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NZ banks use covered bonds, retail deposits as funds buffer

Wednesday 9th May 2012

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New Zealand banks have increased their use of covered bonds and retail deposits to pay for their lending programmes as the cost of sourcing money from overseas threatens to keep rising.

Reserve Bank Governor Alan Bollard said New Zealand's financial stability has improved since the last report in November as policy programmes in Europe allay fears of a market breakdown. Still, the fragility of the situation in the Northern Hemisphere is far from over, and that could continue to push up wholesale funding costs for local lenders.

Any disruption to global funding markets was singled out as a "key risk" to New Zealand banks.

"Funding costs have increased significantly in the past year and renewed funding market dysfunction could see funding costs increase further," the bank said in its May financial stability report. "Ongoing caution towards bank debt on the part of investors has seen issuance move to more senior forms of debt - particularly covered bonds which are cheaper than other forms of bank debt."

The heavier reliance on covered bonds and retail deposits has enabled New Zealand banks to cover most of this year's funding needs, and means most banks will be able to meet the Reserve Bank's higher core funding ratio of 75 percent from January next year.

The ratio was introduced to ensure local banks didn't rely too heavily on short-term wholesale loans, which could put them under pressure if the financial system collapsed as it did in the 2008 global financial crisis.

New Zealand's banks have until the end of the year to extend the maturity on about 20 percent of their existing long-term wholesale funding, when it will no longer quality for the core funding ratio. By the end of 2015, about 70 percent, or $38 billion, of funding will need to be refinanced.

Rising spreads on bank debt has encouraged has encouraged large companies that issue their own debt to bypass lenders as a source of funding, and instead go directly to the market.

The spread-to-swap ratio in the secondary market for New Zealand bank's covered bonds was as much as 195 basis points as at April 18 for Bank of New Zealand's 2018 note, whereas the spread-to-swap ratio for Transpower New Zealand's 2018 bond was 135 basis points.

New Zealand bank lending grew 3.3 percent in the year ended Feb. 29 after negligible growth previously, though it's still "subdued in comparison with the pre-crisis period and lower than normal for this stage in the economic cycle."

The Reserve Bank plans to have its open bank resolution (OBR) policy by the end of the year, and will require all registered lenders with retail funding of more than $1 billion to have OBR functionality in place by June 30 next year.

The OBR policy would formalise the Reserve Bank's existing powers to close a failing bank temporarily and impose a financial 'hair-cut' across its investors and depositors, to allow a swift reopening, which would hopefully prevent a bank run while sheltering taxpayers from the cost of a government bail-out.

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