NZ banks likely to have to rely on domestic deposits in near term for stable funding, given EU mess, RBNZ says; Mortgage, business rates may rise

There may be upward pressure on term deposit rates over the near term as New Zealand banks struggle to raise cash from offshore wholesale funding sources due to the European sovereign debt crisis.

Business and mortgage lending rates may also rise if those wholesale markets remain problematic well into 2012, the Reserve Bank of New Zealand said in its December quarter Monetary Policy Statement.

Meanwhile, New Zealand banks raising cash through covered bond issues are facing the risk of being crowded out in the market by their Australian parents, which have just been allowed to issue covered bonds by the Australian government.

Marginal bank funding costs had been relatively steady over the past 18 months but were near the top end of recent experience, driven by higher long-term wholesale funding costs, the RBNZ said.

Recent deals made in international funding markets by banks had been particularly costly, suggesting there was significant upward pressure on costs at present.

“New Zealand banks have done very little unsecured long-term funding this year, but there has been some success in issuing covered bonds. Since June, three of the major trading banks have successfully issued covered bonds, although pricing has been on an upward trend,” the Reserve Bank said in the MPS.

“In mid-November, two Australian banks issued covered bonds for the first time, following changes to Australian legislation that allowed banks to access this source of funding. Since then, market conditions have deteriorated and the pricing of any subsequent issues is likely to be considerably higher,” the RBNZ said.

Plans for New Zealand banks to issue covered bonds had been pushed out, given pricing conditions and the risk of being crowded out by their parent banks.

“With raising unsecured term funding still problematic, it seems New Zealand banks will have to rely on domestic retail deposits over the near term for more stable sources of funding,” the Reserve Bank said.

“Should wholesale term funding markets remain problematic well into next year, there is the risk of local banks tightening lending conditions or upward pressure on interest rates faced by domestic firms and households,” it said.

“Overall pricing pressures on bank funding are likely to remain high over the foreseeable future. The recent downgrade of New Zealand Government’s sovereign long-term credit rating has had little impact on bank funding conditions. However, a further downgrade to the sovereign rating could elicit a more substantial market reaction.”

The Reserve Bank said monetary policy would need to take account of bank funding pressures.

NZ$160b in retail deposits

Despite term funding pressures likely to get stronger through 2012, the Reserve Bank noted strong deposit growth and weak credit demand had significantly reduced the pressures on banks to raise term funding.

“In aggregate, banks are currently comfortably above minimum regulatory funding requirements and, if current trends in deposits and credit continue, only a modest level of wholesale term funding will need to be raised over the coming year,” the Reserve Bank said.

Credit growth had peaked in 2007 before falling markedly leading up to the financial crisis. Since mid-2009 grown had been very tepid, with the stock of loans and advances at NZ$320 billion having barely risen over the last 12 months, the Reserve Bank said.

“Comparing October 2011 to a year earlier, loans and advances rose by 1.5% or ust under NZ$5 billion. Weak credit growth reflects soft economic conditions, global market uncertainty and pressures on households and businesses to reduce debt levels,” the RBNZ said.

“Simultaneously, banks are experiencing strong deposit growth, with annual growth running close to 9% in October. This equates close to NZ$13 billion in extra deposits, taking the stock of retail deposits to about NZ$160 billion,” it said.

“While it appears that modest growth in credit could be met from rising deposits, banks also have maturing wholesale debt on their balance sheet. Banks are estimated to have about NZ$15 billion of maturing core funding over the next 12 months or so.

“If credit growth remains subdued and deposit growth remains strong, then much of that maturing funding could be met from retail deposits. If credit growth picks up, then clearly the banks’ funding requirements would increase,” the Reserve Bank said.

SOE sale effect?

Meanwhile, Governor Alan Bollard was not concerned about the government's pending mixed ownership model SOE share sell down, which is tipped to raise NZ$5-7 billion starting from late 2012. Finance Minister Bill English said last month that one of the intentions of the sell-down was to get money "out of bank accounts and helping build the economy".

“We’ve looked at the numbers in broad terms. It looks like the sorts of amounts we’re talking about from those mixed-ownership model sales, are likely to be a very small proportion of domestic deposits," Bollard told media.

In fact that NZ$5-7 billion would account for part of the NZ$13 billion increase in domestic deposits over the last year. The share sales may slow the growth in domestic deposits, but wouldn’t do much more than that, he said.

(Updates with comments on mixed ownership share sales)