New Zealand tightens control on Aussie banks – the reasons

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New Zealand has a rather untypical financial industry structure: the country doesn’t have its own banks, but it relies entirely on Australia’s big four banks.

As reported by Financial Review, the fact that the two countries share the same banks and the same “client” for exporting their commodities (China), if for some reason both economies fail, what would be the priority for CBA, NAB, Westpac and ANZ.

Naturally, according to Australian law, should a crisis occur, the priorities of the four major banks should be Australia and not New Zealand. So, the new bank capital rules that came into effect on Thursday, December 5th, are the result of sustained effort to protect the economy of New Zealand from uncertainty.

The new bank capital rule requires all four banks to construct Tier 1 capital of 16% of risk-weighted assets within the span of 7 years.

Regarding the new rule, this is what the Chief Executive of BusinessNZ, Mr. Kirk Hope, said:

Australia’s banks play a big role in our economy and even if their decisions don’t directly relate to business in New Zealand, they can have a massive impact – which can be negative.

The problem is that the shareholders of the two banks are in a race to serve the two not-so-different, yet different economies. Just like Australia, New Zealand acts as a net importer of capital – a fact that exposes the country to commodity cycles and other risks. However, the economy of New Zealand may be even more vulnerable because it is smaller and in the US sub-prime mortgage crisis, NZ suffered significantly more than Australia, which proved resilient in the catastrophe.

The new bank capital rule set by the Reserve Bank of New Zealand (RBNZ) requires Australian banks to increase the tier 1 capital ratios to 16% – a rule that will require an additional $NZ20 billion to be held, so that the economy of New Zealand is better protected from a banking crisis.

While the rule seems to strict, RBNZ has extended the deadline for banks to do this by two years. Now, instead of five years, Aussie banks will have seven years to build the extra capital required. How this is likely to be done, according to Financial Review, is that banks will retain more of their earnings in their subsidiaries in New Zealand, while at the same time reducing their profits in Australia.

In addition to protecting the economy, the new rule is expected to increase the NZ interest rates, as banks will seek to compensate themselves for the much higher cost of equity proposed.

The new required level of 16% is twice as big as the current one of 7%. RBNZ has confirmed that it will demand total capital of 18% of risk-weighted assets, as tier 2 instruments making up the additional 2% to the new 16% of tier 1.

The period during which banks will have to transition to the new rule begins on July 2020. The RBNZ commented that the new bank capital rules are even conservative compared to what other countries have already established. Such a move is needed, according to RBNZ, to better protect the economy of New Zealand.

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