Thursday 11th April 2019
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Information released under the Official Information Act adds to the weight of evidence that there is scant analysis behind the central bank’s proposals to raise minimum bank capital requirements.
The information release was in response to an OIA request from former Reserve Bank official Michael Reddell.
In a blog-post called “The Emperor’s Clothes are Threadbare,” Reddell writes that although he had assumed that the central bank would have done “extensive and detailed analysis of its capital proposals,” ... “the evidence is increasingly against that presumption.”
The proposals include nearly doubling the minimum amount of tier 1 capital the big four Australian-owned banks have to hold from 8.5 percent of risk-weighted assets currently – and just 4 percent pre-GFC – to 16 percent.
The central bank also wants to reduce the benefits the big banks get from using their own internal methods of calculating risk weightings and it wants to forbid the use of hybrid securities in the make-up of tier 1 capital.
Hybrid securities, which normally behave like debt but which can be converted into equity or written off if required, cost about a fifth the cost of raising pure equity.
In February, Reserve Bank governor Adrian Orr’s latest monetary policy statement said the impact on bank pricing would be 20-40 basis points and deputy governor Geoff Bascand has subsequently said that any repricing would be “lost in the noise” of how banks price mortgages or the interest rates they pay on deposits.
Reddell had asked the Reserve Bank for documents supporting its estimates of the impact on bank’s lending margins and any material or analysis to support Orr’s claim that the proposals will be “well within the range of norms” seen in other countries.
In response to his Feb. 13 request, the Reserve Bank this week provided a scant five pages, much of which had already been publicly released later in February.
The first of these pages was a table: “Stylised example of the pricing impact of different required returns on equity.” The Reserve Bank provided no information on when the table had been prepared.
That table shows a fictitious bank balance sheet showing ROE in the year ended September was 13.4 percent and that, if that bank raised its tier 1 equity ratio from 11.4 percent to 17 percent but didn’t change its pricing, ROE would fall to 9.2 percent.
If that bank raised its average interest margin on lending from 4.4 percent to 4.62 percent and lowered its average interest rate margin on deposits from 2.64 percent to 2.43 percent, ROE would rise to 11 percent.
Reddell describes this table as “one page of arithmetic” and that it was “the sort of exercise a new graduate should have been able to churn out in a couple of hours.”
It includes no discussion or analysis about whether the scenarios used were correct, no engagement with estimates other analysts have come up with and no discussion of what difference it makes that the big four banks are all Australian owned, Reddell notes.
Nor does it discuss the impact of likely competition from non-banks not subject to the same capital requirements. “Breathtaking really,” he says.
This casts doubt on the validity of the Reserve Bank’s rubbishing of UBS analysis estimating that the banks would raise their mortgage lending margins by 80-125 basis points as being “an outlier.”
In a new note this week, UBS says it continues to stand by its analysis and adds that lending margins to the agricultural, particularly dairy, sector and to small-to-medium enterprises are also likely to rise.
“We believe it is unrealistic that the Australian banks will accept such a low ROE from their New Zealand subsidiaries, especially relative to retail and business banking ROE in Australia of 14-15 percent,” it says.
“With the major banks maintaining 86 percent market share in New Zealand, we do not believe competitive forces will be sufficient to offset such repricing while credit rationing is also likely.
“As a result, we continue to believe the economic impact of these bank capital proposals may be significantly larger than the RBNZ estimates, potentially putting pressure on both the RBNZ official cash rate and New Zealand dollar.
The broking firm says the banks’ reactions to Australia’s royal commission into financial services “demonstrate the banks’ desire and ability to pass through much of the cost” to customers.
It says the banks’ ROE on dairy loans in New Zealand is below their current cost of capital and that the new capital rules would take ROE into “the mid-single-digit range.”
That would mean either or both higher lending rates and credit rationing to the dairy sector.
“We believe this could put additional pressure on the dairy sector as it recovers from a period of low prices and over-borrowing,” UBS says.
KPMG partner John Kensington has suggested one reaction by the Australian banks to the capital requirements could be to sell their agricultural lending books to some overseas bank which would lack the history of lending through the generations to farmers that the Australian banks have.
Kensington suggested such an overseas bank would lack the tolerance to nurse farmers through hard times that the Australian-owned banks have demonstrated.
UBS now estimates the big four banks collectively will need to raise $21 billion more capital to comply with the proposals, which is in line with the Reserve Bank’s own estimates.
The rest of the information released to Reddell covers ratings agency Standard & Poor’s estimates of comparable bank capital ratios across a number of countries that had already been released publicly in February.
Consultation on the Reserve Bank’s capital proposals closes on May 2.
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