Funding ratio likely to hit lending rates

Photo / Herald on Sunday

Borrowers can expect to experience slight upward pressure on interest rates now that the Reserve Bank has increased its core funding ratio (CFR) to 70 per cent from 65 per cent, a banking expert says.

The CFR was introduced last year to help instil more conservatism into the banks' balance sheets in the aftermath of the global financial crisis.

The ratio requires banks to put greater focus on retail funding and wholesale term funding and to place lesser reliance on short-term wholesale funding, much of which comes from abroad.

The Reserve Bank last year set the ratio at 65 per cent. On July 1, the ratio went to 70 per cent and it will soon consider whether to put it up to 75 per cent on July 1 next year.

The central bank estimates the impact on the banks of moving the ratio to 70 per cent from 65 would be to increase bank funding costs by 5.2 basis points to 11.25 basis points. This translates into funding cost increases of between $27.5 million and $65 million for the big banks.

"Long term funding and retail funding is more expensive, so this will flow through into the banks' cost of funding," Sam Shuttleworth, a partner at PricewaterhouseCoopers (PWC), said.

"The banks look at their net interest margin, so 10 basis points is quite significant to them," he told the Herald. "The question then is will that flow on to customers and the answer is yes, it will probably help to push up lending rates," Shuttleworth said.

Before the global financial crisis, New Zealand's major banks had become increasingly reliant on short-term overseas funding.

The banks' core funding ratios fell from 2002 to 2005 - a period of strong credit growth, when there was a drop in the share of retail deposits as a funding source and an increase in the share of short-term wholesale funding from overseas.

"The subsequent global financial crisis demonstrated the downside risk of becoming overly reliant on short- term overseas funding and the real risks involved which ultimately culminated in the authorities (the taxpayer) having to step in with liquidity support," the bank said in a regulatory impact assessment.

During the crisis, the central bank introduced broad domestic market liquidity measures, while the Government provided domestic and wholesale funding guarantee schemes for the eligible institutions.

"These measures helped banks to maintain access to funding but they came at the cost of increasing moral hazard within the financial system," the bank said. "Hence, they were intended as an emergency response but clearly not as a long-term solution."

The Reserve Bank's longer-term response consisted of ensuring that banks increase their share of more "sticky" funding to guard against reversals in short-term funding markets, and that they have a sufficient stock of liquid assets to meet short-term obligations, even in times of severe disruption.

The banking industry globally is shifting back to more conservative lines. Basel Committee on Banking Supervision, which is made up of the world's major central banks, has formed Basel III, which covers liquidity and capital adequacy issues.

PWC's Shuttleworth said the Reserve Bank's rules on core funding should ensure that New Zealand is already "ahead of the curve" before Basel III comes into force in 2019.

New Zealand's banks have been willing to co-operate, and have already exceeded their ratios.