International credit rating agency Fitch says the Reserve Bank's proposals for increased bank capital adequacy ratios are "radical" and "highly conservative relative to international peers". Photo by Lynn Grieveson.

International credit rating agency Fitch says the Reserve Bank’s proposals for increased bank capital adequacy ratios are “radical” and “highly conservative relative to international peers”, but the result will ultimately be “significantly stronger buffers” against financial system shocks.

“The RBNZ’s proposals also go well beyond the international norm in addressing risk-weighted assets (RWA) differences between the banks that use the internal-rating based (IRB) approach – the four major banks – and banks using the standardised approach.”

Fitch says the changes, which are subject to consultation until March before final decisions in June next year, will require New Zealand banks to add some $20 billion of top quality Tier 1 capital to their balance sheets over 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.

The total is likely to be greater as the banks grow.

The agency does not expect the large banks to find this change difficult to accommodate, although it may both raise lending rates “to help earn a commensurate return on the capital invested, which in turn could incentivise the smaller banks to follow”.

“Over time, this might also weigh on loan growth,” Fitch director Jack Do says in commentary on the proposals, which were released last Friday.

For second-tier banks, so-called “domestic systemically important banks” (D-SIBs), Fitch notes that the higher capital requirements and, in some cases, their mutual ownership may present some challenges to meeting higher capital adequacy ratios that may, in turn, erode their competitiveness relative to the big four banks, ANZ New Zealand, Bank of New Zealand, ASB Bank, and Westpac.

Investor appetite for a new Tier 1 instrument that could be used by D-SIBs “remains uncertain,” says Fitch.

In separate commentary issued on the proposals yesterday, the BNZ’s interest rate strategist Nick Smyth agreed lower lending and higher interest rates were likely and that while full economic impacts were uncertain, “the changes are a headwind” to economic growth and may prompt the RBNZ to move more slowly to raise the benchmark interest rate, the official cash rate.

A lower “neutral OCR” may also be implied, said Smyth.

If growth were affected and there was less offshore debt issued by New Zealand banks, that could create the conditions for a weaker New Zealand dollar, while restrictions on the amount of debt that could be held on bank balance sheets as Tier 1 capital may dampen demand for New Zealand government bonds and “other liquid assets for prudential purposes”.

“The RBNZ’s survey of international studies suggests that a reasonable estimate is that a 1 percent increase in Tier 1 capital from current levels would increase the price of bank credit by 6 basis points,” said Smyth. “That would point to an approximately 25 basis point increase to large banks’ overall funding costs based on an increase from the current ratio to the proposed 16 percent minimum. Were banks to hold a hypothetical 2 percent buffer, for instance, that would point to an approximately 40 basis point increase in banks’ funding costs.”

Leave a comment