KEY POINTS:
The credit crunch has put New Zealand's banks to their biggest test in decades. So far, they have weathered the storm - as have their Australian parents, despite a few bumps and bruises.
However, while the extraordinary events on financial markets over the last 15 months and last
three months in particular have been negotiated without too much difficulty, local banks will have to contend with the fallout in the real economy, which is shaping up to be a once-in-a-lifetime economic slowdown.
In March, prompted by a string of bank failures in the US and more prominently the demise of large mortgage lender Northern Rock in the UK, the Business Herald asked "Are Our Banks Safe?"
The credit crisis was then contained within the financial sector. Experts said our banks had little, if any, exposure to the toxic US credit-backed securities that precipitated the crisis, were well capitalised, and were in a good position to withstand the resulting stress.
The situation has worsened considerably since then, with the demise of a large proportion of America's investment banks, an unprecedented freezing up of crucial international money markets and a desperate and dramatic response from governments and central banks. But New Zealand's banks have continued to maintain themselves on an even keel.
No one the Business Herald spoke to saw any reason to believe our banks would not continue to ride out the crisis.
"In terms of their ability to weather the storm going forward, I'm reasonably optimistic," said Deloitte partner Richard Kirkland.
The key to this is the "vanilla" flavour of our banking industry which, by and large, has not indulged in riskier practices such as the "originate to distribute" model of lending which has derailed the US industry.
"Our banks have pretty much got on with the business of banking. They are diversified on the asset side and well capitalised."
Our local banks will make the point they are better capitalised than overseas banks that have identical "Tier One" capital. Tier One capital is the bedrock cash reserves banks must hold as a buffer against tough economic times.
The Reserve Bank's comparatively onerous method of calculating Tier One capital relative to overseas jurisdictions means an 8 per cent of risk-weighted assets Tier One capital ratio is probably equivalent to 9 per cent elsewhere.
The minimum regulatory requirement is 4 per cent.
But one measure of banks' health that has deteriorated here is the level of impaired assets or loans that are not being repaid.
The increase, evident in the general disclosure statements banks are required to make publicly available each quarter, has increased at a breathtaking rate.
But this needs to be put into perspective. It is increasing off an incredibly low base, a legacy of a golden period of profitability and asset quality for the industry.
While still low in absolute terms, the level of impaired assets is expected to rise much further as the credit crunch spills into the world's real economies. The business world is bracing itself for a once-in-a-lifetime economic downturn, even if consumers appear largely oblivious to the approaching storm clouds.
"Banks are going to wear credit losses on a scale which is probably unprecedented in recent history, that's part of the game," says Kirkland.
So how bad will things get for the banks?
"All the hallmarks are that we are back in a situation like the early 90s. It's the only reference point we have."
The late 80s and early 90s were not a happy time for the Australasian banking industry, with the State Bank of Victoria and the State Bank of South Australia failing, Westpac finding itself in a "parlous condition" as a result of exposure to commercial property investment firms and the New Zealand Government being forced to bail out the BNZ.
At least the banks have enjoyed a long period of plenty during which they have put on a layer of fat that should see them through the lean times.
"They earn a stream of profits in good times so they've got capacity to absorb some losses in bad times," says Massey University head of banking studies David Tripe.
"We should regard this as a normal outcome."
New Zealand banks' largest exposure is to housing loans but Tripe appears to have gained a better understanding of the profile of the banks' housing portfolio since March and believes the area where banks may lose money - newish loans at high loan to value ratios to owner occupiers - are only a relatively small share of the total.
"I would be surprised if banks' losses in relation to residential loan portfolios exceeded $1 billion to $2 billion altogether. It's not going to be hugely drastic. It will dent profitability but won't render them insolvent."
But the credit crisis has put the banks under pressure on the other side of the ledger. They are now paying a lot more for the 40 per cent or so of their funding sourced from overseas markets, or they would be if they were actually able to access these markets which have yet to return to any semblance of normality.
The complete breakdown last year of key overseas markets, including the US and European commercial paper markets, sparked fears that our local banks might effectively run out of funds.
That raised the spectre of "credit rationing" a financial famine where otherwise healthy businesses and other borrowers would be starved of the credit which is the life blood of our economy.
While the danger may have been overstated as the political parties jockeyed for position during the election campaign, the Government nevertheless followed other countries and introduced a wholesale funding guarantee intended to ensure that when the markets did begin functioning again, New Zealand banks would be able to access them on equal terms.
In the meantime, the RBNZ has continued to expand its array of "liquidity measures" to ensure the financial system doesn't run dry.
While the banks get to grips with the wholesale guarantee, they've also had to contend with the unintended consequences of the retail deposit guarantee introduced a few weeks earlier. Up until the introduction of the scheme, at the same time as Australia acted, the two countries were one of very few that didn't have some kind of retail guarantee or deposit insurance scheme.
Although introduced as a two-year interim measure, the consensus is that the guarantee will be very difficult to reverse.
PricewaterhouseCoopers partner Paul Skillender points out that Treasury's briefing to incoming Finance Minister Bill English floated the idea that New Zealand would have to consider some permanent form of scheme.
The main banks, which bear much of the cost of the scheme in its present form, dislike it immensely as they say it has seen retail deposits they covet flow into weaker institutions like finance companies.
What's more, it has distorted the relationship between risk and return on the local investment market.
It's safe to say Treasury and the Reserve Bank will spend considerable time and effort tweaking the scheme to come up with something less disruptive over the next couple of years, but this will be just one facet of what Skillender sees as an inevitable round of new banking regulation prompted by the international crisis.
Skillender points out that New Zealand has for some time had a relatively high reliance on so-called "market discipline" where the Reserve Bank is comparatively hands-off in its prudential supervision. That, he believes, will inevitably change as a result of the crisis.
"To me all the signals are there that in the next couple of years you'll see a reshaped, more intrusive and interventionist RBNZ supervisory regime coming into force."
