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Opinion: How the RBNZ’s new bank funding policy will stabilise interest rates, currency swings
November 18th, 2009
By Roger J Kerr
The news snippets from last week’s RBNZ Financial Stability report and associated appearances before the Parliamentary Finance and Expenditure Select Committee have wide-reaching implications for borrowers and investors alike.
New Zealand is seemingly leading the world again in finding new ways to better control bank credit expansion (thus inflation) so that the burden does not so heavily fall on just high interest rates/high exchange rate to slow things up and control inflation.
It also seems that the RBNZ have been taking note of our continuous bleating over recent years that the collateral damage to the productive economy from the high interest rate/high exchange rate monetary settings has been too great i.e. the medicine has just about killed the patient.
Monetary policy in New Zealand has for a long time badly needed some mates. It appears that one has been created. The new RBNZ liquidity and funding rules on the banks are now firmed-up, with 65% of bank liabilities required to be funded from sources greater than one year (Core Funding Ratio). The ratio will increase to 75% in stages over time (not stated when as yet).
Any registered bank that fails to comply with these funding rules under the RBNZ’s prudential supervision regime may find their banking licence under review. The banks have been aware for some time that these liquidity and funding rules would be imposed on them and have been re-positioning their respective funding books so that they comply.
What it means is that they will be no longer be able to fund heavily off short-term offshore CP markets at low margins – they are forced to lengthen the term of their wholesale and retail funding arrangements. They pay higher credit spreads for offshore term funding and the local retail deposit war is also resulting in cost of funds well above BKBM and swap base rates.
As could be expected, the banks will find every way they can to pass these extra costs onto unsuspecting corporate and household borrowers. Unfortunately the end-borrowers are the ones paying the cost of this mismanagement of funding risk by the banks over recent years.
The RBNZ obviously had no confidence that the banks would self-regulate themselves with prudent funding risk management policies/limits and could not be trusted to their own devices to withstand another credit meltdown.
As I have stated previously, many corporate borrowers in New Zealand could teach the major banks a thing or two about funding and liquidity risk management policies.
The new Core Funding Ratio on the banks in New Zealand will be watched by banks and central banks around the world, as the influential “Economist” magazine recognised in an article on the subject last week. The case for a few large and locally owned banks to emerge to take business away from the Australasian big-4 incumbents grows every day.
What does all this mean for the track of 90-day and swaps rates over the next 12 to 24 months?
In my view, the increased bank and thus end-borrower credit spreads (or lending margins) now prevailing allows the RBNZ to set base OCR and 90-day BKBM market rates at lower levels than previously. Up until 12 moths ago “neutral” monetary policy settings were considered to be an OCR around 6.00% to 6.50%. The new order with the Core Funding Ratio imposed on the banks and higher bank credit spreads means that “neutral” is now closer to 5.00% to 5.50%.
Those borrowers with facilities priced-off 90-day BKBM will have a major advantage over those priced-off the bank’s cost of funds. In other words, the banks’ actual overall cost of funds is going to be well above BKBM and swap rates. To have the same impact on borrowing and spending behaviour in the economy, the RBNZ will not have to lift OCR base rates as high as previously.
The RBNZ can now pull a few more levers on controlling credit growth in the economy than just relying on the OCR interest rate sledgehammer. Presumably they can also lift and reduce the 75% minimum at any time if they think it will assist their monetary policy control of inflation.
These bank funding regulations, together with a tighter fiscal policy from the Government, will combine to take the onus and pressure off interest rate changes to control inflation in New Zealand. More long-term stability in interest rates will reduce the wild swings of the Kiwi dollar and be beneficial for the economy as export industries invest and grow with more confidence.
Well done Dr. Bollard! Yes, we do give bouquets when they are earned, as well as the normal brickbats!
____________
* Roger J Kerr runs Asia Pacific Risk Management. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com
Tags: Alan Bollard, Bank funding, Fiscal policy, monetary policy, OCR, Official Cash Rate, Prudential liquidity policy, RBNZ, Reserve Bank of New Zealand, Roger J Kerr
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November 18th, 2009 at 8:09 am
This should see mortgage rates rise by how much?
