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RBNZ's new farm lending criteria means the big four banks require almost double regulatory capital on loans

RBNZ's new farm lending criteria means the big four banks require almost double regulatory capital on loans

By Gareth Vaughan

The Reserve Bank will tighten the screws on the big four banks' farm lending from the end of June.

A central bank spokeswoman confirmed to that changes to farm lending criteria, outlined in the Reserve Bank's May Financial Stability Report, will take effect in full from June 30. That's despite a plea from David Hisco, the CEO of the country's biggest rural lender ANZ NZ, for the Reserve Bank to phase the changes in over a period of time.

Hisco told last month that "obviously" ANZ would have to pass on higher costs to its customers and explaining this to them wouldn't be "a pleasant task."

The Reserve Bank spokeswoman said the changes will result in an increase in regulatory capital each of the four major banks - ANZ, ASB, BNZ and Westpac - must hold for farm loans, but not farm servicing or support industry loans.

"The precise impact on each bank will vary depending on the nature of their rural portfolio," the spokeswoman said.

"The banks’ initial positions were risk weights of around 50% - but taking into account changes in the banks’ own view of risk and our new requirements, we expect the system average risk weight to be around 80-90%. This compares to the 100% requirement that applied to these banks prior to 2008 when the Basel II regime took effect."

The new requirements will apply to banks that have been accredited as advanced banks under Basel II, and use their own internal models to calculate capital requirements, she added. This is just the big four. But other rural lenders such as Rabobank operate on what's known as the standardised approach, she said, which applies a risk weight of 100% to all farm loans.

'Well signaled'

Asked whether the Reserve Bank expected banks to pass on any increased costs directly to their farmer customers or take reduced margins themselves, the spokeswoman said the new rules have been well signaled by the Reserve Bank and largely anticipated by the banks themselves.

"The (Reserve) Bank plans to publish more information in this area around the end of the month," she added.

The tightening of the screws on farm loans comes at a time of continuing farmer deleveraging. The latest monthly Reserve Bank sector credit data, for April, shows bank lending to farmers has fallen by NZ$1.013 billion from its peak in September last year.

The data shows agriculture lending falling to NZ$47.249 billion in April from NZ$47.480 billion in March and from a peak of NZ$48.262 billion last September. Year-on-year it's down 0.1% marking the first ever annualised drop in farm lending since the Reserve Bank series began in December 1990 when farm debt was NZ$5.07 billion.

The Reserve Bank says the new farm lending requirements for the big four banks will better take into account the possibility of large falls in farm land prices and the homogeneity of farm lending exposures. 

Reserve Bank Governor Alan Bollard recently told a parliamentary select committee that banks had been very lucky dairy prices had rebounded. Bollard said that as the global financial crisis kicked into gear, with dairy prices going up, farmers rushed out to borrow and consolidate and banks "rushed out to lend."

"It's pretty clear to us and it should be to them as well, that they over-stretched themselves," Bollard told the select committee. "Actually some of them have been very lucky that dairy prices have picked up again."

Fonterra recently announced an unchanged cash payout forecast for the 2010-11 season at up to a record NZ$7.80 per kilogram of milk solids, meaning the cooperative's payout to farmers is likely to be around NZ$10.4 billion. This is up around NZ$2.2 billion from the previous year and is due in part to a 4% increase in production to 1.37 billion kgs of milk solids and higher commodity prices.

Feds not worried

Philip York, Federated Farmers' national board member with responsibility for economics and commerce, said the organisation wasn't especially concerned that the Reserve Bank move might lead to higher borrowing costs for farmers.

"Most banks have indicated they have got their capital requirements in the position they should be anyway," York said. "They've certainly had a lot of time to adjust and from what we can make out it's not going to make any difference."

The changes have been a long time in the pipeline. The Reserve Bank delayed initial plans for a tightening of the capital rules after protests from farmers and bankers that such a tightening would add 30-50 basis points to farm borrowing costs. See our April 2010 article here.

And auditing firm KPMG warned in its recent annual Financial Institutions Performance Survey that increased capital requirements on farm loans could act as a brake on growth in the rural economy and increase borrowing costs to the productive sector, possibly hampering an export-led recovery.

But York said both lenders and borrowers would have to pay greater attention to lending risks than they perhaps had three or four years ago.

"In effect a lot of the money that was lent by the banks, willy nilly at one stage, was done without too much risk analysis," York said.

"We think people borrowing money should be put in a position where they can not get into difficulty and where they can pay it back. If that means requiring a higher deposit or such, I don't have too many problems with it."


In the Financial Stability Report the Reserve Bank notes ANZ, ASB, BNZ and Westpac were accredited to operate as 'internal models' (IM) banks under the Basel II capital framework that took effect from 2008. Under Basel II they were allowed to use their own models as a basis for determining their minimum capital requirements, subject to their models being accredited by the Reserve Bank.

