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Ramp up the Core Funding Ratio, even if banks are squeezed, says Geoff Simmons

Ramp up the Core Funding Ratio, even if banks are squeezed, says Geoff Simmons

By Geoff Simmons

Economic data is reading a little bit like the zombie apocalypse at the moment: the dollar hit an all-time high this week while inflation is the highest it has been in 21 years.

Commentators are haunted by reminders of past crises, such as the Dutch Disease, so named when North Sea oil returns choked manufacturers in the Netherlands.

There are hints of the stagflation (high inflation and stalled GDP) we last saw in the 70s.

Even commodity prices seem to be losing their former gloss.

Well, desperate times call for desperate measures - that is why the next Monetary Policy Committee meeting on Thursday is the right time for the Reserve Bank to start pulling its new lever, the Core Funding Ratio.

The Core Funding Ratio was introduced with great fanfare in April last year, with the promise that it would help secure our banking sector against future crises.

The basic idea is that the Core Funding Ratio requires banks to source a certain chunk of their funding from "stable" sources - like domestic customer deposits or long term funding.

The upshot of this is that unless banks can source enough of this kind of funding, they won't be able to make any more loans.

So far this Core Funding Ratio has been introduced gradually by the Reserve Bank, so that banks have had time to adjust. Term deposit rates did rise a little as a result. However, when the tool was launched the Reserve Bank hinted at the possibility that this ratio could move up and down according to economic cycles.

In the good years, private banks would be required to build up a war chest of stable funding that they can rely on when times turn tough. Conversely when the bottom falls out of the property market and bad debts pile up, the restrictions can be reduced.

The economy faces record inflation and exchange rates. If the Reserve Bank responds to inflation threats by using its traditional tool - interest rate hikes - the economy faces the prospect of even higher exchange rates.

This is exactly what happened in the boom of the mid-2000s: the Reserve Bank pushed up short-term interest rates, which attracted lots of foreign capital looking for short term gains. This succeeded in pushing the exchange rate up, which hurt exporters, and didn't really quell the boom.

The other possibility is to do nothing, which also carries risk.

The low interest rates we have at the moment only seem to be helping the Auckland housing market, not the places that need it like Christchurch. And if inflation gets embedded in the economy, then it becomes much harder to get rid of. Looking at the demands of 8.9 per cent wage increases from firefighters, and the price gouging that the service sector is engaging in during the lead up to the Rugby World Cup, this is a real possibility. So the Reserve Bank is between a rock and a hard place.

That is why the time is nigh to use this new tool as an alternative to traditional interest rate rises. If the Reserve Bank signalled a higher Core Funding Ratio, it would force banks to rely more on domestic customer deposits - so deposit rates should rise, and loan rates should rise to match them.

As a result more of our borrowing would be financed by domestic savings rather than international borrowing. This would remove the incentive for foreign lenders to flood the country with their "hot money", which normally happens when interest rates rise.

Less foreign money coming into the country would in turn reduce the pressure on the exchange rate, which is good for exporters. This move would also be good news for domestic bank deposit holders, and in the ideal world it might even encourage a few more Kiwis to save.

Of course you won't hear bank economists calling for this change, and with good reason. Kiwis are notoriously poor savers, so our banks are reliant on overseas money for their loan books. Incredibly the most notable example of this foreign borrowing lately has been state-owned Kiwibank. A higher Core Funding Ratio would mean banks have to pay more for deposits to encourage Kiwis to save, or make fewer loans, or both.

All of this means lower profits, so a higher Core Funding Ratio will ultimately put a squeeze on banks. Which might be a good thing, depending on whether you think our penchant for credit-soaked expansions remains unrealistic.

Given all the risks in the world economy at the moment, a bit more prudence can hardly hurt. Greece may have been saved from toppling for now, but there is no guarantee that the whole European house of cards won't come down, triggering another round of bank bailouts.

And of course the United States economy is like watching a slow motion car crash. This change alone would probably not be enough to curb our soaring exchange rate and save our non-commodity industries, but it would be a good start.

Of course, don't expect such bold moves from the Reserve Bank this Thursday. After all it is only charged with controlling inflation. Ultimately a soaring exchange rate makes its job easier.


Geoff Simmons is an economist at Gareth Morgan Investments
This article was first published in the NZ Herald.

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Geoff - useful thinking, but, if 12-month+ funding is cheaper offshore than onshore, then what?

The policy does not robustly specify the ratio of wholesale to retail funding, it just deals with duration of funding, as a whole. Essentially, X% must be more than 12-month+. It doesn't tell banks where they, must, acquire such funding. It could all be acquired offshore. What does that do for NZ savers? We know what same does for NZ monetary policy - it bypasses it. 

So what needs to change to make this ratio a "weapon" to help NZ savers? To name but one group of Kiwis suffering because RBNZ and government are sitting on their hands.

Cheers, Les.


It's a nice thought but goes against RB policy to make savers bailout the splurgers and ensure the govt has a comfy ride past the election.

