By Alex Tarrant
The International Monetary Fund is recommending the Reserve Bank of New Zealand increase its core funding ratio for banks by more than it's currently planning, and for the central bank to publish stress tests done for the major banks last year.
IMF Mission Chief for Australia and New Zealand Ray Brooks, on the IMF’s annual visit to the country, said New Zealand’s reliance on short-term offshore funding meant the country was still exposed to funding shocks, meaning the Reserve Bank should look at its policy for the make-up of bank funding.
The RBNZ’s core funding ratio stipulates banks must currently have 65% of their funding from retail deposits and wholesale funding sources with durations of at least one year, and will be increased to 75% by mid-2012.
The ratio was implemented to reduce New Zealand banks' reliance on short-term funding, and came after the failure of Lehman Brothers in the United States in September 2008, and the subsequent global funding squeeze, cut off much of New Zealand banks’ offshore funding lines.
Brooks said the core funding ratio, introduced on April 1 last year, had been very helpful in decreasing banks’ vulnerability to short-term ‘hot’ offshore wholesale funding.
“But the short-term external debt of the country as of September last year – the latest data – still remains high at 50% of GDP, and so there’s still exposed funding risks,” he said.
“We would advise that the core funding ratio be increased more than planned over time to further to further reduce that risk. The Reserve Bank of New Zealand has some plans to increase it, we think it needs to be raised further.
“And under the Basel III [regulations] there’s a new definition called the ‘net stable funding ratio’, that I think would imply [a] somewhat higher core funding ratio than planned by the Reserve Bank of New Zealand,” Brooks said.
Stress tests should be released
In light of New Zealand’s exposure to short-term funding, Brooks said the Reserve Bank should carry out further ‘stress tests’ on the banks with a scenario where funding lines were disrupted, on top of prolonged high unemployment and falls in property values.
Last year, the RBNZ and Australian Prudential Regulatory Authority carried out bank stress tests with the IMF with a scenario of unemployment rising to 11%, house prices falling 25%, and commercial property values falling 40%.
“So they were fairly significant stress tests,” Brooks said.
“The results for the Australasian banks together show that there was some resilience of the banks to those quite sizeable, but plausible stress tests,” he said.
However, the test results for New Zealand banks on their own had not yet been published. The tests for New Zealand's banks showed roughly the same results as for their Australian parents, he said.
“We would encourage the authorities to publish the test results for the New Zealand banks as a whole,” Brooks said.
“We’d also encourage them to look at what would happen if there was a rise in unemployment over a substantially longer period than in the recent stress tests, together with a rise in long term interest rates from both an increase global interest rates and an increase in the country risk premium,” he said.
The Reserve Bank should look at a scenario encompassing a disruption to bank funding.
“These are some of the stress tests that we know the Australian regulatory authority’s working with the banks to look into as well. As are many of the European banks, looking at what [are] sizeable but plausible shocks,” Brooks said.
“You could invent such a shock that would completely wipe out any banking system anywhere in the world if it was large enough,” he said.
“What we would encourage the authorities to do here is to think about the merits of raising bank capital gradually over time to levels that are significantly above the new Basel III requirements, as a buffer against these shocks.”
This was particularly important as there was a perception the large banks in New Zealand were too big to fail, and posed a significant contingent fiscal liability.
“In sum, the stress tests have shown they [the major New Zealand banks] are resilient to some sizeable shocks, but we would encourage further stress testing and [consideration of] raising the level of bank capital,” Brooks said.