By Bernard Hickey
The Reserve Bank has highlighted the increasing use by banks of 'hot' wholesale money markets overseas as local term deposit growth has fallen behind lending growth.
It warned this opened the banks up to being susceptible to disruptions on those markets in the event of a new bout of global financial turmoil and it expected these pressures would force banks to compete harder for local term deposits by increasing interest rates.
The bank regulator made the comments in its half-yearly Financial Stability Report (FSR), in which it pointed out that if the recent divergence between credit and household deposit continued, the banks would have to increase their own borrowing from wholesale money markets.
"That would add to the already significant volumes of market funding that banks are expected to roll over in the medium term," the Reserve Bank said.
"Banks will need to replace about NZ$40 billion of market funding that will no longer count towards the Core Funding Ratio (CFR) within the next three years," it said, adding that changes by the Australian Prudential Regulation Authority (APRA) to its APS222 standard meant the New Zealand subsidiaries of Australian banks would have to reduce their reliance on funding from their Australian parents.
A significant portion of this funding would have to be raised offshore, the bank said.
"While CFR requirements will mean that most of this funding would be raised at longer terms, greater offshore funding increases rollover risks as banks will be required to raise funds more regularly, and in greater volumes, from offshore wholesale markets," it said.
The bank said the availability and cost of raising funds varied.
'Pressure on credit ratings'
"For example, a material increase in banks’ use of market funding could threaten credit rating downgrades, as credit rating agencies view the reliance on offshore funding as a key weakness of the major New Zealand banks," the bank said.
"In addition, a number of potentially large international vulnerabilities could disrupt global funding markets, including: a sharp unwinding of vulnerabilities in China; further stress in European banks and economies; a rise in protectionism in global politics; and possible spillover effects on emerging market economies if US interest rates rise," it said.
"Some of these shocks could disproportionately affect New Zealand banks. For example, investors could worry about the impact of a crisis in China on the solvency of New Zealand banks, given China is the second largest market for New Zealand exports and a sharp reduction in New Zealand export demand would harm the domestic economy."
'Rates have bottomed out'
Governor Graeme Wheeler also pointed a recent rise in long term interest rates globally and the rise in local term deposit and longer-term fixed mortgage rates as a indicator that rates may have bottomed out.
"We've certainly seen an increase in mortgage rates just as we've seen an increase in deposit rates as well, as banks are finding that their credit growth is exceeding their deposit growth and they are having to basically access offshore wholesale finding, which is more expensive, and also they are having to compete more to try and get deposit inflows as well. So you are seeing those rates rise," he said in the news conference after the release of the FSR.
Wheeler later told the Parliamentary Finance and Expenditure Select Committee that "we've probably seen the bottom now in long term global interest rates."
Deputy Governor Grant Spencer said the bank had cautioned borrowers for some time they needed to be careful in the event of a rise in interest rates.
"People need to be very careful about borrowing increasingly large mortgage amounts at very low interest rates, because it is only a matter of time before rates do increase, and if you look internationally, in recent weeks there are indications that those global interest rates have turned up," Spencer said.
"How far that goes in terms of the trend remains to be seen, but I think a lot of people are saying that we may have seen the bottom of the interest rate cycle."