Reserve Bank tells banks to get their ducks in a row before the core funding ratio is lifted to 75% next year

By Gareth Vaughan

The Reserve Bank is gently but firmly telling banks they "need to be conscious" that the percentage of funding they must secure from domestic and wholesale sources with terms of more than a year will rise to 75% next year.

In its bi-annual Financial Stability Report the central bank notes the major banks have only recently started to issue significant amounts of debt in long-term markets and it might take time to expand their investor bases.

"Banks need to be conscious that the minimum core funding ratio (CFR) is scheduled to rise to 75% in 2012," the Reserve Bank points out.

The central bank's comments come after Westpac CEO George Frazis told interest.co.nz last week that the Reserve Bank ought to delay next year's CFR increase if hiking it as planned threatens to reduce the availability of credit and delay an economic recovery.

The CFR was introduced on April 1 last year. It sets out that banks must secure 65% of their funding from retail deposits and wholesale sources such as bonds with maturities of more than one year. It's designed to reduce New Zealand banks reliance on short-term offshore wholesale funding "or hot money."

The Reserve Bank plans to lift the CFR from 65% to 70% this July and then to 75% in July 2012.

"I’d reassess the 75% or the timing of that depending on what’s happening in the economy," Frazis said.

'Significant progress'

Meanwhile, the Reserve Bank does note that banks have made "significant" progress in addressing their vulnerability to short-term disruptions in crucial overseas funding markets.

"The portion of bank offshore funding not maturing for more than 90 days has increased from around 45% in 2005 to around 65% at the end of the 2010 as banks work to boost their core funding ratios," the central bank says in its Financial Stability Report.

"Alongside this reduced reliance on short-term funding, banks have significantly increased their holdings of liquid assets to help buffer against short-term funding disruptions."

In a country report on New Zealand released this week the International Monetary Fund noted all the big four banks - ANZ, ASB, BNZ and Westpac - currently have CFRs above 75%. However, the banks say if the CFR is set at, say 65%, they effectively need a cushion above 65% of another few percentage points.

Breaching the CFR could cost a bank its bank status

A Reserve Bank spokeswoman confirmed all the banks have thus far met CFR requirements and are currently doing so "by a comfortable margin." She said it was a condition of bank registration that they do so.

"There is a strong incentive for banks to meet the CFR, as failure to do so has to be reported in their General Disclosure Statements and is therefore publicly available," the spokeswoman said.

"Such a failure might also impact on how a bank is viewed by ratings agencies and investors as they would likely take a dim view of a bank that was failing to meet a formal prudential requirement.  In addition, since the ultimate penalty for continued breaches could be the loss of its registered bank status, this serves as a powerful discipline on the banks to meet such requirements."

As for banks'  liquid asset positions, BNZ's chief financial officer Ken Christie told interest.co.nz last week that his bank currently has cash and liquid securities "well in excess" of NZ$8 billion following last November's 1 billion euro covered bond issue and weak demand from customers for new lending.

So far the only New Zealand bank to have issued covered bonds after raising about NZ$2.57 billion since last June in issues to European and domestic institutional investors, BNZ has now held a non-deal investor roadshow in Melbourne, Sydney and Brisbane as it looks to issue covered bonds in Australia next. Both Westpac and ANZ have, however, laid the groundwork for covered bond issues.

Covered bonds are senior debt instruments backed by a dedicated group of home loans assigned to provide security for the debt known as a “cover pool.” Popular in Europe, they are usually issued for terms of between five and 10 years. The way they're structured means if the issuing bank defaults, the assets in the cover pool are carved off - or ring fenced - from the bank issuer’s other assets solely for the benefit of the covered bondholders.

The Reserve Bank notes that covered bonds provide banks with an additional source of term funding. The central bank says it's continuing to work on the development of a regulatory framework for covered bonds, including legislative changes to provide additional certainty to investors, and disclosure requirements.

"We expect to finalise the framework by the end of 2011," the Reserve Bank says.

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