The International Monetary Fund lauds the Reserve Bank's core funding ratio

By Gareth Vaughan

Liquidity rules introduced by the Reserve Bank last year, including the Core Funding Ratio (CFR), have been hailed as a success by the International Monetary Fund (IMF) which says they've helped reduce our banks' reliance on short-term overseas funding and could assist with monetary policy during buoyant economic times.

In a report on New Zealand the IMF notes the Reserve Bank moved in advance of other countries to introduce the new rules in April last year due to New Zealand banks' dependence on short-term overseas borrowing. The policies implemented included liquidity mismatch ratios, which compare a bank's likely cash inflows with its likely cash outflows, and the CFR.

The CFR sets out that banks must secure 65% of their funding from retail deposits and wholesale sources such as bonds with maturities of more than one year. The Reserve Bank plans to lift the CFR to 70% this July and then 75% in July 2012.

The IMF says that since the onset of the global financial crisis in 2008 New Zealand banks have improved their funding structures.

"They have significantly increased their retail and long-term wholesale funding so banks ' reliance on short-term wholesale funding declined from 53% of total funding in 2007 to 42% in late 2010," the IMF says.

"The four major banks' CFR is currently high at above 75%."

Furthermore, the IMF says the experience of the global financial crisis and the introduction of the liquidity rules have made banks willing to pay more to attract retail deposits.See all term deposit rates for one to nine months here.

"A widening in funding spreads since the crisis along with greater use of long-term wholesale funding has seen bank funding costs relative to the policy rate increase substantially, which is equivalent to tightening of policy rates of about 100 to 150 basis points," the IMF says.

KPMG's annual Financial Institutions Performance Survey, out last week, recorded a NZ$10 billion, or 5%, rise in bank customer deposits during 2010. However KPMG also said the country's big five banks - ANZ, ASB, BNZ, Kiwibank and Westpac - reduced their overseas borrowing by just 1% last year to 34%. Among the banks ASB holds the largest portion of overseas funding at 46%, down from 47% in 2009.

Meanwhile, the IMF notes the Reserve Bank's liquidity policy is likely to have the most impact when banks have strong credit demand. To satisfy this demand they'll have to use mostly customer deposits and long-term wholesale funding rather than short-term "hot money."

"Aside from ensuring that credit growth is funded from more stable sources, this may put some upward pressure on bank funding costs, potentially reducing to some extent the need for the Reserve Bank to raise the policy rate. Through this channel the CFR has the potential to play a role in assisting monetary policy."

The IMF also says joint stress-testing conducted with the Australian authorities last year showed New Zealand banks’ resilience to "sizable but plausible " shocks.

"Banks’ key vulnerabilities are their exposure to highly indebted households and farmers together with their sizable short-term offshore borrowing. The authorities should continue to strengthen their stress testing of banks and consider the merits of gradually raising bank capital to levels well above the Basel III requirements."

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