By Bernard Hickey
The Reserve Bank's plan to increase the core funding ratio (CFR) from its current 65% to 75% within the next two years could add around 50 basis points to bank funding costs, which would in turn be passed on to mortgage and business lenders in the form of higher interest rates, said KPMG Head of Financial Services Godfrey Boyce.
(Adds background on RBNZ's previous comments that the CFR may add 10-20 basis points to lending rates and would be reviewed dependent on market conditions)
Banks will be forced to raise term deposit rates for local retail savers and raise more longer term bonds in offshore markets, which would push up funding costs, Boyce said in releasing KPMG's Financial Institutions Performance Survey (FIPS). Given total bank lending of almost NZ$300 billion at the end of 2009, such an increase would push up borrowing costs for households and businesses by around NZ$1.5 billion a year.
"If you push the ratio out to 75% over the next couple of years that's going to increase the cost of funds, and that will be passed on to customers. It would be at least 50 basis points," Boyce said.
The Reserve Bank's final CFR policy was announced in October and was implemented from April 1. The policy will force banks to lift their ratios to 70% by July 1 next year and 75% from July 1 2012. The policy requires the banks to fund that percentage of lending from longer term and more secure sources such as term debt and local retail deposits, rather than from wholesale short term interbank markets.
“The Reserve Bank will keep this plan under review in the light of funding market conditions and banks’ experience in complying with the initial requirement.”
Figures in KPMG's FIPS report show that the collective CFR of New Zealand's banks has risen from 55% in mid 2008 to over 65% by early 2010. Over that time the banks' cost of funds rose by between 100 to 150 basis points and has been passed on in the form of higher term deposit rates and higher fixed mortgage rates, although a portion has been driven by banks' own push to find more secure (and expensive) funding.
Boyce said the major banks were also driving the push to finding more secure, longer term funding sources that were less reliant on international inter-bank markets that froze in the wake of the Lehman Bros collapse. Banks would have to find billions of dollars extra each year in term deposits to help boost their ratios over the next couple of years, he said.
"How big is the savings pool? Where will these funds come from?" he asked, adding there would be pressure to withdraw cash from other assets such as housing and stocks.
Pressure on margins
Elsewhere, KPMG's FIPS report documented a 90% fall in aggregate profit from the banks to only NZ$300 million in 2009, representing a return on equity of 1.5%, mostly because of tax settlements. Boyce said he was surprised the banks managed to maintain their collective lending margin for the 2009 year at 210 basis points, up 3 basis points from a year ago. The banks had been largely successful in increasing lending rates for business and residential borrowers over the last year, despite the Official Cash Rate being flat.
However pressure on margins had been building since September last year as banks fought to build retail deposits by lifting term deposit rates.
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