By Martien Lubberink*
Earlier this month, the Australian prudential regulator and our Reserve Bank published their views on the resilience of the banks they supervise.
APRA’s Wayne Byres cautioned his audience: yes, Australian banks are resilient, but only just.
They will struggle in a housing market downturn.
In fact, if you read between the lines of Byres’ speech, you will notice that Australian banks just managed to scrape through the latest stress tests.
Our Reserve Bank, however, is much more upbeat and confident.
This month’s Financial Stability Report commends our banks for capital levels that are well above regulatory minima. New Zealand’s banks are resilient, profitable, and healthy.
This worries me.
How can New Zealand’s banks be healthy while their counterparts across the Tasman are fragile?
I don’t think they can.
There are three reasons why our banks are probably more fragile than our Reserve Bank wants us to believe.
First is that similar circumstances dictate similar policy responses, second is the capitalisation of banks elsewhere, and third is the way the Australian parent banks of our big-four banks manage capital.
Similar conditions, different policy responses?
Conditions in both countries are similar, in particular with respect to house prices. These are elevated, and we know that booming house prices predict prolonged economic badness. APRA’s Byres notices that the proportion of lending attributable to housing has increased significantly over the last ten years. This trend shows up in the growth of the risk-based solvency ratio over the (simple) leverage ratio. The trend also shows up in a drop of the ratio of Risk Weighted Assets to Total Assets. This is because supervisors regard housing loans as low-risk loans.
The table below, which compares data from our big-four banks and their Australian parents,shows that the ratios behaved similarly for both New Zealand and Australia.*
In both countries, the growth of the risk-based ratio (CET1 Ratio) over the last year outpaced the growth of the leverage ratio. In addition, the ratio of Risk-Weighted Assets to Total Assets decreased for both countries.
In a response to this trend, Wayne Byres uses firm language to demonstrate that he takes the risks of the housing sector serious. He promises to keep the health of banks’ housing portfolios under considerable scrutiny.
Our Reserve Bank’s response is much more modest. Yes, it identifies the risks of the housing sector. However, it relies on the LVR restrictions. These have done some good work to stabilise housing prices, but did not prevent growth in household lending (5%) to outpace GDP growth (3.5%). The Reserve Bank’s modest response may rely on the comfortably high capital ratios. But are these ratios really that high?
Other countries’ capital ratios
New Zealand capital ratios are just on par with Europe, where banks are still recovering from the GFC. For example, the New Zealand CET ratio of 10.8% is just above the European average CET1 ratio of 10.1%, reported on a fully implemented Basel III base. EU countries that are comparable to New Zealand, e.g. Denmark, Finland, Norway, and Sweden report an average CET1 ratio of 15% (!)
In addition, the Reserve Bank refers to an awkward CET1 benchmark ratio when it concludes that our banks are well capitalised. It refers to the 4.5% minimum CET1 ratio requirement. However, in normal circumstances the benchmark should be 7%, a ratio that includes the 2.5% conservation buffer on top of the 4.5% minimum. Moreover, the Reserve Bank’s Financial Stability Report reveals that this year’s stress tests made banks dip into the conservation buffer: Under stress, CET1 ratios would drop by 3%, which presents an ominous sign of bank resilience.
Capital management
My last worry for now is that Australian parent banks likely manage the location of capital and respond to high requirements imposed on them by our Reserve Bank. They may move capital from home to host, from Australia to New Zealand. As a consequence, the home banks look poorly capitalised, but their New Zealand subsidiaries look healthy.**
The table above shows exactly this. Where New Zealand banks report healthy solvency ratios, the parent holding banks look feeble. Note the differences: The average New Zealand CET1 ratio for 2014 is almost 2% higher than its Australian counterpart (10.8% versus 8.9%). The New Zealand leverage ratio is also significantly higher.
Because of capital management, the Kiwi capitalisation ratios are probably deceptively high. They may reflect requirements imposed on them by our Reserve Bank. If that is the case, then New Zealand subsidiaries are just sufficiently capitalised, not “well above regulatory minima.” In case our Reserve Bank does not impose high requirements or restrictions on capital transfers, the Australian parent banks will find ways to repatriate capital. Given the poor performance of Australian banks in the latest stress test, this may happen sooner rather than later. As a result, the New Zealand subsidiaries may end up having less capital soon.
