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Fitch may change its NZ bank ratings if capital requirements become too onerous

Thursday 4th April 2019

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International ratings agency Fitch Ratings is warning it may downgrade its ratings of New Zealand’s big four banks if the Reserve Bank’s minimum capital requirements become so onerous that their Australian parents look to divest them.

In reaffirming the “AA-“ ratings of all four of New Zealand’s largest banks, with a stable outlook, Fitch emphasises that’s largely because of the strong support of their parents, which are Australia’s four largest banks.

The Reserve Bank is proposing to increase the minimum tier 1 capital of the big four from 8.5 percent of risk-weighted assets to 16 percent, as well as increasing risk weightings.

When the proposals were released last December, Fitch described them as “radical,” “highly conservative relative to international peers,” and said that they “go well beyond the international norm.”

Now Fitch says it’s difficult to compare New Zealand banks’ capital position with international peers “due to the different treatment of capital and risk-weight calculations across global regulators. However, the major banks compare favourably on unrisk-weighted capital ratios.”

That’s a point made in a 2017 report by PricewaterhouseCoopers commissioned by the New Zealand Bankers’ Association.

It said the way New Zealand banks measure capital is more conservative than banks in other countries and, if their common equity levels were measured on a like-for-like basis, tier 1 capital would already be above 16 percent.

The New Zealand banks’ reported capital at the time PwC wrote its report was 10.3 percent. A Reserve Bank paper released yesterday says it is now 12.2 percent.

Fitch says the New Zealand banks benefit from a strong level of ordinary capital support from their parents and that it may change their ratings should it change its view of their importance to their Australian parents, if the cross-border regulatory approach changes “or if the RBNZ’s final capital proposals are so onerous that there is a significantly increased chance of the parents divesting their New Zealand operations.”

Another reason Fitch could change its ratings is if there’s a prolonged closure of international wholesale markets.

“The major banks’ funding profiles are a weakness relative to similarly rated international peers, due to the reliance on offshore wholesale funding,” it says.

“This is unlikely to change significantly in the medium term.”

Offshore funding accounted for about 40 percent of the big four New Zealand banks’ total funding before the GFC and it has since fallen to 22 percent, according to the Reserve Bank’s latest Financial Stability Report.

“The funding risks are well-managed through a diversification of maturity, currencies and product. Liquidity management is sound and most of the banks’ liquid asset holdings are high quality and sufficient to cover capital market debt maturing within 12 months,” Fitch says.

"The affirmation of the four major banks’ issue default ratings and support ratings reflect Fitch’s opinion that there continues to be an extremely high likelihood of support from the banks’ Australian parents, if required,” Fitch says.

“Fitch sees the banks as key and integral parts of their banking groups, having strong integration across management, risk frameworks and treasury teams,” it says.

“The prospect of support is bolstered by strong linkages between the Australian and New Zealand banking regulators, which Fitch believes would work together to ensure the stability of both financial systems.”

Fitch says the four major banks’ large market shares – they account for about 88 percent of New Zealand’s banking system – “and pricing power allows them to generate sustainable profits through the cycle without weakening risk appetite.

“This in turn supports asset quality and capitalisation. The banks share common drivers, reflecting their similar business models and strong domestic franchises,” it says.

The ratings agency says it expects New Zealand’s GDP growth will be flat over the next two years and that the banks’ operating environment will remain broadly supportive because of the strong labour market and low interest rates.

“Nevertheless, macroeconomic risks remain elevated due to the high leverage in New Zealand households.” Fitch puts household debt at about 164 percent of disposable income at Sept. 30, 2018 and says that’s higher than most global peers.

“High leverage means households are susceptible to an interest rate or labour market shock, weakening the ability of households to service their debts. Such a shock could also lead to weaker levels of consumer spending and economic growth, which would adversely affect the banks, although this scenario is not Fitch’s base case.”


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