RBNZ delays increase in Core Funding Ratio for banks to 75% from 70% by 6 months to Jan 1, 2013 due to volatile global funding markets

By Bernard Hickey

The Reserve Bank of New Zealand has warned that risks to New Zealand’s economy and financial system have increased in recent months because of the European financial crisis.

Releasing its half yearly Financial Stability Report (FSR), the Reserve Bank announced it would defer a planned increase in the Core Funding Ratio (CFR) for banks to 75% from 70% until January 1, 2013 from July 1, 2012.

This ratio was created by the Reserve Bank in the wake of the 2008 financial crisis to improve the ability of New Zealand’s banks to cope with a freeze in short term international funding markets.

The ratio has forced banks to increase the amount of funding they obtain from term deposits in New Zealand and from longer term bond issues internationally.  It has forced them to reduce their reliance on ‘hot’ international money markets where ‘commercial paper’ funding is rolled over every 90 days.

The Reserve Bank said it was delaying the increase in the CFR to give the banks more flexibility if financial markets deteriorated further.

Deputy Governor Grant Spencer said the New Zealand banking system was better placed to weather the current market turbulence than at the outbreak of the financial crisis in 2008.

“The banks have increased their capital and liquidity buffers over the past few years.  They now have a stronger retail deposit base and their wholesale funding is at longer terms, making the banks less vulnerable to disruptions in offshore markets,” Spencer said.

“Given the current market tensions, however, the Reserve Bank has decided to defer by six months its planned further increase in the core funding ratio (CFR) which was to have occurred in July 2012,” Spencer said.

“It is now intended that the CFR will increase from 70 percent to 75 percent on 1 January 2013, giving the banks more latitude in managing their funding programmes.”

The FSR (page 15) shows that about NZ$15 billion of longer term bank funding, which currently qualifies for the CFR, is expected to move to shorter terms over the next 12 months.

The bank said new issues of longer term debt or additional local term deposit funding was required in coming months to maintain core funding levels.

“New covered bonds are likely to provide some of this funding, as covered bond have generally continued to function well with little change in spreads,” the bank said in the FSR.

“However, banks may only encumber up to 10% of their assets as collateral in covered bonds. Thus covered bonds will only be able to provide a portion of bank funding needs, requiring banks to raise unsecured long term funding or additional retail funding as market conditions allow.”

Greek contagion

Spencer said financial systems in many countries remained under stress because of an overhang of private and public debt, particularly in Europe where there was a fear of contagion from Greece.

This has made access to offshore debt markets more challenging for New Zealand’s banks, he said.

“In New Zealand, households and businesses have been containing debt, which has helped to reduce the country’s overall external imbalance.  However, these efforts have been offset, in part, by rising levels of public debt,” he said.

Elsewhere, the Reserve Bank warned the government needed to continue its budget tightening and that both households and farmers remained vulnerable to a sharp economic slowdown because of their high debts.

Here is RBNZ Deputy Governor Grant Spencer on why the CFR hike was delayed:

(Updates with economic weather report video, video of Grant Spencer)