"At the time they were accredited, the Reserve Bank advised IM banks that the models they applied to New Zealand farm exposures were inadequate and would be further reviewed post-accreditation. In cases where models were insufficiently conservative, it was necessary to require banks to hold additional capital pending this further work."

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the RBNZ is operating a bit like S&P - wind up the screws on a sector when the going is tough - result =  faster collapse!

Surely, given the gravity of the situation a softly, softly approach would be more prudent? Having said that AB is an academic and doesn't see the hardship that his tools can and do inflict.

Farm interest rates will rise, and any possible flows through to the domestic economy will be many years away.

4% growth is looking shaky AB.

the RBNZ is operating a bit like S&P - wind up the screws on a sector when the going is tough - result =  faster collapse!

Surely, given the gravity of the situation a softly, softly approach would be more prudent? Having said that AB is an academic and doesn't see the hardship that his tools can and do inflict.

Farm interest rates will rise, and any possible flows through to the domestic economy will be many years away.

4% growth is looking shaky AB.

I would have thought it was the perfect time to reign things in, commodity prices are at an all time, what better time than now?

Some people need saving from themselves, because they won't do so by themselves.

to philthy 

no new investment is going into farming now (except from offshore). Increasing the servicing cost of a farm will mean that it will only take longer for the average farmer to repair their balance sheets. This also means no new plant, just paying down debt, no spare cash to buy that new Holden Ute. Working existing capital harder, until it breaks. Productivity falling over time.  Those farmers that are over geared and stretched now will take a bath.  Farm prices will remain subdued, or likely fall further. The price of milk will rise. Farm prices may very well fall to a more realistic level, however given that NZs economic recovery is based around export and dairy why take this risk? All this for what purpose? What do they want to achieve? Suppress demand? Manipulate farm price? what? The only thing the RBNZ will achieve is the  transfer of wealth in the form of farm assets from those that are stretched to those that aren't (most likely those wealthy farmers that have no debt and are nearing retirement). They are the potential beneficiaries here as they have the ability to acquire the neighbouring "distresssed" sale. 


So you are trying to say it's riskier to the economy if some farms are forced to pay down debt (getting them in a less risky position), but making less profits.
Than if farmers are allowed to overextend, and major banks are allowed to overextend as well, both in search of profits.
In a volitile world where even Standard and Poors have said commodity prices could fall 60% at any time.

I think on balance making a few less profits, against the risk of major farms or major banks going broke is a no brainer. Banks would take down a lot of other stuff with them.

It's been proven from overseas if banks aren't forced to play safe with other peoples money they won't, they don't care it's not their money.

I don't subscribe to the theory that you need to borrow massively to be rich, most of the richest countries in world aren't that way because they borrowed up to their eyeballs.

Hi Plithy

Nay, what I'm saying is that fundamentally returning less than than 5% on capital is a poor investment, to both the farmer and nation as a whole.

If profit is too low then tax revenue is also low, evidenced by the fact that only $26M of corporate tax was paid by this sector last year, despite positive trading conditions (low interest rates and high commodity prices).

This suggests that the key driver of farming is capital gain and being over geared. A 15% CGT payable on the asset value seems a logical step to keep prices down, and ensure that the industry is paying its way. What the banks do is secondary to that.

What annoys me intensely is that farming is almost seen here as a industry that is deemed too big to fail. Government assist struggling farmers yet all other business is left to its own devices and attempts to insure unforseen risk. What about the stuggling exporter being screwed by high exchange rates imposed by AB? Its likely that the owner has just as much equity tied up in their business? why therefore should farming be treated any different to other business. Especially when they are still failing left, right, and centre.

Shares held offshore are taxed on unreasilised gains. Tell me one good reason why this shouldn't be the case with the average farm when clearly, they are motivated by capital gain. 


I agree with your CGT comment, no argument from me there.
I think the government is doing as much if not more than the RBNZ to push up the dollar, through all it's borrowing.

Another way around that concern over the dollar is capital controls that BH has mentioned a few times, on things like overseas land sales.
That would certainly help the dollar stay lower, and considerably help out the real farmers, that are there to produce things, and export.

Not the ones just sitting around hoping for capital gains, the ones you may as well call speculators rather than farmers.

I think he's more concerned about the banks at the moment. What he is doing is forcing the banks back to more prudent, less risky lending. The banks hate it because its less profitable.

what's the least risky asset? According to the RBNZ it is first mortgages. what generates income and cash flow for our nation? business do. What's the riskiest asset according to the RBNZ? Business are. How are we to get 4% growth, when the RBNZ prescribes investing in housing stock? See the problem.

