Reserve Bank to introduce new farm lending capital requirements from June

By Gareth Vaughan

The Reserve Bank plans to introduce new farm lending capital requirements in June in a move that's expected to see banks assign more equity to the funding of rural loans and probably lead to higher borrowing costs for farmers.

A Reserve Bank spokeswoman confirmed to interest.co.nz yesterday that the central bank plans to have new farm lending capital requirements in place from the June quarter this year. She said further details should be revealed in the Reserve Bank's next Financial Stability Report due on May 11.

The central bank has been looking to implement new capital adequacy rules for rural lending for some time.

Last year it delayed their introduction after banks expressed concerns it could significantly increase lending costs for farmers. At that point interest.co.nz was told the new criteria would have required banks to assume higher levels of defaults for rural loans and put aside more capital to back those loans. Bankers said the changes would have increased lending costs by between 30 to 50 basis points.

Richard Bowman, BNZ's head of agribusiness, told interest.co.nz that although he's not privy to the central bank's plans the assumption is for a tightening of rural lending criteria.

"What it does do for us, and all the banks, is it will mean that we have to apply more of our equity balance sheet to funding agriculture loans which in effect has the effect of making funding to the sector more expensive," said Bowman. "So that's the impact it'll have to farmers."

Philip York, a Federated Farmers national board member with responsibility for economics and commerce, said he too was unaware of the details of the Reserve Bank's plans.

"We know something's going to happen in the June quarter but we don't know anything about it," said York. "It may be onerous, it may be not so onerous. The last thing you want to do when agriculture at the moment is coming up with the goods is to stifle it.  We've got to be very careful about this."

Concerns over rural debt levels have rumbled around for the past couple of years. Farming comprises about 15% of new Zealand bank lending, according to the Reserve Bank. The latest Reserve Bank sector credit data shows agricultural debt down by NZ$52 million in February to NZ$47.75 billion from NZ$47.8 billion in January, but up NZ$385 million versus February 2010's NZ$47.36 billion.

A Reserve Bank paper from 2009 which discusses a particular focus from the central bank on housing and farm lending, gives an example of a farm loan worth NZ$1,000 having a minimum capital requirement of NZ$80.

The Reserve Bank flagged changes to rural lending criteria in its November 2009 Financial Stability Report.

In addition to concerns with the banks’ modelling of housing loans, the Reserve Bank also has concerns regarding the treatment of rural exposures under the banks’ models. The Reserve Bank is concerned that the current treatment is ‘procyclical’: the models tend to see farm lending as unrealistically safe during upswings, but during rural downturns like the current one they produce much higher risk weights that could overly constrain lending.

The Reserve Bank has proposed changes that should produce assessments of rural lending that are more ‘through the cycle’ in nature. The Reserve Bank has consulted industry on these changes and expects to implement the revised requirements in mid-2010, to allow for a reasonable transition period.

And in last November's Financial Stability Report the central bank had a warning for farmers, saying farm prices may need to continue falling to see “substantial” buying interest reemerge and this could see dairy farmers who took on debt to expand during the boom times wind up in negative equity.

Bowman said the BNZ's focus was on funding cash flow positive farms and focusing on cash flow as its primary source of repayment. The message he is giving to farmers is that there's an opportunity to make a lot of cash at the moment, with commodity prices at record highs, if farms are run well.

"Farmers need to be very careful about what they do with the cash," said Bowman. "We're certainly not encouraging the sector to rely on any potential capital gain in the near-term. Wealth creation comes from generating cash and using it very wisely. That's the message we're giving."

BNZ estimates its shares of the rural lending market has risen by 1.4% to about 19% over the past two years.

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