90 seconds at 9 am: Regulators' new focus on bank capital

US economic indicators soft; but Wall Street hits highs; China tightens dairy rules; China chooses yes-men; APRA readies tighter capital rules; UST 10yr yield at 2.33%; oil up, gold up; NZ$1 = 73.5 US¢, TWI-5 = 76.9

17th Jul 17, 7:28am by David Chaston

Here's my summary of the key events over the weekend that affect New Zealand, with news local banks are facing regulators who want them to bolster their capital.

But first, American retail sales unexpectedly fell -0.2% in June from May and that is a second straight month of decline, which casts a pall over the expectations for economic growth in the second quarter. They are however +2.8% higher than the same month a year ago. This data will be in stark contract to what is expected out of China later today where retail sales are expected to be +10.6% higher in June from a year ago.

And reinforcing the downbeat theme, the latest consumer confidence survey also shows weakness, down -2.1% in July from June, although up compared with the same month a year ago. This measure has been slipping each month all year.

Turning up however is industrial production in the latest Fed survey. It rose +0.4 percent in June for its fifth consecutive monthly increase. Factory output moved up +0.2 percent; although it has gone up and down in recent months. Construction and mining accounted for the balance of the June gains.

All this activity is happening without any rise in inflation. Core inflation is up +1.7% year-on-year in July, pushed up by energy and services, and held back by food.

The American consumer is the driver of the world's economy and the picture painted by this data is an uninspiring one. But company earnings are strong and Wall Street likes what it sees. The major stock indexes have closed at record highs.

Across the border, major forest fires in the west of Canada may see upward movement in the prices for logs and other timber products, especially in export markets.

And international dairy producers are scrambling to meet an end-of-year deadline to register their products with the China Food and Drug Administration. Companies will only be allowed to register a maximum of three brands in China, to prevent a proliferation of foreign brands crowding out domestic ones weakened by the 2008 melamine scandal.

And some political news from China: a senior Chinese official who was a contender for top leadership has been put under "corruption" investigation, Reuters is reporting. This is ahead of the next Party Congress, one where President Xi is expected to cement his grip on the country. The predisposition for yes-men in senior positions signals a period where leadership innovation is now to be suppressed. And somewhat related, images of Winnie the Pooh are being blocked by China’s online censors following comparisons with President Xi.

In Australia, their housing market sentiment softened noticeably in the June quarter. Sentiment fell in all states. Prospects for capital gains and rental growth both slowed.

And something to watch out for from APRA this week. They will be issuing a paper on how they will define "unquestionably strong" when assessing bank capital levels. The head of APRA will be stepping down soon, and some observers see him bowing out leaving a tough standard, one that will require ten of billions of dollars of new capital by the big Aussie banks. Our own RBNZ is consulting on what should qualify as bank capital, which also has the postential our banks could be forced to raise new, more direct pure capital, sidelining the "clever" hybrid instruments they have favoured recently.

In New York, the UST 10yr yield ended last week at 2.33%.

The price of oil is up just slightly and is now at just over US$46.50 a barrel, while the Brent benchmark is now just on US$49.

The price of gold is up by +US$11 at US$1,228/oz.

And the Kiwi dollar has recovered a little further and is now up at 73.5 USc. But we are lower on the cross rates at 93.8 AU¢, and at 64.1 euro cents. As a result the TWI-5 index will start the week at 76.9.

If you want to catch up with all the changes yesterday, we have an update here.

The easiest place to stay up with event risk today is by following our Economic Calendar here ».

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15 Comments

by bw | 17th Jul 17, 7:38am 1500233927

Australian property market?

Reserve Bank of Australia fears igniting the housing "powder keg",

http://www.afr.com/news/economy/deloitte-says-rates-wont-rise-until-201…

by sharetrader | 17th Jul 17, 8:19am 1500236394

so now we have reserve banks reluctant to use there main blunt tool to control inflation because they allowed huge amounts of debt creation.
we know the time is coming where inflation will take off because of all the money created, most has gone into assets which have inflated beyond normal measures

by Colin | 17th Jul 17, 11:20am 1500247232

Central Banks are trapped they desperate to raise rates to be ready for the next recession but unable to with economies now saturated in debt. Game up

by scarfie | 17th Jul 17, 12:03pm 1500249804

Or we will get debt destruction, and all the paper wealth associated with it will disappear. Ultimately that must happen, what happens between now and then is the question.

by Bobster | 17th Jul 17, 11:29am 1500247756

I am very concerned about the Australian property market. There will be a catastrophic crash, I just don't see any other outcome. Once confidence in capital growth goes, prices will fall and continue to fall for some time. There's lots of supply, the market is held up at the moment purely by hot air. It's Ireland in 2006.

by unaha-closp | 17th Jul 17, 12:37pm 1500251856

That is not a catastrophe, just a normal end of cycle property correction. It is not like Ireland, where the Irish went mad building. The Aussies merely built normally and will soon have a moderate cost rental market. This can then attract the next influx of young people and businesses with good value overheads.