Looks like a tough mechanism compared with the limp OCR
November 18th, 2009 at 8:25 am
Here’s my NZ Herald column on this from Sunday.
http://www.nzherald.co.nz/business/news/article.cfm?c_id=3&objectid=10609289
cheers
Bernard
November 18th, 2009 at 8:38 am
What a crap piece of analysis. Think about it: thanks to this policy, banks will be paying higher rates for the same money borrowed offshore… overseas lenders will be RECEIVING those very same higher rates… that Kiwi dollar is going to look more attractive than ever. This is not the same as imposing a tax, which would create a wedge between the rate paid by borrwers and the rate received by lenders.
November 18th, 2009 at 8:42 am
I think its great, it should help to rein in NZers’ lemming-like urge to borrow large for speculative purposes, ie houses & farms.
However, I wonder whether the law of unintended consequences will apply. The growth of genuinely productive & job-making businesses depends on deep liquid financial markets. These don’t really exist in NZ (for reasons why, ref 1987 & various other episodes before & since), so borrowings from banks for growth are the key source of funds. Will this regulation of Bolly’s starve this sector?
I’m not asking this in any way that is critical of Bollard. Something has to be done to halt our suicidal tendencies before net overseas debt spirals into a totally hopeless situation. But I question where it might also remove a lever for growth.
Cheers all.
November 18th, 2009 at 9:59 am
What’s stop banks from arranging someone’s account in different currency allocated in the other country at lower interest for loan or higher for investment?
Globalisation has its cost.
The Pandora’s box has been open.
November 18th, 2009 at 10:01 am
“The banks have been aware for some time that these liquidity and funding rules would be imposed on them and have been re-positioning their respective funding books so that they comply.”
Dont you mean RE IMPOSED
“The RBNZ obviously had no confidence that the banks would self-regulate themselves with prudent funding risk management policies/limits and could not be trusted to their own devices to withstand another credit meltdown”
The RBNZ never ever did have “confidence” It is the Government back in early 90s that had the “confidence” removed the tools… and it has been since then all the RB has been able to do is warn… and it is this that for the 1st time in NZ histrory we have had , not a boom, but a blow out in real estate and off shore borrowing for domestic real estate causing huge issues.
I have been saying this for yrs….and a hell of a long time on these blogs
BH yep good column BH….but this should have been done way back in 2005/06 along with your warnings of a bust.
We are always going to get ups and downs in different financial sectors, but if the RB has the basic tools removed to prevent blowouts and crashes… we end up in the position NZ is in now.
If one in retrospect was to pin point any single day that caused the woes of today it would be the removal of these tools by the gov in the early 90s (93?)
Maybe “The merchant of Venice” should be std reading for all politicians
November 18th, 2009 at 10:08 am
The more I look at these ‘tools’ the more I expect their implementation to be delayed again and again until they are shelved. The April 2010 start date is the first delay! The power of the banks comes in the suggestion rates might have to shoot very high from mid 2011 thanks to the way the RBNZ is using its ‘tools’. Suggestions made at the highest level and not for the media to know about. Just one word in the right earhole in the Beehive and it’s goodbye to the power of any new ‘tools’ because voters would lash out at the govt regardless of who was causing the pain. In the real world, the govt is in a bearhug with the banks and my money is on the bear.
November 18th, 2009 at 10:14 am
The more I look at these ‘tools’ the more I expect their implementation to be delayed again and again until they are shelved. The April 2010 start date is the first delay! The power of the banks comes in the suggestion rates might have to shoot very high from mid 2011 thanks to the way the RBNZ is using its ‘tools’. Suggestions made at the highest level and not for the media to know about. Just one word in the right earhole in the Beehive and it’s goodbye to the power of any new ‘tools’ because voters would lash out at the govt regardless of who was causing the pain. In the real world, the govt is in a bearhug with the banks and my money is on the bear.
November 18th, 2009 at 10:20 am
Let’s see. The big four banks got through the financial crisis without having a liquidity crisis (see http://davidhillary.blogspot.com/2009/11/more-evidence-nz-big-banks-had-ample.html ), and, rather than saying to them: “This is the level of crisis you are supposed to plan for, and be able to handle without government help”, so they can survive the next one, Dr Cullen decided to help them when they didn’t need it, so that next time, they can’t get through a crisis without government support (see http://davidhillary.blogspot.com/2009/10/turning-on-dime-crown-retail-deposit.html ).
