Inside the Finance & Expenditure Committee's 'special advice'; What else they saw

Readers may be interested in viewing the documents supplied to the Finance and Expenditure Committee by 'Special Advisor' Ulf Schoefisch, that were used as a base for its report slamming New Zealand's Australian owned banks a week ago. As well as the Reserve Bank's latest Financial Stability Report (FSR), two other documents were relied on by the committee for evidence behind their claims and suggestions in the report. They are aptly named 'Specialist advisor report 1', tabled on May 13 as an overview of the FSR; and 'Specialist advisor report 2', tabled on May 20 with additional comments on the FSR. Among other points (see below), one of the reports indicates that the impending increase in NZ Government bond issuance may increase the cost of funds for NZ banks in the near future. The reports also raise concerns surrounding the Reserve Bank's Term Auction Facility, and how much banks are charged to access this funding line. We invite readers to also read the two reports and comment below.

One interesting comment in the second report is about the increase in New Zealand government bond issuance, announced earlier in the year, and that this will effectively increase the cost of funds for the New Zealand banking sector:

The tension regarding appropriate banking sector profits and interest margins will most likely be reinforced by the forthcoming marked increase in debt issuance by the Debt Management Office. Following years of gross issuance of Government Stock of $2.5 billion, this year's bond programme has been raised to $5.5 billion. Annual funding requirements from 2009/10 onwards are likely to be in a range of $10-15 billion. This will put increasing upward pressure on the New Zealand yield curve and increase the effective cost of funds for the banking sector - both in domestic and offshore markets. Monetary policy operating solely through variations in the OCR will be largely ineffective in offsetting this development, thereby increasing the focus on banks' interest margins during a period of a renewed rise in retail lending rates.

The first report, which was an overview of the FSR, included a comment taken from the press conference following the release of the FSR:

Are banks too cautious, particularly re business lending? Response: RBNZ is concerned about excessive tightening of lending standards. Is watching the situation closely. No strong evidence (other than anecdotes) that banks are refusing to lend on sound business propositions.

In the case of overall lending, it included the statement:

NZ bank lending has slowed markedly, which is partly demand driven and partly due to tightened lending criteria.

It also points out that the RBNZ has urged the banks to be more proactive in their provisioning. Labour Finance spokesman David Cunliffe (who is on the FEC) attacked the banks' increased provisions for voluntary bad debts on TV1's Q&A on Sunday (see chapter 5) with BNZ CEO Andrew Thorburn. Cunliffe pointed out that if you were to take these provisions away, bank profits would have gone up as opposed to the reported falls. "BNZ's profit on bank lending in the last 6 months apparently dropped $11 million but at the same time the provision for voluntary bad debts went up 66 million, if you back out the difference in fact their profitability on bank lending in New Zealand went up 24.5%," Cunliffe said. The report outlined:

NZ banks have experienced a sharp upturn in impaired assets, with provisioning having fallen behind (RBNZ urges more proactive in provisioning going forward).

The Reserve Bank, in the FSR said: "Asset quality is deteriorating as weakness in the domestic economy stretches borrowers' ability to service debt, highlighting the need for banks to increase provisioning and ensure that they maintain sufficient capital to absorb unexpected losses. Loan impairments are likely to rise further, albeit not to the same degree as witnessed in several other economies over the past 18 months." The second special advice report includes one reason why NZ banks have may not accessed the wholesale funding guarantee as much as expected. It added that it seemed the Australian-owned banks would be able to access a further NZ$25 billion from their Australian parents:

Part of the reason for the lack of utilisation of the NZ (wholesale guarantee) scheme has been its high cost. It has been more cost effective for the New Zealand banks to borrow via their parent companies under the Australian scheme. According to RBNZ information, current inter-company funding of this type stands at around $30 billion. Under the Australian prudential guidelines lending to a subsidiary must not exceed 50% of the parent bank's tier 1 capital. That suggests that a further $25 billion would be available through this funding avenue. Although this appears to be a solid buffer at first sight, it currently equates to less than 20% of NZ banks' total offshore funding. With the proportion of banks' international liabilities that mature within 90 days remaining above 40% (approx $55 billion), this buffer could be eroded fast if global financial conditions deteriorate again.

It adds:

Despite the fee reductions (for the wholesale guarantee), bank funding via the parent institutions remains the more attractive option, given that New Zealand's country risk premium exceeds that of Australia. Furthermore, the readily available TAF (Term Auction Facility) facility relieves the pressure on the New Zealand banks to pursue the direct offshore funding route.

According to the report, the Reserve Bank had indicated that a further NZ$18 billion could be obtained by the banks under the Term Auction Facility (as at the date of the FSR). The second report questioned comments made by RBNZ deputy Governor Grant Spencer on the cost of TAF funds faced by banks:

The Committee asked the Deputy Governor about the interest rate charged on the TAF funds, inquiring about possible preferential lending terms. He responded that the funds were lent out at 'market rates', implying that banks did not receive favourable funding conditions. That assessment appears somewhat questionable. The banks are supposedly borrowing from the RBNZ as a lender of last resort because no other funding avenue is as readily available at the funding cost charged by the RBNZ. Consequently, since there does not appear to be a 'market' at the funding rate charged by the RBNZ, that rate can, by definition, not be a 'market rate'. That suggests that, by providing TAF funding, the RBNZ effectively subsidises the banking sector.

The Reserve Bank's own TAF figures can be found here by clicking on the D3 Open Market Operations link and then accessing the 'TAF' tab on the spreadsheet. The process involves an auction every week (although funds are not necessarily bid for every week) for a limited amount of funds available to the banks for terms of approximately 3, 6 and 12 months. As collateral, the banks hand over securitised AAA rated mortgages to the RBNZ. To date, NZ$8.28 billion has been issued through the TAF. The weighted averages of successful bids for each respective term are largely in line with New Zealand bank bill rates, and in some cases slightly higher. Issuance through the TAF has fallen away over recent months after seeing strong demand in November and December. For more on the Parliamentary report, see our initial piece here. You may also like to see Bernard Hickey's piece 'Why Parliament's attack on banks is wrong on 8 counts'. Your views and insights? We welcome comments and any further insights on this article and its source documents in the comments field below. We practice a form of collaborative journalism that aims to include the insights and expertise of our readers to improve our articles. That includes clearly identifying any errors and correcting them. We also update articles with relevant new information and commentary and will label our articles Update 2 etc. We know we don't know everything and we know we're not always right. We appreciate your help in constantly improving and deepening the knowledge and debate on interest.co.nz.