Bollard will stay with the policy dictated to him by Bernanke..zirp or near zirp and stuff the savers.

Long term consequences of near cheaper for longer....are not a priority...doing what the banking bosses demand is.

The NZ economy is playing permanent host to the parasitic banks.


Does anyone know about the agreement with the BIS that Bollard and other RB leaders have signed up to regarding the taking of bank depositor funds in the event of a crash?

Apparently it is on the RBNZ site if you know what to look for.


Add LTV change and we could even get lower property prices sooner.

Oh dear JK and BE need to get re-elected so just shut down any fancy ideas until after November.

Another suggestion would be to levy overseas borrowing for shorter terms. The RB could do that easily. It would decrease the spread between risk levels of shorter term to longer term borrowings and lock the banks into sourcing all of their short money locally. A bonus for thrifty pensioners with a bit of cash who do not want to lock it up for longer than necessary.

Just two hours ago I put $80k into shares that I would normally have left on deposit for another 6 months. That  is my risk assessment of whether I can accept 3% net of tax from my bank.


FYI Matt Nolan at TVHE respectfully disagrees with Geoff here.…

"In the current context, where we are crawling out of a recession and where inflationary pressures are starting to manifest themselves we can all agree we are nearing the time when monetary policy must “tighten”.  However, I would disagree that changing the CFR makes sense as the way to tighten. Using the CFR will lead to a larger increase in domestic interest rates and/or sharper drop in output, just to keep the exchange rate stable."


... and drop the OCR*.

= ?

Cheers, Les.

* + RB to short in the process.


The Govt is borrowing up to $300 million per week........ $15 billion per yr.    M3 money supply is growing at almost 6% yoy. .. ( yiks.!! )

Total Business credit has reduced from about $83 billion to $73.5 billion over 3 yrs

Total rural credit has gone from $43 billion to $47 in the same time period

Total housing credit has gone from $161 billion to $171 billion

In Oct 2008 Govt issued securities ( debt ) was about $29 Billion

In June 2011 it is now $65 Billion.

It does not take a rocket scientist to see where the growth in money supply stems from and also where the buying pressure on our exchange rate is coming from. ( while the world still has confidence in our economy , Govt. borrowing, at these levels, can only strengthen our exchange rate )

The above article does not even begin to address any of this...?????

If the Govt continues to borrow at these extraordinary levels......  does anyone really think that tweaking prudential policy, or raising the ocr, will make much difference...?????

The OCR at its current extreme low levels is very, very distortionary..  ( It seems counter intuitive ,... but negative real returns on term deposits, is a very destructive thing )

Maybe the best way to stem inflationary pressure... ( within the context of the archaic tools we use ) ... is for the Govt. to reduce its' spending.

At the end of 2007 our total oversaes debt was about $217 billion    .... now it is about $250 billion.  ( $20 billion of that is the increase in Govt borrowing )

New Zealand has yet to "rebalance"...and yet to sort out its' "structural deficit"....  as Bill English likes to say.

Our core problem is that we simply borrow too much...  

And i do question whether we can simply grow our way out of our problems...  ( Key and English and Treasury must be natural optimists.... or maybe it's  the mind altering drugs ) AND this is without taking into account the great uncertainty of the Global economy.

Having said all that....   I do think the core funding ratio can be a wonderful tool to influence the total amount of overseas debt that NZ has....  and as we have seen with greece...  that is an important thing.


Me thinks.

Cheers  Roelof






I'll just add.....  

We are in a new paradigm.. in my opinion.

The world has moved from a secular deflationary background into a secular inflationary background...   eg. Commodity prices will never be cheaper, Prices out of Chine will never be cheaper ..etc

Over the last 20 yrs growing money supply at 6% ....  seemed benign.

In todays inflationary environment  6% money supply growth, within the context of 1% GDP growth,....   is no longer seemingly benign..

The Reserve Bank is totally out of touch...   in my view....    They will be playing "catch up ".

I think they are going to have to reinvent all those econometric models they use...



They should ramp it right up.
We know the government won't do anything about inflation, so someone has to.
The government will just keep smiling and waving while inflation gets out of control and it gets to the point where no one in this country will be mad enough to try to save money anymore, and we finish up broke as one of the most indebted countries in the world - although we're not far off already.
Financial mismanagement is an understatement.


The core funding ratio is cementing in place long term returns and monopolistic position of the Aussie banks. However this stabiliy is at the expense of householders who are watching there deposits errode. Classic stagflation. Bollard recently lifted the risk weighting for farms. Wrong move. He should have done it for residential property. This would represent a defacto ocr hike. It is imperative that we get our psyche away from investing in non productive assets


In addition the CFR is supposed to help control the concentration of assets that banks hold. Ramping up the risk weighting on property would require the banks to hold more capital against this portfolio and make it less profitable. It would drive capital into other productive areas of the economy. It would also protect the tax payer when or if the property bubble should burst. Farms on the other hand generate cash, therefore banks aren't lending just against the value of the asset.