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* For this table to calculate the ratios, I summed the total amounts of CET1 capital, Tier 1 capital, Risk Weighted Assets (RWA’s) and Total Assets of ANZ, ASB, BNZ, and Westpac and their respective parent companies: ANZ, CBA, NAB, and Westpac. I used data from June 2014 and June 2013, from the banks disclosure statements and annual reports.
** A complicated procedure called “prudential consolidation” combines the capital positions of all subsidiaries into a consolidated capital position, which the table reports for the parent banks in the lower part of the table.
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*Dr Martien Lubberink is an Associate Professor in the School of Accounting and Commercial Law at Victoria University. He has worked the the central bank of the Netherlands where he contributed to the development of new regulatory capital standards and regulatory capital disclosure standards for banks worldwide and for banks in Europe (Basel III and CRD IV respectively).
7 Comments
NZ bank equity is $31 billion
NZ Bank liabilities $391 billion ( total liabilities less equity)
Leverage:... x12.6
So.... if they should ever have 5% bad debts.. $20 billion
if they should have 5% of depositors running for the doors... $18 billion
THEN.... they have no equity left.....????? they would have to stop lending...and recapitalize...get there balance sheet in order...
AND... considering , they borrow short term and lend longterm.... they look about as robust and solid as all those failed finance companies did.... A lose of trust would kill them.
Thank God we have a reserve bank to give the banks "liquidity"... Banks are privileged.
http://www.rbnz.govt.nz/statistics/tables/g3/
Maybe I'm being too simple..??
you are right Roelof.
take into account that a hell of a lot of agricultural debt is built around asset price appreciation (capital growth), as opposed to positive operating cashflows - a correction here would on its own wipe out any excess capital. furthermore with the demise of finance coys banks are carrying alot more risk on-balance sheet now than they were say 10 years ago.
Dunno but it looks worrying to me, and worse, you miss one thing, negative equity even if the debt doesnt go bad.
What is the FHB above 90% debt? if we see say a 20% drop in value then the bank holds mortgages of less than they lent, they also need to re-capitalise for that, that is another 5%?
Then there is the dairy debt and the payout looks weak...how many farmers with huge debt need $6+?
regards
Roelof,
I think you may be confusing one thing, although your overall conclusions look correct to me. Deposits are liabilities to banks, so if 5% of depositors took their money out, the banks liabilities reduce by 5%, and their equity remains the same. They may be less solvent from a cash point of view, apart from your correct conclusion that the Reserve Bank ensures they always have money especially if just because of a bank run.
Your bad debt risk presumably could be real. The author suggests property loan risks are higher than the banks recognise. I'm not so sure. NZ law is different to US law for example, where here even if property prices drop below the mortgage value, the borrower still has liability unless they go bankrupt, or if a company, into liquidation. It is therefore commercial loans or loans of $100s of millions to property developers that are most at risk- and where the finance companies fell over. Farm loans could be in that category. Still, if the economy tanked, monetary policy would be eased, largely protecting the banks.
From a brand point of view the NZ banks' parents would likely step up with capital rather than walk away from a NZ government supported money making machine in any case.
One of the conclusions from the paper is that the RBNZ should probably look across the ditch at the health of the parents; that may be the real risk. They fall over, (maybe because of inflated property prices ever crashing, and likely some very large loans to miners that could be at risk) then there would likely be real repercussions here.
Maybe though worst case NZ law protects NZ from a collapse over there; possibly through some nationalising of the local banks in an emergency?
So, I am not convinced that the way monetary policy is conducted in NZ is optimal, but the NZ banks look pretty sound to me
Stephen... yes if 5% of depositors took their money out... the banks liabilities would reduce by 5%...
BUT... it is most likely the Bank would have to dip into its equity ( retained earnings ... )... to pay out those depositors...
OR... maybe can demand repayment on some of the loans they have made.... and use that money to pay out to depositors...??? or... thery can borrow to pay out depositors.
Classic problem of borrowing short term...and lending long term... ( and demand deposits...are about as short term as you can get )
Who knows... If we are only half way thru a global Asset boom..... and asset prices ...especially Real Estate.... double in value from current prices.... there might be some problems...
I'm not an expert... so this is just me using common sense..
Cripes, the inflation challenged are chattering amongst us yet again.
....These have done some good work to stabilise housing prices, but did not prevent growth in household lending (5%) to outpace GDP growth (3.5%)
Household lending growth is nominal whilst nominal GDP growth has been adjusted downward by the implicit price deflator to record 3.5%. Stats NZ only release the latest similar GDPE June year growth data - nominal annual growth came in at ~7.766%
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