those
findings below in the context of windfall profitability:
a Energy sector – profits in 2022 grew by 41% as compared to 2019, though this
was driven in large part by one business. Excluding that outlier, the sector grew
by 27%. Our research did not suggest clear evidence of windfall gains in the
sector.
b Construction sector - profits in 2022 grew by 36% as compared to 2019, with a
large variance between profits (and losses) within that sector. To the extent that
growth was experienced, it was driven by high demand for housing which could
be viewed as a windfall event. However, as demand is now subsiding, many of
these businesses will now be experiencing decreases of profitability and applying
a windfall tax to this sector may have adverse impacts on the Government’s
broader wellbeing objectives.
c Aged-care sector - profits in 2022 grew by 88% as compared to 2019, largely
driven by a growing demand for aged residential care facilities increasing the fair-
value movement of properties. Officials consider that this is a second-order
symptom of rising housing prices, and could be considered a windfall gain,
though the actual gain is as a result of capital gains which would not otherwise be
taxable, and declining house prices may be unwinding recent windfall profits.
59. Additionally, officials note that there is some initial evidence that the agricultural sector
may have derived windfall gains during and after the pandemic, though reviewing the
extent of those gains would require a specific research project given the breadth and
complexity of the sector in New Zealand.
60. If Ministers wish to examine a windfall tax in relation to any of these sectors additional
research would be required. Officials note that they have not had sufficient time to
comprehensively consider these sectors in this report, but initial views suggest that the
windfall tax options considered in the section above could be applied without significant
alterations.
T2023/53 Project Cricket Page 19
Next Steps
61. Officials are available to discuss this report and its findings at your request.
62. If you wish to progress a windfall tax on the banking sector officials will require
additional direction on the design of that proposal. Noting the various complexities
inherent in that exercise, we request that you discuss your initial preferences with us
ahead of any further commissioning.
63. If you wish to investigate ongoing supernormal profits in the banking sector, we
recommend you discuss a Commerce Commission-led market study into the banking
sector with the Minister of Commerce and Consumer Affairs’.
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Annex 1: Detailed assessment of potential arguments for the existence
of windfall profits in the banking sector
Did lower than expected impaired losses due to improved economic outlook in late 2020
through 2021 lead to windfall profits in the banking sector?
64. Nominal bank profitability fell significantly in 2020 as banks increased provisioning for
impaired loans in anticipation of a pandemic-driven economic downturn. During the
March to September 2020 quarters, the large banks added around $1.3b to
provisioning for impaired assets.
65. The improving economic outlook from late 2020 through 2021 allowed banks to reduce
their provisioning for losses, resulting in lower impairment expenses and increased
profits. For the five quarters from December 2020 to December 2021, impaired asset
expense for the large banks was negative, meaning revisions to estimated loan losses
added around $336m to profits over the period. For comparison, impaired asset
expenses for the large banks over the five quarters pre-pandemic (December 2018-
December 2019) reduced profits by $390m. If underlying impaired asset expenses had
remained at this level over December 2020 to December 2021, revisions to loan loss
provisions (e.g. due to an improving economic outlook) would have contributed around
$726m to profits over the period.
66. Whether the improved bank profits arising from lower provisioning for impaired asset
expense are a windfall depends on whether the profits were anticipated (with
corresponding actions taken to generate those profits).
67. The Treasury considers that bank profits arising from the improving economic outlook
in 2021-2022 are not a windfall because at the point the loans were issued, those
profits were anticipated. We think the point of loan issuance is the preferred starting
point for assessing any windfall profits because origination decisions are the main
action banks can take to manage impaired asset expenses. The majority of loans on
issue during the early pandemic had been issued well before March 2020, meaning the
improving economic outlook in 2021 would have restored some of the profitability
banks had anticipated at the time they issued the loans. For the improvement in
expected loan losses to be a windfall, the banks would have had to have anticipated
the pandemic when originating the loans prior to March 2020.
