Wednesday 27th February 2019
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UBS is sticking to its analysis of the likely impact of the Reserve Bank’s proposals to double minimum bank equity levels.
It says the interest bill on a $500,000 mortgage could go up by as much as $6,100 a year.
The central bank has rubbished UBS’ work as “an outlier,” but UBS calculates that even if the RBNZ’s own much lower assessment proves correct, that will still raise the annual interest cost of a $500,000 mortgage by $2,000 a year.
The UBS analysts also say it is “highly unlikely” the central bank will change its capital proposals.
The Reserve Bank says its proposal to require banks’ tier 1 capital to be comprised solely of equity and to rise from 8.5 percent of total capital currently to 16 percent over five years will raise lending margins by 20-40 basis points. Deputy governor Geoff Bascand said on Tuesday that this will amount to “little more than noise.”
UBS analysts Jonathan Mott and Rachel Finn say that even on the Reserve Bank's own numbers, that is likely to mean that New Zealand mortgage rates will have to rise by 38-75 basis points, but it thinks the more likely increase will be 86-122 basis points – the upper end of its assessment would push the 4 percent interest charge on a mortgage up to 5.22 percent, all other things being equal.
That’s a minor change from their January assessment of 80-125 basis points when they said the RBNZ proposals “appear unnecessary and potentially damaging.”
“We acknowledge the theoretical arguments that net interest margin widening will be absorbed by depositors, creditors as well as borrowers,” the analysts say.
Given that the banks’ Australian parents will also have to meet the Australian Prudential Regulation Authority’s capital requirements to make them “unquestionably" strong, “this is highly unlikely,” their report says.
“We believe mortgagors and SMEs – small and medium-sized enterprises – will again bear the brunt of this repricing,” it says.
The Reserve Bank’s view is that with better capitalised and “safer” banks, shareholders, depositors and creditors would accept lower returns and that competitive pressures would limit their ability to pass on the higher costs of capital.
UBS points out the central bank is relying on analysis done in 1958 by economists F. Modigliani and M.H. Miller.
Available evidence suggests what actually happens is different. For example, since 2014, both increased regulatory requirements and their own growth has meant the major Australian banks have had to raise an additional A$50 billion in common equity.
Westpac was quite explicit in October 2015 that it was raising its mortgage rates because of increased capital requirements – higher capital requirements “will increase the cost of providing mortgages,” Westpac said the same day it raised an addition A$3.5 billion of equity.
The RBNZ has estimated the extra capital the big four Australian-owned banks will need to raise to meet its current proposals would be about $20 billion and has said this could be met by the banks retaining 70 percent of earnings over the five-year phase-in period.
UBS says other alternatives the banks could choose are repricing, rationing credit – if the banks stopped lending – switching corporate and institutional business via Australia or demerging their New Zealand subsidiaries.
“We believe that each of these options is likely to have an economic impact on New Zealand which is larger than currently assumed by the RBNZ.”
The central bank’s estimate is a one-off reduction in GDP over the longer term of 0.17 percentage points.
UBS’ analysis shows the banks’ implied return on equity (ROE) currently is 13.1 percent and net interest margin (NIM) is 2.17 percent.
If the lower end of RBNZ’s estimate is what actually happens, NIM would rise to 2.37 percent and the implied ROE would fall to 10.5 percent. At the upper end of the Reserve Bank’s estimate, NIM would rise to 2.57 percent and ROE would still be lower at 11.7 percent.
But if the banks wanted to maintain ROE at the current 13.1 percent, NIM would have to rise to 2.82 percent, potentially lifting mortgage interest rates by 122 basis points.
The Australian-owned banks account for about 88 percent of New Zealand’s banking system.
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