Opinion: Monetary tightening by stealth

By Roger J Kerr Larger corporate borrowers in New Zealand who have operated under strict funding and liquidity risk control limits per their Board-approved treasury management policies over the last 10 to 15 years, will be having a bit of a chuckle at the new RBNZ imposed liquidity/funding risk controls the banks now have to conform to. The corporate funding risk policies forced a spread of debt terms and sources, even though this may have meant these borrowers had to borrow longer-term at higher credit margins than shorter-dated alternatives at times. The efficacy of such policies have paid of in spades over the last 24 months for those corporates who complied to them. These funding risk policies protected them against the worst consequences of the credit crisis. These borrowers were therefore not over-reliant on bank-sourced debt funding and have not suffered from banks increasing lending margins by 300% over the last 12 months. The banks themselves incurred massive funding risks (that they were disturbingly not necessarily aware of!) in the boom years pre mid-2007 by borrowing short and lending long. They borrowed from the lowest margin debt markets, being the US and European commercial paper markets (30 and 90-day funding terms) and on-lent the money on 30-year residential property mortgages. The banks should have looked at the funding risk policies of their corporate customers and they may have learnt something about managing financial risk. Today the banks have to adjust their funding books to comply with the new RBNZ rules that require 75% of funding to be greater than 12 months "“ the "core funding ratio". The banks have two years to phase-in to the new regime and comply. The banks borrowing margins are higher for term money, be it wholesale or retail funding. What this means for monetary conditions is that the banks' cost of funds are going to increase and it will be much harder for retail and corporate lending margins to decrease from current high levels caused by the credit crunch/banking crisis. Add on the extra capital Australian banks have had to raise at a higher cost and monetary conditions in New Zealand have tightened without the OCR moving. The RBNZ are now imposing more regulation and control on our banking sector, because the banks have shown they cannot be relied on to operate prudential funding risk policies themselves. Unfortunately it is all too late after the horse is well and truly bolted from the stable door. Who pays for this increased risk control and so-called financial stability? Who do you think? And the morale of the story is? - Banks used to ask corporate borrowers for a copy of their treasury policy to ensure risks were appropriately managed before the banks lent them money. These days the corporate borrower should be asking the bank for a schedule of its debt/liability maturities and sensitivity analysis to credit shocks before the corporate borrowers from the bank. No change to the OCR at this Thursday's review is by far the most likely outcome. However, the market focus will be on the accompanying words and whether the RBNZ have changed their outlook on the economy (yet again!) "”"”"”"”"”- * Roger J Kerr runs Asia Pacific Risk Management. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com