By Gareth Vaughan
Just what scale of economic downturn could the big four Australian owned banks survive? A pretty large one based on detail contained in the International Monetary Fund's latest report on New Zealand.
"A recent stress test conducted jointly by the Reserve Bank of New Zealand and the Australians included a 40% fall in the world price of New Zealand commodity exports, a six month freeze on wholesale debt markets, a cumulative output loss of 4%, a rise in unemployment to 11½ percent (it's currently 6%), and a fall in house, farm and commercial property prices of 30%. The test indicated that the banks would still comply with the minimum Tier 1 capital ratio in place at the time of 4%," the IMF says in its report.
The stress tests described took place in 2012, with some detail on them released by the Reserve Bank at the time.
Capital adequacy ratios measure the amount of a bank’s capital expressed as a percentage of its risk weighted credit exposures. These risk weighted credit exposures adjust the amount of assets on a bank’s balance sheet based on their perceived riskiness, with weightings potentially ranging from 0% to well above 100%. For example, loans to governments in OECD countries are regarded as less risky than home loans, which in turn are viewed as less risky than loans to businesses.
Capital adequacy ratios are designed to ensure banks can absorb "a reasonable level" of losses before becoming insolvent. The Reserve Bank says applying minimum capital adequacy ratios protects depositors and promotes the stability and efficiency of the financial system. Of the two types of capital measured, tier one capital such as ordinary share capital, can absorb losses without a bank being required to cease trading, and tier two capital such as subordinated debt, can absorb losses in the event of a winding-up and thus provides a lower level of protection for depositors.
The Reserve Bank increased banks' minimum Tier one capital ratio to 6% from January 1, 2013. As of March 31 this year ANZ NZ had a Tier one capital ratio of 11.1%, ASB 12.6%, BNZ 10.58%, and Westpac 12.2%. ANZ NZ had risk weighted exposures of $72.719 billion at March 31, Tier one capital of $8.075 billion, Tier two capital of $936 million, and total capital of $9.011 billion.
'Long-standing structural issues will remain sources of financial sector risk'
The IMF did, however, raise some concerns about New Zealand banks. It pointed to their high loan-to-deposit ratios (see chart below), and ongoing reliance on offshore funding. New Zealand banks have been reducing the amount of offshore funding they use. In its bi-annual Banking Perspectives report released in February, PwC estimated the big four banks plus Kiwibank, sourced one-third of their funding from overseas.
And late last year ANZ strategist Carrick Lucas estimated New Zealand banks' offshore funding had fallen $36 billion, or 25%, to $106 billion since the global financial crisis, or to 30% from 41% as a proportion of overall bank funding. A key reason for this is the Reserve Bank's introduction of the Core Funding Ratio (CFR) in 2010. Designed to reduce New Zealand banks' reliance on short-term overseas borrowing, the CFR sets out that banks must secure funding for at least 75% of their lending from equity, retail deposits, and wholesale sources such as bonds (including covered bonds) with durations of at least a year.
"New Zealand’s financial system remains sound and analysis shows that New Zealand’s banking sector would be resilient in the face of a severe economic shock. The banks are well capitalized - all comfortably meet the new Basel III minimum capital requirement - and liquidity buffers are solid. Non-performing loan ratios are low and declining and recent stress tests indicate that, even under adverse assumptions, they do not pose risks to the healthy capital positions," the IMF said.
"Banks continue to shift toward more stable funding sources, and use of offshore borrowing has been reduced and is of longer maturity. Nevertheless the banks face long-standing structural issues that will remain sources of financial sector risk over the medium term. The four largest banks are systemically important with broadly similar business models, and their reliance on offshore funding, while declining, is still high by international standards and represents a risk."
"Residential mortgages and agricultural lending account for most of banks’ assets, sectors vulnerable to price fluctuations and where leverage is still high. Although as subsidiaries the major banks are not dependent on borrowing from their Australian parents, they are still vulnerable should a parent get into trouble which could affect their access to offshore borrowing," the IMF added.
RBNZ's 'comprehensive stress testing'
Releasing its Financial Stability Report in May the Reserve Bank detailed plans to develop a "comprehensive" stress testing framework for the New Zealand banking system, which it describes as a major strategic initiative.
As reported by interest.co.nz in March, this will feature the first Reserve Bank-led stress tests of New Zealand owned banks including Kiwibank, TSB, SBS, Heartland and the Co-operative Bank. The Reserve Bank worked with the Australian Prudential Regulation Authority on stress tests of the New Zealand subsidiaries of the big four Australian banks in 2009 and 2011-12.
"What we want to do is try and have a more consistent and comprehensive framework across the banks so that we can run regular tests on a comparable basis, and make more sense out of the results right across the banking system," Reserve Bank Deputy Governor Grant Spencer said in May.
Rather than having "ad hoc, one-off tests", the Reserve Bank wants to have a more consistent, comprehensive framework. This will be "just another tool in the toolkit" of prudential management of the banking system, Spencer said.
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