RBNZ bank capital proposals go well beyond the international norm, are highly conservative & positive for banks' credit profiles, Fitch says

New Zealand banks are unlikely to face major challenges in meeting the Reserve Bank's proposed new capital requirements given the five-year transition period, but would probably increase lending rates to recoup a return on the capital invested which could reduce lending growth, says credit rating agency Fitch.

Fitch describes the Reserve Bank proposals as highly conservative compared to international peers, both in terms of minimum capital requirements and changes to risk-weighted asset (RWA) calculations. Its press release was entitled; NZ's radical bank capital proposal sets a global standard.

"The new framework will ultimately result in significantly stronger buffers to withstand stress in adverse operating environments, which would be positive for banks' credit profiles, although we do not expect any immediate rating changes," says Fitch.

"The RBNZ's proposals also go well beyond the international norm in addressing RWA differences between the banks that use the internal-rating based (IRB) approach - the four major banks - and banks using the standardised approach [the NZ owned banks]."

The credit rating agency notes the Reserve Bank's estimate banks would need to increase Tier 1 capital by $14 billion from where they were at this March, and require $6 billion to replace non-qualifying Additional Tier 1 capital, doesn't take into account growth over the transition period. It also suggests banks will want to maintain their own management buffers above the proposed minimums.

"The standardised and regional banks will not be affected by the RWA changes and we do not expect any to have to meet the domestic systemically important bank buffer, but they could still find it more difficult to comply with the new requirements than the major banks, due to their recent rapid growth, lower earnings and, in some cases, mutual ownership. This in turn may negatively impact their competitive position relative to the major banks," says Fitch.

Fitch says it will comment further on potential credit rating implications once the final rules are released.

Below is Fitch's full release.

The Reserve Bank of New Zealand's (RBNZ) proposed changes to its capital framework, published 14 December, set standards that are highly conservative relative to international peers, both in terms of minimum requirements and changes to risk-weighted asset (RWA) calculations, says Fitch Ratings. The new framework will ultimately result in significantly stronger buffers to withstand stress in adverse operating environments, which would be positive for banks' credit profiles, although we do not expect any immediate rating changes. 

The RBNZ proposal sets a "prudential capital buffer" of 9%-10% of risk-weighted assets (RWA), essentially in the form of common equity Tier 1 (CET1) capital, which would raise minimum CET1 requirements to 14.5% of RWA for domestic systemically important banks (D-SIBs) and 13.5% for all other banks, from 7% currently. Additional Tier 1 instruments, which are proposed to only consist of non-redeemable preference shares, will remain limited to 1.5% of RWA. The CET1 requirements consist of a 4.5% regulatory minimum, a 7.5% conservation buffer - which is an increase by 5pp and more than double the highest in any other market - a new 1.5% counter-cyclical buffer, and a new 1% D-SIB buffer. In total, Tier 1 ratios will increase to at least 16% for D-SIBs and 15% for other banks which compares to the system average of about 13.5% at present. 

The RBNZ's proposals also go well beyond the international norm in addressing RWA differences between the banks that use the internal-rating based (IRB) approach - the four major banks - and banks using the standardised approach. The central bank expects its adjustment of its 'IRB Scalar' and output floor to increase the average RWA calculation of IRB banks to 90% of the outcome under the standardised approach, which is much higher than the 72.5% "fully-loaded" output floor finalised by the Basel Committee in December 2017. The RBNZ expects the aggregate RWA of the four major banks to increase by NZD39 billion to NZD290 billion relative to March 2018 levels.  

The changes to regulatory minimums and RWA calculations would together require banks to increase CET1 capital by a total of NZD14 billion over five years from current levels, according to the RBNZ's estimates. The major banks, which the authorities consider systemically important and are likely to be designated as D-SIBs, account for around NZD13 billion of this. Another NZD6 billion will be needed to replace outstanding non-compliant Additional Tier 1 instruments. These increases do not take into account growth over the transition period and banks are also likely to maintain their own management buffers above the proposed minimums, as the proposal details discretionary payment restrictions and supervisory responses that will escalate as a bank sinks deeper into prudential capital buffers.  

The banks are unlikely to face significant challenges in meeting the new requirements as the RBNZ has proposed a five-year transition period. However, we consider it likely that the major banks would increase their lending rates to help earn a commensurate return on the capital invested, which, in turn could incentivise the smaller banks to follow. Over time, this might also weigh on loan growth. That said, the RBNZ expects only a minor impact on borrowing rates for customers. 

The standardised and regional banks will not be affected by the RWA changes and we do not expect any to have to meet the D-SIB buffer, but they could still find it more difficult to comply with the new requirements than the major banks, due to their recent rapid growth, lower earnings and, in some cases, mutual ownership. This in turn may negatively impact their competitive position relative to the major banks. The RBNZ is considering a Tier 1 instrument for mutual banks to address problems posed by their ownership structure, but investor appetite for such a product remains uncertain. 

Consultation on the proposals is open until 29 March 2019 and the RBNZ expects to finalise the rules by June 2019. The RBNZ intends to publish a D-SIB framework and confirmation of which banks are to be classified as D-SIBs alongside the finalised capital rules. Fitch will comment further on potential rating implications once final rules are available.