68. In addition:
a The improved profitability in late 2020 through 2021 was not unique to the
banking sector. The improved economic outlook in late 2020 benefitted many
sectors of the economy.
b Loan loss provisioning is subject to significant revisions as estimates rely on
economic forecasts and assumptions, which were particularly difficult during the
pandemic crisis.
c Low losses in part reflected significant actions by banks to support their
customers (businesses and households) through the pandemic, such as the
COVID-19 mortgage deferral scheme. This approach was encouraged by
Government and regulators.
T2023/53 Project Cricket Page 21
Did alternative monetary policy during the pandemic lead to windfall profits in the banking
sector? Were the benefits of alternative monetary policy not fully passed on to bank
customers in the form of lower interest rates and fees?
Large Scale Asset Purchase Programme
69. The Reserve Bank implemented the Large Scale Asset Purchase (LSAP) programme
in March 2020 to provide further support to the economy, build confidence, and keep
interest rates on government bonds low. The LSAP programme involved the Reserve
Bank purchasing New Zealand Government Bonds and Local Government Funding
Agency Bonds on the secondary market, funded through the electronic creation of
money and the crediting of banks’ settlement accounts with the Reserve Bank. The
LSAP programme results in:
a Increased bank assets – the money created to pay for these purchases shows up
as an asset to banks in their settlement accounts with the Reserve Bank, which
receives a floating rate of the OCR in interest payments from the Reserve Bank.
The LSAP increased bank settlement balances from an average of around $7.5
billion in the decade up to 2020 to around $50 billion in September 2022.
b Increased bank liabilities – the proceeds from the sale of the bonds are deposited
in the bank account of the seller of the bond, with these deposits being liabilities
to the bank.
c A switch in the type of assets held by the bank – if a bank is the seller of the
bond, their asset mix changes as they’ve converted a long-term fixed interest
asset (the bond) into a short-term floating interest asset (settlement cash).
70. From the perspective of the banks when executing a bond sale on behalf of a customer
under the LSAP programme, it effectively created additional floating rate assets (their
settlement balances with the Reserve Bank) and additional liabilities (in the form of
deposits held by the seller of the bond) at an unknown rate, either a fixed term deposit
or a floating on-call deposit or transactional account.
71. Rising interest rates have generated a loss on the LSAP transaction to the Crown, but
a corresponding gain to those parties who shifted their net asset position away from
long-term fixed low interest rate bearing assets. Because they weren’t locked-in to low
long-term fixed interest rates, those parties have benefitted from rising interest rates. .
As advised in T2022/2562, our latest best estimate of the expected direct fiscal loss
from LSAP is approximately $11.1 billion in higher interest payments.
72. There are three main ways in which the banks may have benefitted from the LSAP,
being.
a if the banks would have been holding low-interest, fixed-rate bonds if the Reserve
Bank had not purchased them, and/or
b if the banks materially shifted the structure of their assets and liabilities in
anticipation of increasing floating interest rates on settlement cash balances (e.g.
by increasing long-term fixed term deposits at the prevailing low interest rates).
c if the banks did not fully pass-on the increased interest rate on settlement cash to
customers in the form of higher deposit interest rates and lower fees, increasing
the banks’ net interest margin. The role of net interest margins in bank profitability
is discussed in the next section.
73. While the Crown is paying around $11.1 billion more in higher interest rates, it is not
clear who in the financial system is benefitting from it.
T2023/53 Project Cricket Page 22
74. We note that you have received advice from the Reserve Bank on interest on
settlement cash. We have not compared this option to the others identified in this
report.
Funding for lending programme (FLP)
75. From December 2020 to December 2022, the Reserve Bank offered three-year funding
to banks priced at the OCR in return for high quality collateral. The FLP was designed
to provide monetary stimulus by reducing bank funding costs and retail interest rates.
76. In effect, the FLP was a subsidy to banks for lending (and one that wasn’t available to
lending market competitors such as non-bank deposit taking lenders). The FLP in
effect guaranteed that relatively low-cost stable funding would be available to banks
even if funding conditions worsened, and that guarantee reduced the need for banks to
pay up for buffers of more expensive sources of long-term stable funding such as term
deposits or wholesale funding (even in the absence of actual drawdowns).