And now, after, I know I repeat myself, the big four banks got through the financial crisis without having a liquidiy crisis, the RBNZ, decides that it knows better than the banks what is good for them, so it will saddle them with additional costs by requiring them to change their funding mix.
And how will the banks respond? Hmm… let’s see, probably by reducing their financial strength and increasing their risk tolerance, since they aren’t as exposed to liquidity risk, and they know the government will help them out during the next crisis. Isn’t this exactly what Dr Rod Carr, then deputy governor warned about back in 2001? He warned of intrusive government regulation and moral hazard as a consequence of bailing out banks (see http://www.rbnz.govt.nz/research/bulletin/1997_2001/2001jun64_2Carr27jun.pdf ).
The RBNZ should go back to Dr Carr’s work and require large banks to be able to be creditor-recapitalised within 1 business day, so that creditors know that should the bank falter, the government won’t stop it failing, and should it fail, they will bear the losses, and that the large banks will re-open the day after failure without interruption. In this way, a) government regulation of banks can be greatly reduced and b) the government can be less inclined to bail out faltering or failed banks.
November 18th, 2009 at 11:01 am
‘The day of the tools’ will be delayed into the future beyond Nov 2011. Key wants to retain power first with a safe margin of seats and put the boot into Goff’s lot. Any fiddle with the banks can wait even if the Kiwi climbs higher.
November 18th, 2009 at 11:03 am
Sounds like a good step forward. What would be really cool is if they could somehow encourage the banks to stop favouring the housing market interest rate wise & start loaning at lower rates to businesses.
November 18th, 2009 at 11:50 am
Ed: Yes I agree, see my post above. In a way, it seems like another blunt instrument, likely to result in what I understand the Americans euphemistically call “collateral damage”
Cheers
November 18th, 2009 at 12:33 pm
Its not a blunt instrument at all….it is simply a tool to tweak with
BUT since the RB has not been able to tweak for 15 od yrs, the economy/banks have got so way out of whack, to get it back it may seem, on the short term a blunt instrument..
Its like a lawn, with a few weeds in, doesnt take much to get back, a few brown spots.
But if left to go wild, may as well kill the whole thing off….it applies to anything.
And its not as if things will be changed over night…
“The new RBNZ liquidity and funding rules on the banks are now firmed-up, with 65% of bank liabilities required to be funded from sources greater than one year (Core Funding Ratio). The ratio will increase to 75% in stages over time (not stated when as yet).”
There is no way that the banks havnt seen it coming, and had to to sort themselves out…so I dont see any need to delay to any extent….althu they are not good at listening to “warnings” they should have been acting on this one long before now.
If not, tough bickies.
This Government has got to be seen to have the backbone to get tough.
November 18th, 2009 at 1:20 pm
I don’t see that this solves the problem at all. Mrs Watanabe will still be able to buy her Kiwi denominated Uridashis. And our banks will still be able to issue them. Please tell me I’m wrong.
November 18th, 2009 at 3:41 pm
Don’t it really pee you off when someone else has already thought of your great idea?
Monday this week I made the following comment about this topic:
http://www.interest.co.nz/ratesblog/index.php/2009/11/16/top-10-at-10-south-canterbury-losses-china-bubble-to-pop-mad-butcher-vs-chrisco-dilberts/comment-page-1/#comment-47427
(Plus see further comments in that thread.)
So got to thinking about how ‘The Guernsey Way’ (interest free public credit) could be combined with, increasing the core funding ratio to 100% – ie. full reserve banking. However, I thought that too incredible and defaulted back to the ‘mixed’ approach, ie. ‘The Guernsey Way’ and ‘The North Dakota Way’ – the latter went in the NZMEA submission to the oppositions banking inquiry. In mulling that over came across a vid by Bill Still, who presents better than Ellen Brown, see here where he describes North Dakota state bank:
http://www.youtube.com/watch?v=sGNPEQDXxwo
So blow me down with a feather as he cites the same idea as a salve to the US’ woes, in parts 20/21 of ‘The Money Masters’ vid series on You-Tube. The link below is to part 19 where he sums up and proposes the ‘public credit’ and full reserve banking solution:
http://www.youtube.com/watch?v=CIPHd4Gjcck&feature=related
I wonder if Dr. B is thinking this way?
