The New Zealand Reserve Bank’s long-signaled move to increase capital reserve ratios has in the end proven slightly less severe than some banking sector experts predicted. But it remains unclear what impact the move will have on interest rates.

Ultimately the banks will have to raise around $20 billion to reach the new safety requirements, the Reserve Bank announced in December. But they will now have seven years to do it, not five as originally suggested. And instead of needing to source the new capital solely from equity, they will now need to find roughly $11 billion of equity and can create the remaining $9 billion through issuing preference shares.

There are 26 banks operating in New Zealand, with 14 in the retail market. And it’s no surprise that the bulk of the increased capital demands will fall on the big four Australian-owned banks. The major banks in the sector will have to increase their total capital to 18 per cent, from a minimum of 10.5 per cent now.

But smaller banks such as TSB, Co-operative, Kiwibank, and SBS, will under the new regime require total capital of 16 per cent, which is up from what they hold now but below the larger banks.

What impact will the changes have on banking?

There are differing opinions on what impact the changes will have on the banking and wider financial services sector, what is certain however is that the result will be largely dictated by the response of the big banks.

It is likely that lending will be directed away from sectors where return on equity is low, with the capital requirements diminishing returns in sectors where risk re-pricing is not possible. Highlighted sectors include agriculture, small business lending, and unsecured consumer loans.

Within property lending itself, more emphasis is expected be placed on lower-risk sectors such as residential mortgages, rather than construction lending, which can be a higher risk.

At ASAP Finance we have already witnessed a redirection of borrowing into the non-bank sector, and it is not uncommon for our clients to approach us for development finance for projects which, a year ago would have been exclusively funded by a main bank.

A reduction in the supply of credit and banks holding lower risk-weighted assets has been a determining factor in analysts calls of increased mortgage pricing and decreased interest rates for savers.

The Reserve Bank is estimating that the changes could potentially increase borrowing rates by around 20 basis points – i.e., 0.2 percent. But some of the leading banks have predicted interest rates on mortgages and other loans could rise by more, with ANZ reportedly believing the impact could be up to 60 basis points, while Westpac stated it expected the gap could widen by 40 basis points.

In the lead up to RBNZ’s announcement, upside risks to mortgage interest rates and downside risks to lending painted a picture of low economic growth supporting calls that the RBNZ would need to drastically cut the OCR in 2020. Subsequently, RBNZ’s softer approach has led ANZ to suggest OCR cuts may be less than originally expected.

The next steps

According to Reserve Bank GM for financial stability Geoff Bascand, the bank has listened to the feedback and reviewed all the data and was confident the decision was the right one. The next step in the process will be consultation on a draft of the detailed regulatory requirements during the first half of next year, with the new regime taking effect on 1 July.

“Banks make profits from lending,” says the Reserve Bank. “The competitive market will continue and if one bank pulls back in a particular segment of lending, we expect another will step up.”

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