77. A key question therefore is whether banks profited from the FLP by not passing on the
benefit of lower funding costs to customers in the form of lower loan interest rates.
Reserve Bank research estimated that the FLP caused six-month term-deposit rates to
decline by 15 basis points and mortgage rates to fall by a similar amount following the
FLP announcement. The Reserve Bank’s recent review of monetary policy
2
noted “net
interest margins on bank lending have remained around their historical level, consistent
with ongoing pass-through of lower funding costs to lenders due to the FLP”.
78. Any impacts of the FLP on bank profitability have likely begun declining as the expiry
date of the programme approaches, meaning that banks need to start competing for
retail deposits more again.
Figure 6: Interest rates and the cost of funds
(Source: Reserve Bank – In Retrospect: Monetary Policy in New Zealand 2017-22, figure 37)
Increased loan volumes due to monetary and fiscal stimulus during the pandemic
79. Bank lending growth was high from late 2020 to late 2021 compared to pre-pandemic
lending growth (2017-2019) though not above the period of high credit growth in 2015-
2016. According to the Reserve Bank’s credit conditions survey, lending growth during
this period was largely driven by high demand for residential mortgage loans. However,
2
In Retrospect: Monetary Policy in New Zealand 2017-22
T2023/53 Project Cricket Page 23
total bank lending as a proportion of GDP remains equivalent to pre-pandemic levels
suggesting over bank lending has grown in line with the wider economy.
80. Credit growth during the pandemic (2020 onwards) was driven by residential lending, in
turn driven by low mortgage rates interacting with restricted housing supply. Business
lending declined. Demand for credit is expected to moderate as the economy slows
over the next year. In that context, policymakers are again looking to banks to support
customers and avoid tightening the supply of credit in a way that would worsen the
downturn.
Increasing net interest margins due to rising interest rates
81. Rising interest rates can support net interest margins
3
. Because banks have significant
amounts of transactional deposits earning low interest, sharp increases in interest rates
often boost short-term profitability. This effect may have been amplified by higher liquid
assets / settlement cash than is typical due to the LSAP programme.
3
Net interest margin measures the difference between the interest income a bank makes on its
lending and the cost of the funds used to finance that lending. NIM is therefore a key measure of how
profitable a bank is at its core business of borrowing and lending.
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Figure 7: Annual growth in bank and non-bank deposit taker lending by sector
(Source: Reserve Bank)
Housing Personal consumer Business Agriculture
T2023/53 Project Cricket Page 24
82. Increasing net interest margins (NIM) since Sep 2021 explain some of the increases in
profits, particularly for the June and September 2022 quarters for which the net interest
margin was above recent averages.
83. Comparison of lending and term deposit rates relative to a benchmark for the cost of
funds suggests recent increases in NIM are largely driven by lower term deposit rates.
The indicative margins on new or repriced mortgages and business lending were
relatively elevated in 2020 compared to wholesale interest rates but have fallen during
2022 (purple line below).
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Figure 8: Quarterly bank interest income and expense ratios and net interest margin
(Reserve Bank Income Statement Survey)
D1. Interest income to interest-earning assets D2. Interest expense to interest-bearing liabilities
D3. Net interest margin
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Figure 9: Residential lending interest rates and spread
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Home loan 2 year special rate 2 year swap rate Home loan spread
T2023/53 Project Cricket Page 25
84. On the other hand, the margin on term deposits, which were previously relatively
expensive for banks (a positive spread to wholesale funding, partly because term
deposits support banks’ liquidity/funding prudential requirements) improved over 2021
and 2022 (purple line below). We expect recent increases in NIM will be temporary as
depositors shift from low or zero interest accounts to higher interest term deposits in
response to higher interest rates. Moreover, sharp increases in interest rates will
provide a strong incentive for borrowers to shift to the most competitive rates.
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Figure 10: Term deposit interest rates and spread
(Source: Reserve Bank)
6 month term deposit rate 6 month bank bill Term deposit spread
