The Reserve Bank has softened the blow to bank profits, dividends and mortgage rates slightly by tweaking its capital upgrade proposals. Bernard Hickey reports.

After over a year of heavy lobbying by banks and many in business opposed to tougher capital rules for banks, the Reserve Bank has softened the blow a bit.

Its final decision released at midday allowed the banks to raise $9 billion of its required $20 billion capital upgrade through cheaper forms of equity, and will allow the banks seven years to adjust, as opposed to five years under last year’s proposal.

The end result is an expected 20.5 basis point increase in mortgage borrowing costs, down from 32 basis points in the original proposals. That also increased the net benefits to the economy from around 0.22 percent of GDP per year to 0.43 percent per year. That is equivalent to around $1.3 billion of benefits to New Zealanders each year by reducing the risk of a banking crisis from around once every 55 years to once every 200 years.

The banks are likely to be grudgingly happy about the reduced costs to their shareholders and the longer adjustment period. The Reserve Bank will be happy it hasn’t ‘caved’ on its requirement for a $20 billion capital upgrade to ensure New Zealand’s risk reduces to once in 200 years, rather than the once-in-100 years argued for by many.

The main changes included:

* Allowing banks to use $9 billion worth of redeemable perpetual preference shares as Tier One capital out of total extra capital of $20 billion. The previous proposal would have allowed the banks to raise $6 billion through non-redeemable perpetual preference shares. But that earlier proposal was opposed by the banks on the grounds this type of preference share issue was un-saleable if it was non-redeemable. The change is to make it redeemable and for the banks to use $9 billion rather than $6 billion, which is effectively increasing the lower quality capital source from 0 to $9 billion. The real effect is to lower the cost of capital for the banks from the upgrade.

* Lowering the main Tier 1 capital requirement for non-systemically important banks (i.e. the small ones outside the big four such as Kiwibank, Heartland and SBS Bank) to 14 percent from 15 percent. The Tier 1 requirement for big banks was unchanged at 16 percent. Those big banks also have to have a 2.0 percent of capital buffer for being systemically important, which is up from one percent in the earlier proposal. The small banks also have to have a prudential capital buffer of 2.0 percent.

* The transition period has been lengthened to seven years (July 1, 2027) from five years.

* Removing the requirement for a leverage ratio.

Overall, the final decision retained the following changes proposed last year:

* The big four banks will require 16 percent tier one capital, up from a minimum of 8.5 percent. Banks currently have around 14.1 percent tier one capital, given they like to hold a significant buffer over the minimum required to keep a banking license.

* The big four banks will have to report their capital using both their own internal models and the more conventional Reserve Bank model, which is the one the smaller banks use.

* Removing the ability for banks to issue contractual contingent (so-called Co-Cos) instruments to raise capital.  

The Reserve Bank is due to hold a news conference at 1pm. We will update that further then.

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