I doubt it and I doubt we will ever have sufficient LEADERSHIP in NZ to remodel KiwiBank toward even the BND approach (with all central government finances transacted through it,) OR, consider NZ regions having their own ‘community focused banks’ (with all local gov. finances transacted through them) OR, maybe a sector specific bank, say ‘The Exporters Bank’, or ‘Productive Economy Bank’ – given we seem to have plenty of banks for the ‘Unproductive Economy’!!
No harm in dreaming a bit eh?
November 18th, 2009 at 3:50 pm
“Don’t it really pee you off when someone else has already thought of your great idea?”
Nope…Depends if one is more interested in themselves or the over all solns…or A Yank (dont look that up in the Websters dictionary if you are one)
Working for, or being a boss who gives credit to everyone else, around, even if not fully deserved, is one of the most +ve methods to manipulate (sry motivate got to be PC) loyalty and get results
November 18th, 2009 at 3:56 pm
Steps – that wasn’t the point. Tongue was firmly in cheek. Anyway, any thoughts on the rest of that stuff. Cheers, Les.
November 18th, 2009 at 4:01 pm
John, word is the Japanese govt bond rates are rising…mrs whatsit might well get her loot out from Noddyland sooner rather than later…unless the returns here go higher!
November 18th, 2009 at 5:26 pm
Les Rudd Says:
“Steps – that wasn’t the point. Tongue was firmly in cheek. Anyway, any thoughts on the rest of that stuff. Cheers, Les.”
Yeah I know….. just wondered if you would bite on it lol
Thoughts…like said before
“Maybe “The merchant of Venice” should be std reading for all politicians”
Banks business, even households have been surviving on the old 1/3 ratio for centurys…then some Finance minister and his economic cronies decided better of old commonsence…Im not pro any party, so who ever was in at the time…we voted for them.
As a side note: I see a bright future…for our grandchild en, in the same way post WW2 saw for us…Those at Uni are studying, why everything hit the fan, just as those who where at Uni in the 1930s.
And maybe the guys who run economics , politicians, big business thought and planned FOR their grandchildren, we wouldn’t be in this mess…..Know one can tell me they didn’t know about the 1/3 ratio…They just saw big swimming pools in their back yard.
And those are riding things out without too many issues…they did plan.
November 19th, 2009 at 8:02 am
Thanks Wally, I hope you are right, though Dr Verhoeven might take up the offer if Mrs whatsit doesn’t. What do you reckon mortgage rates have to go to before the property market is really affected? 9.95% is my guess.
November 19th, 2009 at 9:54 am
Steps – thanks, good points.
Philly – “Something has to be done to halt our suicidal tendencies before net overseas debt spirals into a totally hopeless situation. But I question where it might also remove a lever for growth.” Yes, it’s not all sweetness and light. Sure it pushes back against the inflation and debt cancer, but recovery growth is put at risk. That could be mitigated with a North Dakotan/Guernsey approach, I suggest:
http://www.interest.co.nz/ratesblog/index.php/2009/11/18/opinion-how-the-rbnzs-new-bank-funding-policy-will-stabilise-interest-rates-currency-swings/#comment-47854
What do you think?
November 19th, 2009 at 3:23 pm
Roger Kerr says “It also seems that the RBNZ have been taking note of our continuous bleating” what a croc, I challenge Roger Kerr, non biological twin of roundtable Roger Kerr, to present us with anything he has ever said that has ever challenged the modern monetarist unfettered free-market mantra.
The supposed solutions re changing period of lending, or any other solution that does not involve us reinstating the right to issue our own sovereign public credit backed by the future utilisation of our own resources, is nothing but a deceptive attempt to calm those being herded into the box cannon of private banking network debt slavery in order that they don’t attempt to break out.
I cant wait to I get sometime to rip into recent announcements re non-government backed deposits and government backed deposits.
Until Saturday folks, good luck to you and your families.
December 15th, 2009 at 1:44 am
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