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'Excessive' RBNZ bank capital proposals to add up to 1.25% to mortgage rates: UBS

Thursday 17th January 2019

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The Reserve Bank's proposal to require New Zealand trading banks to run much more conservative balance sheets can be expected to add between 0.8 and 1.25 percentage points to home mortgage rates, the Australian arm of Swiss banking giant UBS says.

"We believe the RBNZ's endeavours to strengthen the banks could come at a significant cost to the New Zealand economy as they appear to be materially underestimating the likely mortgage repricing," UBS says in a note from its Sydney-based analytics team.

Announced just before Christmas, the proposed changes would require the New Zealand's four largest banks - all Australian-owned - to add some $20 billion of top-quality Tier 1 capital to their balance sheets during the next five years, $6 billion of that to replace non-compliant instruments that the proposals would no longer treat as having Tier 1 status, based on their current size.

UBS questions why the RBNZ has set the proposed threshold to be "the highest in the developed world", based on "academic hypotheses" and to a level the bank suggests is "excessive".

The UBS analysis challenges the claim by RBNZ governor Adrian Orr that the new capital adequacy ratios will have "only a minor impact on borrowing rates for customers".

All four banks would need to raise more capital, all of which would be targeting a rate of return of around 11 percent in current investment markets.

"We think investors will demand at least this return," said UBS. "We estimate banks will need to reprice their NZ mortgage books by around 80 basis points" to generate a 12 percent group return on equity and by "125 basis points to maintain current ROE".

In other words, today's ANZ Bank floating interest rate for home mortgages of 5.79 percent could be expected to rise to between 6.59 percent and 7.04 percent - a level not seen for a decade since the global financial crisis in 2008 sparked a historic fall in interest rates.

New Zealand weathered the GFC relatively well compared to other parts of the developed world financial system because its banks had strong balance sheets, in part because of stringent standards set by the regulators of their Australian parents.

While UBS acknowledges the banks would be under both regulatory and political pressure not to raise lending interest rates, they would respond to such restriction by lending less, with potentially a "materially adverse impact on the economy".

UBS also challenges the RBNZ's view that the changes would have no material impact on group capital requirements.

"We disagree, as migrating group capital to New Zealand would reduce the capital maintained" on Australian parent banks' balance sheets. "A stronger New Zealand would be dilutive to Australia unless fresh capital is raised."

Lower dividends to shareholders could also be expected, in proportion to the extent of new capital-raising required. It estimates Bank of New Zealand's owner, the National Australia Bank, would have to reduce dividends by 29 percent, while ANZ Bank would be looking at an 11 percent dividend cut.

UBS speculates that if the New Zealand banks' Australian owners were unable to earn adequate returns on capital, they might look to sell out of the New Zealand market - a move that UBS acknowledges could be welcomed by New Zealanders who would see this as "regaining control of their banking system from Australia".

However, if forced to stand alone, New Zealand banks would face higher funding costs and would lose access to the implied guarantee provided by their Australian owners, in the event of a severe economic downturn.

"This implicit guarantee is very valuable to New Zealand."

The UBS analysis echoes the early response of the international credit rating agency Fitch, which last month called the RBNZ proposals "radical".

The RBNZ justified the proposed changes, saying "bank crises happen more often than people care to remember" and that the proposals were expected to make the New Zealand banking system "resilient to shocks that might occur only once every 200 years".

Submissions on the proposals close on March 22.


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