Proposed Bank Capital Impact
The Reserve Bank’s proposed bank capital requirements will have a considerable impact on investors, writes Mark Withers.
1 June 2019
In recent times investors’ nervousness radars have been tuned into tax changes that have had extensive impacts on the property market and outlook for investors.
And for those of you that have been in the market as buyers you may have sensed that gaining finance approval from our major banks for property investment projects is just not as easy as it used to be, thanks in no small measure to the LVR requirements imposed on banks.
Investors may then have had their attention diverted by the announcement back in December when the Reserve Bank issued proposals to require banks to significantly increase their capital holding in order to strengthen their ability to weather a storm.
Whilst this may seem sensible, the impacts of complying with this proposal will have a ripple effect down to investors who tend to be the borrowers and deposit holders that supply the banks with money to lend.
The proposal will place upward pressure on bank lending rates and downward pressure on deposit rates as the banks look to increase margins to maintain profitability to offset their own costs of holding higher capital amounts.
The Reserve Bank suggests that they can use downward pressure on the OCR to offset these upward interest rate pressures, but with the OCR already at a low level, commentators doubt whether lowering the OCR will be sufficient to offset the upward pressure from the capital requirements.
Interestingly, the proposed capital ratios were much higher than what many of the banks were expecting and if adopted would mean our banks are required to hold some of the most conservative capital ratios in the world.
Currently, banks are required to hold capital equal to at least 8.5% of risk weighted assets. The banks currently exceed this holding on average 13.4%.
The Reserve Bank's Proposal Contains Three Key Points:
1. Changes that would increase the measure of banks’ risk weighted assets. If adopted this would recast the existing capital ratio held to 11.6%, which cuts the buffer that already exists.
2. The minimum capital ratio would increase to 16% of risk weighted assets under the new calculation model. The fear with this is that banks would want to apply a buffer over and above this which would effectively move the capital requirement to 18%.
3. Convertible debt would no longer be counted towards banks’ tally of capital held. This would mean banks having to move to more costly traditional capital to meet the percentage target.
The requirement to hold more capital adds cost and restricts banks’ ability to pay dividends from earnings. The impact of this would be to look for higher margins with higher interest rates on lending and lower deposit rates to depositors.
This in turn may lead Kiwis to choose to borrow less thereby reducing demand for investment property, especially when higher interest rates promote tax losses that are now ring-fenced under the new tax rules.
The Reserve Bank’s assumption is that for every one percentage point increase in bank capital requirements the cost of bank credit would rise by six basis points. So, if capital ratios rose from 11.6% to 18% there could be a 40-basis point widening of the spread between deposit and lending rates, which is quite significant.
At this stage the proposal is not policy and the Reserve Bank have suggested that changes would be introduced gradually over a five year period. But, it does seem that if enacted, these proposals would only be negative for property investors with borrowed money, who would either be forced to pay higher interest rates and would also find that the availability of credit itself could be further squeezed as the banks retain more capital to maintain their ratios.
So now that the CGT threat is lifted, take some time to strengthen those all-important banking relationships as cracking the finance equation may well be the next big challenge for those of you that are determined to take advantage of the buyers’ market that is developing.
Mark and his team specialise in advising on property-related transactions, valuation and restructure services, and tax planning. Withers Tsang & Co Phone 09 376 8860, www.wt.co.nz