RBNZ's Funding for Lending Programme staying because commitment to it 'is important to ensure the tool remains credible for future use if required'

The Reserve Bank (RBNZ) says its Funding for Lending Programme (FLP) is working largely as planned and it'll be staying in place until its scheduled end in December.

The controversial FLP was launched by the RBNZ in December 2020 to provide additional monetary stimulus to the economy to help the central bank meet its consumer price inflation and employment monetary policy remits by reducing banks’ funding costs and lowering their borrowers' interest rates. As of July 25, banks had borrowed $12.660 billion of three year money priced at the Official Cash Rate (OCR) through the FLP, led by ASB with $3.8 billion.

Interest.co.nz asked the RBNZ a series of questions about the FLP. This included whether, given it was introduced as a tool to stimulate an economy that's now running its highest inflation in 32 years at 7.3%, it could be ended early.

"The FLP is scheduled to end in December 2022. The commitment to the FLP is important to ensure this tool remains credible for future use if required," an RBNZ spokesman told interest.co.nz.

"The drawdown window for the initial allocation of the FLP closed in June 2022. This allocation was roughly two-thirds utilised and any unutilised portion is no longer available. The additional allocation remains open until December 2022."

The RBNZ spokesman says the FLP has worked broadly as intended and as expected.

"We can best observe this by considering the spread between household/business lending rates and wholesale interest rates, i.e. swap rates. Household and business lending rates have been increasing recently, consistent with the tightening of monetary policy, however the spread between these rates and wholesale interest rates is still low, relative to most of the post-Global Financial Crisis period. This is partially, but not entirely, due to FLP. Ample domestic and global liquidity, as a consequence of monetary and fiscal stimulus measures in New Zealand and abroad has also provided a mostly accommodative funding environment for banks, and other users of capital markets, in the past 18 months," the RBNZ spokesman says.

In one of its Bulletin articles in August 2021, the RBNZ said one and two-year mortgage rates dropped between when the FLP was signalled and early 2021, despite swap rates rising substantially, which normally would increase banks’ funding costs, over the corresponding period.

"This development suggests the FLP has been effective at holding down banks’ funding costs. An important feature of the FLP is that it was effective at reducing bank funding costs and retail rates even before banks drew down on FLP funding. This is due to the relative strength of the FLP’s indirect influence on bank funding costs. The indirect influence reduced funding costs for all deposit takers, not just the banks eligible to drawdown on the FLP," the RBNZ said last August.

FLP funding is structured as floating rate repurchase transactions priced at the OCR for a term of three years. Bank participants can access the funding at the equivalent of up to 6% of their total outstanding loans. Eligible securities banks can pledge as collateral for FLP money include Residential Mortgage Backed Securities, New Zealand Government Securities, and Kauri debt issues.

Banks' initial potential allocation was 4% of eligible loans as of 31 October 2020, able to be drawn down between 7 December 2020 and 6 June 2022.  An additional allocation may be drawn down equal to 50 cents for every dollar of net growth in eligible loans from 1 November 2020 up to a maximum of 2% of eligible loans as at 31 October 2020.

"The length of the drawdown windows for the FLP, of 18 months, plus an additional six months for the additional allocation, were chosen to minimise the risk of a refinancing cliff for the New Zealand banking system when this funding matures – in line with our principles for monetary policy tools, in particular effectiveness, efficiency, and financial system soundness," the RBNZ spokesman says.

The interest rate to borrow from the FLP increases as the OCR does. The OCR was 0.25% when the FLP launched and is now 2.5%. The RBNZ describes the FLP as a small part of total bank funding, at a maximum of 6%.

"It is also considered in the [RBNZ] Monetary Policy Committee’s decision as to the overall stance of monetary policy, which is calibrated using the OCR. In other words, the small amount of stimulus being provided by the FLP can be counteracted by the OCR. This might mean that the OCR is marginally higher than it otherwise would be, but is not a barrier to the Monetary Policy Committee influencing overall financial conditions in pursuit of its remit," the RBNZ spokesman says.

"The continued existence of the FLP does not mean that household and business borrowing rates are higher or lower than they otherwise would be. In the absence of the FLP, in the current environment, we might expect to see marginally lower wholesale interest rates – but higher spreads between wholesale and retail interest rates. In other words, financial conditions for households and businesses would be essentially the same. The effects of the FLP are expected to wane as the drawdown window comes to a close."

The RBNZ spokesman adds that, for monetary policy purposes, the OCR is the primary tool for adjusting the policy stance, and it's working as expected, "flowing on through wholesale markets to retail lending rates." 

Meanwhile the $12.660 billion utilisation of the FLP to date is "broadly in line with a range of expectations, in the context of the global funding environment of the last 18 months," the RBNZ spokesman says.

"The Funding for Lending Programme is included as part of a full review and assessment of the formulation and implementation of monetary policy, which is being undertaken in conjunction with the Monetary Policy Remit Review. The outcome of this review and assessment will be published later this year. We note that funding and liquidity concerns have subsided considerably since the inception of FLP – in part due to the programme." 

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