Kiwibank economists say one 'perverse' impact of the RBNZ's forthcoming capital proposals could be that banks focus on residential mortgages at the expense of business lending

Kiwibank economists say one 'perverse' impact of the RBNZ's forthcoming capital proposals could be that banks focus on residential mortgages at the expense of business lending

The Reserve Bank's long awaited final proposals for banks to hold more capital "may set the tone for economic growth next year", according to Kiwibank economists.

And Kiwibank chief economist Jarrod Kerr and senior economist Jeremy Couchman say in their weekly First View publication that the review by the RBNZ (with the final proposals to be announced on Thursday, December 5) represents "a lurch in the right direction but may come at a cost to investors and growth". 

They also suggest that "perversely" one adverse effect could be banks "sharpening the pencil and focussing on residential mortgages, at the expense of business lending".

"From an economic standpoint, capital may be allocated away from growth producing enterprise, to bricks and mortar. And that's not what we need at this point in the cycle." 

Kerr and Couchman say the need for banks to boost capital is likely to constrain credit growth.

"It's easier to accumulate capital as a percentage of assets, if your assets are not growing quickly.

"We have already seen evidence, in the RBNZ credit conditions survey, that banks are tightening credit for higher risk lending in anticipation of increased capital requirements.

"Higher risk lending, by definition, has higher risk weightings, and therefore higher levels of capital allocated per deal."

The economists note that credit conditions have tightened for higher risk agriculture and commercial property.

They say also, that banks will look to find the 'right' mix of retaining earnings and widening interest margins - in the form of lower deposit rates and higher mortgage rates - to meet higher capital requirements and still give their shareholders decent returns on their investments.

"With double digit returns on equity for the Aussie majors, the base is very high, especially in a world of sharply declining 'risk-free' rates.

"At a minimum, we'd expect to see slightly lower rates of credit creation, especially in highly leveraged sectors, such as agriculture and some commercial arenas."

Kerr and Couchman say they also expect to see more "segregation" in the pricing of credit.

There should be, they say a greater margin applied to higher risk lending.

"We see this in institutional lending and may see this in residential also. Investor mortgages, and high LVR mortgages, may end up with interest rates 0.5-1.0%pts higher - as seen in Australia.

"We expect competition in the owner-occupier and first home owner mortgages to remain fierce. The risk weightings are simply lower."

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"We see this in institutional lending and may see this in residential also. Investor mortgages, and high LVR mortgages, may end up with interest rates 0.5-1.0%pts higher - as seen in Australia.

"We expect competition in the owner-occupier and first home owner mortgages to remain fierce. The risk weightings are simply lower."

Good for FHB

It's only good for FHB's who have a sizeable deposit (which is a small proportion).

As mentioned in the quoted section, people with high LVR's are more likely to pay a risk premium. I can't see how this is good for FHB's.

Agree, Miguel - will impact FHB the most. But has wider implications also, given that the market is pretty much relying on FHBs to maintain liquidity at the moment.

Question: what impact would this change have on the credit availability from these banks to developers?

If these banks increase their lending to the buy side of the transaction (mortgages) without freeing up more debt capital for housing and related infrastructure development projects (business lending), we could see more upward pressure on house prices across the country due to an aggravated demand-supply mismatch.

Existing developers holding land - it incentivises rapid development of assets.
Developers acquiring new land - reduces willingness to pay = reduce in marginal land price.

An argument that it will reduce development is fallacious for the (simplistic) above reasons. The (nominal) loss will mainly accrue to those property owners holding land who are (in the case of Auckland) those who have just received windfall gains as a result of the AUP.

They also suggest that "perversely" one adverse effect could be banks "sharpening the pencil and focussing on residential mortgages, at the expense of business lending".

"From an economic standpoint, capital may be allocated away from growth producing enterprise, to bricks and mortar. And that's not what we need at this point in the cycle."

Around two thirds of NZ households have no mortgage debt - the debt to income ratio changes dramatically when those without mortgages are excluded. Moreover, given the iniquity of the risk weighted asset regulatory capital scheme, around sixty percent of bank lending is allocated to residential real estate for one third of households.

Can banks justify rising concentration and credit risks by extending mortgage debt to a minority of NZ households and at the same time starve the debt dependent means of production and wages anymore than they already do?

RBNZ should increase the risk weightage on residential/investment property lending and to property developers and introduce a stricter audit regime to assess high volume lending to these categories. Easy peasy.

You're not - possibly, maybe, perhaps - suggesting that the RBNZ's crusade is gonna generate Perverse Outcomes????

Michael Reddell is not at all convinced about the reasons advanced for the embiggenment of the ratio.

The Bank seems to be wanting to prepare for a Greek crisis, or for a rerun of the Great Depression, without taking account of the stabilisation role monetary policy and a floating exchange rate now play in countries like New Zealand. Without a lot more open engagement on the sorts of risks they see, it is pretty tawdry stuff.