By Gareth Vaughan
Two important developments came out of the Reserve Bank last week with one having the potential to undermine the other.
Firstly the Reserve Bank's much heralded and highly anticipated restrictions on banks' high loan-to-value ratio (LVR) residential mortgage lending took effect. And secondly the central bank issued a report for Minister of Finance Bill English on the operation of the prudential regime for non-bank deposit takers (NBDTs).
In the latter the Reserve Bank discusses potential changes to the definition of an NBDT, which is currently designed to cover finance companies, building societies and credit unions that borrow money from the public to fund their lending activities. The Reserve Bank floats the question of whether entities funded with wholesale money should be dragged into this particular regulatory net.
Basically it concludes the answer should be no, at least if their funding comes from overseas.
Entities funded by their parent or some sort of sister company are "effectively carrying on the business of lending their own money rather than money borrowed from third parties, so do not raise the same kind of prudential risks," the Reserve Bank says.
It adds 'the only persons who would directly suffer financial loss as a result of these entities failing are their owners."
"We think that entities that are funded through offshore sources should generally not come within the scope of the definition. This is because we think that the risk to the New Zealand financial system from the failure of this kind of entity is generally less than would be caused by the failure of a domestically funded entity."
The report then goes on to question whether entities funded through domestic, as opposed to foreign, wholesale money should be covered by the NBDT regime. It concludes the Reserve Bank will carry out further consultation on this issue.
When opportunity comes knocking...
This laissez-faire attitude towards offshore wholesale funders comes with registered banks now required, by the Reserve Bank, to restrict new residential mortgage lending at LVRs of over 80% to no more than 10% of the dollar value of their new housing lending flows. Allowing for exemptions the Reserve Bank estimates this 10% "speed limit" will effectively limit the banks’ high-LVR lending flows to about 15% of their new residential lending, versus the estimated 30% they've been doing.
This creates an obvious market opportunity for other lenders. KPMG's head of financial services, John Kensington, told me last week he was aware of both wealthy private companies and wealthy individuals actively considering entering the mortgage market. This could be through unsecured high LVR lending, or if they're got the financial muscle and appetite to take on the big banks, it could be a broader assault on the home loan market. Entities funded with offshore wholesale money, such as Bluestone Group, have said they're looking.
And GE Capital, the country's biggest finance company which is set to remain outside the NBDT regime, would also have the scale to do this if it so desired. Being outside the Reserve Bank's net means the key regulation GE Capital must contend with in New Zealand is the Commerce Commission policed Fair Trading Act and Credit Contracts and Consumer Finance Act, and the Financial Markets Authority's regime overseeing Qualifying Financial Entities, whereby its subsidiary GE Finance and Insurance has its financial advisor services monitored.
What happens if the horse bolts?
In an August response to submissions on what was then still its proposed LVR restrictions policy, the Reserve Bank acknowledged the risk of "disintermediation." By this it meant the risk borrowers might be able to avoid LVR restrictions by getting loans from unregulated sources.
"Such borrowing would reduce the effectiveness of LVR restrictions in addressing excessive credit growth, but would present less risk to the resilience of the financial system, given that these lenders sit outside the ‘core’ system," the Reserve Bank said.
"The Reserve Bank would closely monitor for signs of disintermediation if LVR restrictions were to be introduced. The risk of disintermediation could be mitigated to a degree by the temporary use of such restrictions. In addition, the current dominance of the banking sector in financial intermediation (relative to history) may help to reduce the scope for opportunistic lending by non-bank lenders."
"Nevertheless, it will be important to carefully monitor and report developments in the non-regulated finance sector, including the activity of overseas lenders. The Reserve Bank intends to consider the case for extending the framework to non-bank lenders in due course," the Reserve Bank added.
So if the horse bolts, and non-bank lenders undermine its LVR restrictions, the Reserve Bank says it could extend the restrictions to non-bank lenders. Presumably it means NBDTs within the prudential regime it oversees. But what will it do if the policy is undermined by lenders who get their funding from offshore wholesale sources?
By continuing to leave offshore, and potentially domestically funded, wholesale funded lenders out of its non-bank regulatory regime the Reserve Bank appears to be running the real risk of undermining its own LVR restriction policy.
If I was Reserve Bank Governor Graeme Wheeler I'd be nervous about this. And if I was a bank CEO, who has been told adhering to the LVR restrictions is a condition of their bank's very registration (banking licence) granted by the Reserve Bank, I'd be angry.
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6 Comments
The apparent failure of the RBNZ to acknowledge that the domestic regulated bank sector is dependent on rollover risk foreign wholesale funding is not inconsequential.
The likes of Resimac and Liberty Financial have made it clear they wish to fill the domestic LVR restriction gap.
Excess high LVR lending undertaken by these outfits could easily morph into forced negative equity sales, which in turn pressures regulated lender's clients to seek the exits along with spooked wholesale funding institutions.
Such risks are repeatedly highligted by the rating agencies in respect of the high level of foreign wholesale funding secured by banks.
Yu notes that stricter regulatory requirements have forced banks to reduce their dependence on wholesale funding markets, although at 32% of total funding, New Zealand big banks' exposure to wholesale funding remains a key sector weakness. Moody's estimates two-thirds of this wholesale funding comes from offshore. The 32% of total funding estimate is down from 37% as recently as April. Read more
In January Moody's highlighted that, at more than 140%, the New Zealand banking sector has the highest loan-to-deposit ratio out of 13 Asia-Pacific countries. Of the big four banks, S&P figures as of December 31, put ANZ's at 135.9%, ASB's at 136.6%, BNZ's at 162%, and Westpac's at 147.4%. Kiwibank's was 109.9%
Yes the most important issue is not the source of funding but whether non-bank lending still has the potential to inflate asset values and hence expose the entire market, both borrowers and lenders including mainstream banks, to asset impairment and defaults following a price correction.
Stephen, TPTB don't want to upset the apple cart. They want to leave a loophole to allow liquidity to continue flowing into the property market while trumpeting their attempts to make housing more affordable for new entrants. and to ensure the stability of the financial system.
They can't afford to precipitate a housing crash like their compatriots did in the United States and Europe, with cascading reprecussions for local governments, homeowners, banks and other finacial players, home improvement retailers, and the wider economy as massive effective demand is wiped out.
The trouble is that people think low interest rates make houses more affordable. They actually make the houses more expensive but borrowing more affordable. So people can afford the interest on a larger principal but can never pay down the principal.
You would think the RBNZ would be able to understand this. Since the RBNZ acted as chief enabler of the leveraged buy out of our housing stock it would appear that they do not.
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