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S and P sees biggest gain from tweaking capital buffers in RBNZ’s new tool-kit

Wednesday 5th June 2013

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Ratings company Standard & Poor's has given the Reserve Bank the thumbs up over its new set of tools to help deflate potential asset bubbles, and sees the most benefit coming from adjusting how much capital lenders are required to keep on their books.

The benefits of the central bank's macro-prudential tools outweigh the downside risks and may help limit excessive asset prices by forcing a re-think on pricing and risk appetite and slowing credit growth, S&P said in a report on the policy.

It sees the most effective tools in taming a potential bubble in the first instance would be the introduction of counter-cyclical capital buffers, where banks hold more capital when the credit cycle has peaked, or adjusting sectoral capital requirements, where banks hold extra capital against sector specific lending.

"We believe the latter could be more favoured if both timeliness and specificity are desired - which we suspect they are, particularly in the context of recent aggressive house price inflation in Auckland and Christchurch," the report said. "However, with housing prices in other cities more subdued, a broad-based approach may have an overall effect beyond that intended."

The Reserve Bank signed a memorandum of understanding with Finance Minister Bill English last month on how it will use the tools. The regulator is looking at ways to cool the country's heating property market without hiking interest rates, which could stoke demand for an already over-valued currency.

Governor Graeme Wheeler has signalled his discomfort with the rapid increase in the level of high loan-to-value ratio lending, and the bank has already tweaked its requirements for how lenders calculate their risk-weightings on high LVR loans, meaning they will need to hold more capital.

S&P said imposing restrictions on the level of low equity mortgages is likely to happen in the short-term and could be "considered a quick win and an appropriate measure." Still, the rating agency expects its effectiveness would be limited relative to imposing capital controls on the housing sector if done in isolation.

Bank of New Zealand and Heartland New Zealand would be the best placed major and regional banks respectively to weather restrictions on low equity lending, while The Cooperative Bank and TSB Bank would also be less likely to feel the effects than others, S&P said.

Sectoral capital requirements on housing would be felt most keenly by the regional banks, excluding Heartland, because of their exposure to residential lending, and could cause the major lenders to compete more aggressively for other business. That could make it more difficult for the smaller regional banks to diversify, S&P said.

The rating agency didn't think increasing the core funding ration would limit excessive credit growth, with most banks already above the minimum requirements.

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