Anyone with Commercial, Agri or Corporate debt exposure should follow the outcome of this review closely.

Essentially, the RBNZ is reviewing the way they set their capital funding ratios from three different angles. The ratio is determined by dividing:

1) Eligible bank capital (think bank equity) by;
2) Risk weighted assets (which is a standardised approach thereby taking all bank loans and weighting/adjusting them based on their respective credit risk)

Sounds simple – right? But the definitions (and what qualifies) for both the numerator and the denominator in that equation is the focal point of the review. Some of the important points I picked up:

1) NZ bank capital ratios were, post GFC, some of the most conservative in the world- but now the rest of the world is catching up. RBNZ believes we should remain relatively more conservative – i.e. ahead of the rest of the world.

2) Internal bank rating models may be a thing if the past in the future. Currently they are leading to quite different outcomes between banks for capital apportionment. Basel is recommending Central Bank driven models (or at least having greater control of the respective levers and inputs in the internal bank models).

3) Banks are responding to the Central Bank pressures by pointing out that bank capital is expensive and any move to make banks hold more may restrict lending and hence GDP growth. RBNZ acknowledges this unintended consequence and will look to take lending efficiency into account as part of its review.

4) Acknowledging that it is difficult and expensive to raise ordinary equity during times of bank stress, there are different allowances as to the instruments that banks can count towards their tier 1 and 2 capital items. Changes in classification here could lead to inadequate capital ratios.

All in all, an interesting mix of challenges and one that is unlikely to lead to NZ banks holding less capital than what they are today. Any increase in capital that any bank needs to hold is likely to lead to higher costs of funding (everything else held equal).

Where your business currently sits from a risk rating perspective, your understanding of the drivers in behind your credit rating and how you present that to your bank becomes a critical governance function of your business.

Andrew Laming
Director – NZ Agri Brokers