A lot of the young people and businesses of Auckland will soon be casting an eye towards Australia. Unlike the rest of the world Auckland has had a decade of really slow construction and will be stuck in a cycle of high rents.

by Bobster | 17th Jul 17, 1:01pm 1500253267

Sorry, but you are wrong. There will be a material oversupply of accommodation, particularly apartments. Rental yields in Sydney are even worse than Auckland, 2-3%. Lots of interest only loans and negative gearing. Rising interest rates. It's a disaster waiting to happen, and it will happen.

by MortgageBelt | 17th Jul 17, 8:15am 1500236153

Given most households buy a house over time, then inflation is really rampant at 15%.
House cost relative to wages is getting greater, so maybe the 'benign' inflation figure and the 'low' interest rates are working against family/household formation in a far greater way than when we had 'normal' inflationary pressures.

by scarfie | 17th Jul 17, 12:09pm 1500250167

Nationally it has been more like 7% if you use M3 money supply. For the last 5 years or so anyway. Check the graph under the tools section, then compare to CPI and GDP.

by Stephen Hulme | 17th Jul 17, 8:47am 1500238054

And something to watch out for from APRA this week. They will be issuing a paper on how they will define "unquestionably strong" when assessing bank capital levels.

Does"unquestionably strong" equate with unquestionably risky?

Derivatives contracts held by New Zealand's major banks surged in value by 38.5% in the year to September 30, 2015.

A chart in KPMG's annual Financial Institutions Performance Survey shows derivatives contracts held by the country's big five banks rose by $770.3 billion, or 38.5%, to to $2.77 trillion. Interest rate contracts comprised the lion's share, jumping 48% to $2.34 trillion. Read more

Hmmmm....

You simply cannot act as a money dealer when the money you are dealing is highly suspect. I am not writing about money in the true sense, such as any tangible form that falls under property laws of custody and bailment, but rather the wholesale “money” that is derived under the much looser and unconstrained terms of financial laws and more so convention. This was another of the great lessons of 2008 that did not stay learned. Read more

The whole paradigm revolves around bank balance sheets. Almost everyone can conceive of the traditional money multiplier, the basic, ancient idea of fractional reserve banking. A bank takes in deposits of money and from that offers claims on it to several people at once. It can do this because people don’t all want to hold money at the same time, and when they do there are more than enough people willing to leave it in the vault for those wanting it back from the bank.

Deposits and therefore loans were created by this process, governed by the liability side concerned mostly over the ability of the bank to meet any sustained withdrawal of whatever (over time, and as economies evolved, it was far more than just gold) resided in its vault.

That system is largely no more. Regulation has moved mostly to the asset side. The Basel Accords were the final step in that direction, an idea that bank managers had agitated for going back into the 1800’s. But how does a multiplier work on the asset side?

A bank that invested primarily in government bonds was not at all the same as one that invested primarily in low quality mortgages or commercial loans. Yet, assuming that raw dollar amounts were the same or similar at each of those institutions, simple capital ratios would treat them equally.

The concept of risk-weighted assets (RWA) intended to overcome this limitation and achieve useful discrimination. Holdings of government bonds would be given a low risk-weighting, whereas holdings of unqualified mortgages or loans to commercial entities unbacked by sufficient collateral would be treated with higher risk-weightings. The net effect, from the regulatory perspective, was that the first bank buying only government bonds would need to hold far less capital than the one buying/lending in only risky assets, a seemingly sound and legitimate proposal.

The view from the banking system was the other way around; meaning that as they saw it you could hold that much more assets if they were to be somehow classified by a low-risk weighting. Though it may not seem it at first, this is a money multiplier. Changing bank assets by RWA is the same as achieving leverage without seriously disturbing capital ratios. Read more

by scarfie | 17th Jul 17, 12:55pm 1500252928

Trying to reduce the risk of leverage is simply an absurd notion. It is a comment I have made here before that if you buy a house with a mortgage you are leveraged twice. You own leverage, at say 4:1, multiplied by the banks leverage. My the property morons here simply can see it, either their bias or lack of capacity blinkers them.

Quite topical really, I was trying to explain leverage to my neighbours on Friday. That was just a side issue on the way to getting them to understand why fixed term deposits are risky. She actually said she didn't care about all this stuff, that the bank has always been a safe place to put their money, and so it always will be.

Sometimes it is about time frames. Referring to the 1930's depression is simply a step too big for most people.

An excellent article Stephen. My challenge to you is to write it again in 500 words or less, and so that my cleaner could understand it.

by scarfie | 17th Jul 17, 12:57pm 1500253073

Interesting how government bonds based ultimately on non productive consumption are considered safe, where as loans to productive enterprise are considered risky.

by MikeM | 17th Jul 17, 8:48am 1500238130

"The American consumer is the driver of the world's economy and the picture painted by this data is an uninspiring one. But company earnings are strong and Wall Street likes what it sees. The major stock indexes have closed at record highs."

Hard to see how strength in the latter will continue without strength in the former.

by bw | 17th Jul 17, 9:00am 1500238828

"The retail apocalypse has officially descended on America"
...and 'things' have only gotten worse since March when this article was published!
"....Thousands of mall-based stores are shutting down in what’s fast becoming one of the biggest waves of retail closures in decades. More than 3,500 stores are expected to close in the next couple months."
https://www.businessinsider.com.au/the-retail-apocalypse-has-officially…
"

by Zombie ponzi | 17th Jul 17, 12:05pm 1500249950

https://www.macrobusiness.com.au/2017/07/bloxo-rate-hikes-coming-xmas/

"Nothing would give me greater pleasure than seeing the RBA hike rates into the dumb bubble but it ain’t going to happen."