Final decisions on the Reserve Bank’s proposed capital requirements for banks won’t be made until the September quarter but they are already having an impact on capital markets.

They are one reason that New Zealand 10-year wholesale interest rates fell to a record low on Wednesday.

The day before the central bank announced its proposals on Dec. 14, the 10-year swap rate ended trading at 2.78 percent. It closed yesterday at 2.31 percent and was recently quoted at 2.335 percent. 

The Reserve Bank proposes to double the minimum amount of tier 1 capital that the four major banks have to hold from 8.5 percent to 16 percent of risk-weighted assets with a phase-in period of five years.

Fergus McDonald, head of fixed interest at Nikko Asset Management, says part of the impact of the new policy proposal is the uncertainty it has introduced.

“If it goes through, and I think the Reserve Bank is pretty adamant, it will have a number of effects. Banks will want to maintain their return on equity so lending margins will probably rise somewhat and deposit rates may fall somewhat,” McDonald says.

The banks will also look at cutting costs wherever possible.

The Reserve Bank has said it expects the policy will have little impact on lending rates, but that if it does, it would react by cutting its official cash rate. The central bank has also said that safer banks should mean investors would be content with lower returns.

McDonald says a rise in mortgage rates, for example, in response to the policy would probably take the place of any increase in the OCR.

Vicky Hyde-Smith, head of fixed interest at AMP Capital New Zealand, says there are many other factors driving longer-term interest rates lower, not least increasingly gloomy stances from the Federal Reserve, the European Central Bank and the Reserve Bank of Australia on the global growth outlook.

The market has already fully priced in a cash rate cut in Australia and has partly priced a second cut, helping to explain why the Australian 10-year swap rate has fallen even further – it was at 2.68 percent on Dec. 13 and was recently quoted at 2.21 percent.

In New Zealand, the market has priced in about a 50 percent chance of a single rate cut, although that’s up from about 40 percent before the bank capital proposals were announced.

The cash rate is at 1.75 percent in New Zealand and 1.50 percent in Australia. 

Standard & Poor’s Corp raised its outlook for New Zealand’s sovereign credit rating of “AA” from neutral to positive on Jan. 31 – another reason for yields falling so much.

But the bank capital proposals “added fuel to the fire” and led to the view that it will mean a lower neutral level for the OCR, Hyde-Smith says.

David Lewis, portfolio manager at Milford Asset Management, says that “the RBNZ capital proposals have impacted the way people are thinking about the prospect of rate cuts in the next couple of years but I wouldn’t call that the major driver.”

The shift towards a more accommodative monetary policy stance – which means a greater propensity to cut interest rates – has been the main driver, Lewis says.

Another of the Reserve Bank’s proposals is that banks’ tier 1 capital should be made up solely of common equity.

The central bank made it clear through the fiasco in 2017 over Kiwibank’s quasi-equity, or hybrid securities, that it doesn’t like such instruments, which usually act as debt but can be converted into equity as required.

The Reserve Bank had pre-approved Kiwibank’s hybrid securities years before but then suddenly changed its mind about whether they counted as capital in March 2017 and then changed its mind back again to accepting they did count as equity in August that year.

Lewis says that’s one aspect of the proposals he is unhappy about.

“We have invested in those sorts of securities – basically every other jurisdiction has allowed them,” he says.

Indeed, while the Australian Prudential Regulation Authority is also proposing to raise capital requirements of the parents of New Zealand’s major banks, it is maintaining minimum tier 1 capital at 6 percent of risk-weighted assets and is assuming most of the additional capital raised will be hybrid securities.

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