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Singapore-based economists say banks are exaggerating the impact of higher capital

Friday 26th July 2019

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The Australian-owned banks in New Zealand are exaggerating the likely impact of the Reserve Bank’s bank capital proposals, according to Singapore-based economists Ben Udy and Marcel Thieliant.

“The RBNZ anticipates only a minor impact on bank lending rates. In contrast, modelling by the banks indicates that the increase in capital would be equivalent to 50-100 basis points of interest rate hikes,” the economists at Capital Economics say in a note.

“What’s more, a number of the Australian parent banks said they may need to reduce the size of their business, demerge or sell their New Zealand division if such changes went ahead. That would be a significant blow to competition in the banking sector in New Zealand and would push up lending rates further,” they say.

RBNZ is proposing to near double the minimum amount of common equity tier 1 capital the four major Australian-owned banks have to hold from 8.5 percent to 16 percent of risk-weighted assets while the smaller banks would need to hold 15 percent.

“We think those concerns are exaggerated. Capital ratios vary across countries and are not perfectly comparable,” they say.

Looking at the relationship between capital ratios and net interest margins in a sample of 16 advanced economies, including Australia and New Zealand, “there’s no evidence that higher capital ratios are associated with larger lending spreads.”

They say the experience in Australia is also that higher capital requirements don’t result in higher lending spreads, citing what happened when in July 2015, the Australian Prudential Regulation Authority told the four large banks they would have to increase their capital ratios by two percentage points.

“Banks duly responded by issuing more shares. Net interest margins edged up afterwards but have fallen back again recently,” the economists say.

Nor did banks tighten lending standards. “What’s more, lending to business remained healthy, which is encouraging because lending to non-rated corporates carries a higher risk weighting than the bulk of mortgage lending.”

Banks in New Zealand are among the most profitable in the world and generated a return on equity of 14.2 percent in the first quarter, they say, citing a range of sources including RBNZ, the Reserve Bank of Australia, APRA, the European Central Bank and the IMF.

“The experience from Australia suggests that banks will respond to higher capital requirements by accepting a permanently lower return on equity than by raising lending rates,” the economists say.

“If banks raise their capital by 60 percent, their return on equity would fall to 9.1 percent, all else equal. That would still be reasonably high by international standards.”

RBNZ has made similar arguments, saying that more capital will make the banks safer and that therefore investors would accept a lower return.

They also think RBNZ may water down its proposals and cited the example of APRA which earlier this month modified its proposals for increased bank capital, now requiring total capital to increase by three percentage points of risk-weighted assets by January 2024.

Previously, APRA had been targeting a four or five percentage point increase in bank capital, significantly less than the more expensive 7.5 percentage point increase RBNZ is proposing.

Another key difference is that APRA expects the Australian parent banks to meet its target by selling tier 2 hybrid securities, instruments that usually behave like debt but which can be converted to equity.

RBNZ takes a dim view of hybrid securities and wants all the additional capital the New Zealand subsidiaries will need to be tier 1 common equity only.


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