At least when we eventually collapse at least we will have bloody impressive looking houses. 

The whole GFC was caused because banks and individuals were overleverages - cheap credit based on ever increasingproperty values and high loan to value ratios - surely it makes sense to try an address these issues rather than do it all over again except next time it will be something closer to the great depression.

Its not like Dairy farmers or banks are actually paying a whole load of tax into the system anyway - If its good for the goverment and the rest of the country to be deleveraging and reducing our indebitness then its good for farming too!  Yes no new Holdens - they can keep the two year old one running a bit longer!  Especially whilst Joe public is paying 50% MORE FOR MILK /CHEESE/BUTTER!

Fact is that the huge increase in comoddity prices has not seen an economic recovery for the country or population as a whole - just farmers getting richer (buying more land with their profits to avoid tax) - or those who are living beyond their means paying off a $1billion in debt - Also if they cannot operate successfully during a period of unrivalled high prices then they have no chance of operating in a more normal or poor price environment.

Farming and banking seem to be the only industries where failure is not an option - government (read ordinary joe public taxes) bailouts at the ready - in a wet summer does the governement bail out ice cream or sunshade sellers - no - If people cant afford a haircut will barbers get weekly compensation - i dont think so but farmers - if its good keep the profits if not  state of emergency and bailout on the way!

If we are not going to price protect goods for joe public, then lets at least share some of the pain with the farmers!




But it's all about the banks.



Bailouts of Greece, or any other country in the Euro area, have little to do with the country, and everything to do with the stability of the EU Banking system.    And no, this is not yet another denunciation of "banksters" but simply a description of the facts.

Banks are interesting businesses.   They take in deposits and they make loans.   They operate in a state of unstable equilibrium, which means that in tranquil times they make steady profits, but in crises they face a particular type of problem, which is that depositors can demand their money back at no notice, but Banks cannot call in their loans so quickly.

To deal with this, Banks hold reseves in cash or near-cash, but there is a conflict.   The more near-cash they hold the lower their profit because of low yield on near-cash, especially today.   But the less reserves they hold, the more vulnerable they are to a crisis.

To handle this, Banks do two things.   Banks with excess reserves lend them to other Banks, to earn yield, and Banks with inadequate reserves borrow from other Banks to beef up their reserves.   And if most Banks are short of reserves, they all go to the Central Bank and borrow there.

We all know that European Banks, especially in Germany, France and Belgium are over-exposed to Greek sovereign debt.   If that debt defaults, those Banks could become insolvent and would certainly become illiquid.

But now it turns out that Banks, especially German Banks, have been making pretty large loans - the total may be up to E350bn - directly to Banks in the PIIGS nations.    This is because PIIGS Banks have been experiencing a slow-motion "run" for over a year and it is additional to the sovereign debt problem.

Sound like a house of cards?    Well, it is.   It only takes one large Bank to fail in one of the PIIGS nations and quite suddenly previously healthy Banks in, say, Germany, could find they are holding large loans that have now defaulted; not sovereign loans but Bank loans.    This could cascade quite quickly across Europe.

Is this hypothetical.   Not at all.   This is what happened when Credit Anstalt defaulted in 1931.   Banks that CA owed money to then failed in their turn, and then Banks they owed money to and so on. And Banks in the PIIGS nations *are* losing deposits. The process has begun; it just hasn't turned critical yet.

This is the real reason why even though Greece has not fulfilled the terms of its first bailout, we must pretend it did.   Not because it is Greece.   Everyone is sick of Greece.   If Greece sank beneath the waves, who would care?    It is because a wave of defaults could begin in Greece and end who knows where.


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It is my understanding that the tightening of the capital requirements on Banks is only affecting the 4 Australian Banks. The other banks although with a smaller market share have already been working under this capital requirement regime. They have been able to compete with the 4 Ausy banks so whats different?  Its just a level playing field now thats all, the 4 Ausy banks need to compete, no need to up the rates.

Actually groudwater my understanding is slightly different. The 4 aussie banks have been operating under a tighter capital regime than the smaller banks, who will over the next year be forced to come into line under the same set of rules. That would mean the playing field is about to get a whole lot more uneven, with the big 4 having a big pricing advantage over the small fellers.

I may be wrong VC but I'm sure I read that the Aussie banks self regulated themselves and the smaller banks were required to operate under a government regulation. However There is obviouslty a difference and if the Ausy banks have the advantage they don't need to up the rates.

I think the danger going forward from what i have read is the non aussie banks or smaller players will be under different capital regimes to before, and so will be forced to put their rates up to hold ground. But that should only affect a minority of NZ farmers anyway who don't bank with the big 4, at least not until their rates go up half a percent.