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ASB says RBNZ estimates of bank capital impact are too low

Tuesday 16th April 2019

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ASB Bank says the likely impact of the Reserve Bank’s proposals to near double the minimum amount of capital banks must hold will be considerably higher than the central bank’s estimates.

However, ASB’s calculations of the likely impact on the cost of borrowing are lower than those of broking firm UBS.

While the Reserve Bank has estimated a 20-40 basis point increase in borrowing costs, ASB thinks the impact will be more like 50 points, although the risk is a higher impact and the effect may be uneven across the economy.

“The range of plausible estimates is wide – anything from 25-75 basis points for lending interest rates and 15-60 basis points for the cost of funds,” ASB says. The impact on the cost of borrowing will most likely be 50-75 points higher, it says.

That would increase the annual interest payments on a $500,000 mortgage by $2,500-$3,750.

UBS has estimated the changes could lift mortgage lending margins by 80-125 basis points, an estimate UBS stands by despite the Reserve Bank dismissing it as “an outlier.”

ASB’s estimate comes as the Reserve Bank has again extended the consultation period on its proposals from May 3 to May 17 after a “small number" of banks and interested organisations requested more time, according to deputy governor Geoff Bascand.

“Given the importance of the issue we want to ensure everyone has an opportunity to deliver a well-considered submission. We remain open to information sharing so as to best make informed decisions,” Bascand said.

The Reserve Bank has received 42 submissions to date.

It is proposing that the four major banks, which are all owned by Australia’s four major banks, should lift their minimum tier 1 equity capital from 8.5 percent current to 16 percent.

The average amount of tier 1 capital is currently is about 12 percent and the banks are likely to want to hold more than the minimum – ASB is assuming about 17 percent.

It says another likely impact during the transition – the Reserve Bank has proposed a five-year phase in period – is that the banks could ration credit.

ASB points out that a mortgage to somebody with a less than 20 percent deposit requires a bank to carry about four times the amount of regulatory capital as for a mortgage to somebody with a more than 40 percent deposit.

“When it comes to capital, loans are not created equally,” ASB says. “When faced with the need to adjust their capital ratios quickly, banks are likely to use their – scarce – capital as efficiently as possible.”

That could mean rural lending, lending to higher-risk businesses and to mortgagees with small deposits “are sectors most at risk of being impacted by the transition to higher capital requirements,” ASB says.

KPMG partner John Kensington, who heads the accounting firm’s banking and finance team, has made the same point that riskier types of lending will probably be harder to get if the capital requirements are increased.   

One reason that ASB arrives at a larger impact than the Reserve Bank’s calculations is that it isn’t putting as much faith in what is known as the Modigliani-Miller Offset, named after the two economists who devised the theory in 1958.

Essentially, that theory is that if banks have to hold more capital, that will make them safer and therefore investors will be happy to accept lower returns.

ASB chief economist Nick Tuffley says he doesn’t think the risk premium investors demand for investing in New Zealand banks will fall very much.

It’s extremely unlikely investors will accept a lower risk premium from smaller New Zealand banks over their much larger parents, he says.

ASB says the cost of bank funding is “typically higher for New Zealand banks relative to their Australian banks given the smaller size of the NZ banking system, NZ’s lower credit ratings and its greater perceived illiquidity.”

It estimates the one-off permanent reduction on New Zealand’s GDP would be up to 1.1 percent once the new capital rules are fully implemented, significantly larger than the 0.3 percent reduction the Reserve Bank has predicted.

While the full impact of higher bank capital requirements will take time to "percolate through the economy", ASB says the pending change was a factor in the change to its forecast profile for the official cash rate, "including 50 basis points of cuts over 2019 and the OCR then on hold at 1.25 percent until 2022.” 

ASB has also lowered its estimate of what constitutes a neutral OCR level from 2.75 percent to 2.25 percent.

Late last month, the Reserve Bank changed its rate stance from neutral to expecting the next move in the OCR will probably be down.


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