Australia's response to financial system inquiry, making banks hold more capital, could drive up NZ interest rates

Thursday 22nd October 2015

The Australian government's response to the financial system inquiry could drive up interest rates at New Zealand's biggest lenders as their Australian parent banks seek higher returns because of the requirement that they hold more capital.

The Australian Federal Government has largely accepted the recommendations of the inquiry set up in late 2013 to conduct "a root and branch examination" of Australia’s financial system and chaired by former Commonwealth Bank chief executive David Murray. As well as agreeing to improve the resilience of the financial system, the coalitionwill take up advice to make Australia's pension system more efficient, stimulate financial system innovation, ensure consumers of financial products such as credit and debit cards are treated fairly, and strengthen regulators.

While their New Zealand operations come under the jurisdiction of the Reserve Bank in Wellington, it is likely some of the impact of changes in Australia will be exported across the Tasman, says David Tripe, associate head of Massey University's School of Economics & Finance.

"It would be a reasonable assumption, if banks need to hold more capital they are likely to up their returns a bit too across the business as a whole," Tripe said. "That in general is likely to push up interest rates, although not by a huge amount."

Australian Treasurer Scott Morrison said this week that while Australia's financial system was "strong, stable and well regulated," it did have potential vulnerabilities. Banks sourced much of their funding offshore and accounted for almost 90 percent of domestic credit for local firms and households. Home loans made up 60-70 percent of total lending, which "creates some concentration of risk in the system" and meant Australia needed a stronger regulatory framework than other countries.

In July, the Australian Prudential Regulation Authority (APRA) lifted the average mortgage risk weight on residential mortgages for the big four lenders to 25 percent from about 16 percent, a move it estimated would require Australia & New Zealand Banking Group (ANZ), Commonwealth Bank (CBA), National Australia Bank (NAB) and Westpac Banking Corp to increase their overall capital by 80 basis points. APRA ultimately wants the banks to lift their capital by 200 basis points to ensure they rank among the world's most secure, a target that may imply A$30 billion of extra capital.

The banks haven't waited for the government response to the inquiry to increase their capital. This month, Westpac announced raised A$3.5 billion discounted rights offer that would lift its common equity Tier-1 ratio by about 100 basis points to more than 14 percent, which the lender said would put it in the top quartile of banks globally. CBA raised A$5 billion in an entitlement offer in August that followed NAB's A$5.5 billion share sale and ANZ's A$3 billion. Funds raised are also for other classes of capital to meet the Basel III requirements of the Basel Committee on Banking Supervision.

Westpac had earlier raised A$2 billion from dividend reinvestment plan and A$500 million from the partial sale of BTIM toward its target of A$6 billion raised this year, and this month became the first of the big four banks to raise home loan rates to protect its margins in the face of increased capital. From Nov. 20, Westpac will hike its variable home loan and residential property loan rates by 20 basis points, saying the lift in mortgage risk weights amounted to an increase of more than 50 percent in the amount of capital required to be held against mortgages.

In July, Westpac chief financial officer Peter King said the cost of holding more capital "will inevitably be borne by customers and shareholders".

New Zealand Bankers' Association chief executive Kirk Hope said the requirement for more capital does in theory imply higher interest rates but in reality, in the New Zealand market, competition in the lending market is weighing on interest rates.

"Credit growth is quite flat and there's a lot of competition in the market for market share," Hope said. "One of the consequences is to dampen interest rates."

He said there may be some issues in relation to surcharges on credit cards, such as those imposed by merchants for online payments over and above the cost imposed by banks.

Massey's Tripe also said card charges are a live issue here, especially with the arrival of 'card waving' technology, which can attract fees for debit card transactions that were previously free. While 'card waving' had been adopted by supermarkets and petrol station chains, small retailers "were rather less enthusiastic," he said.

Australia's plans also include clamping down on financial advisers, their obligations to consumers, commissions on sales of products and boosting the powers of Australian Securities & Investments Commission to ban miscreants from the industry.

Hope said in some ways New Zealand is ahead of Australia in that it had already created a new financial adviser framework in the wake of the finance company collapses.

New Zealand also has its own review underway - the review of the Financial Advisers Act 2008 and the Financial Service Providers (Registration and Dispute Resolution) Act 2008. The Ministry of Business, Innovation and Employment is scheduled to release an options paper in late November.

BusinessDesk.co.nz

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