New Zealand's banks will have to raise around $20 billion to meet tough new safety requirements, but will have more time and flexibility to do so.
On Thursday the Reserve Bank released its final decisions on its capital review, which began in 2017 to evaluate how well the financial system could cope with another financial crisis.
In broad terms, the final decision is similar to its proposals released in December 2018, which said the banks should hold considerably more capital, especially in the case of the four large Australian-owned banks.
But the changes give banks longer to adjust to the new requirements (seven years) while much of the additional capital could be in the form of redeemable preference shares, a cheaper way of borrowing money which the Australian-owned banks that dominate the sector may be able to raise locally.
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In the minutes after the news was released, the New Zealand dollar jumped slightly. ANZ, New Zealand's largest bank, said the overall tone of the changes meant the Reserve Bank would have to cut interest rates by less than it previously thought.
"The overall decision is in line with its previous proposals to increase the overall amount of bank equity, but some aspects are softer," ANZ chief economist Sharon Zollner said.
Starting from mid-2020, the banks which dominate the sector will have to increase their total capital to 18 per cent, from a minimum of 10.5 per cent now. Typically banks carry a buffer above the minimum of at least an additional 2 percentage points.
Smaller banks, including the likes of Kiwibank, TSB, Cooperative and SBS will need to have total capital of 16 per cent, up from what they hold now but below December's proposal.
Larger banks need to hold more capital than capital than their smaller rivals as if one were to fail it could have a severe impact on the economy.
But the final decision includes changes which could soften the impact for the banks, compared to what was proposed a year ago.
While the total amount of capital needed to be raised is broadly the same as expected, the make-up of it is difference, with the Reserve Bank allowing additional redeemable preference shares to count as tier 1 capital.
A Reserve Bank official said the redeemable preference shares, which will be treated as equity but usually have the characteristics of a debt instrument, could account for around $9b of the $20b the banks would have to raise.
The Reserve Bank said the proposals were "a more cost-effective" way for the banks to cope with the changes.
There will also be more time to adjust with the changes, with the transition period increased to seven years, from five years proposed in 2018 "in order to reduce the economic impacts of these changes".
Larger banks which use their own internal risk-based models for calculating capital will need to take a slightly more conservative approach relative to the standardised approach of the smaller banks, although the final decision has been toned down marginally.
The Reserve Bank estimates the changes could increase borrowing rates by around 20 basis points (the difference between a 4 per cent interest rate and 4.2 per cent interest rate).
According to Reserve Bank documents, this could add around $5 a fortnight to the repayment costs of a $100,000 loan.
However, the bank's estimated of the impact on customers on its earlier proposals was questioned.
It suggested the impact of its December proposals could be 20-40 basis points, but some market analysts said the impact could be double that.
There have also been warnings that the changes could push banks to lend more to low-risk sectors, such as residential mortgages, and away from higher risk sectors such as construction, small business and agriculture.
The Reserve Bank claimed the costs of its proposals were far outweighed by the benefits.
Geoff Bascand, the Reserve Bank general manager of financial stability said the final decisions had been shaped by "unprecedented" submissions, public engagements and expert reports.
"We've listened to feedback and reviewed all the data, and are confident the decisions are the right ones for New Zealand," Bascand said.
"We have amended our original proposals in a number of ways so we achieve a high level of resilience at lower potential cost, with a smoother transition path for all participants."
Governor Adrian Orr said the changes were "not just about dollars and cents" but about lowering risk for the entire country.
"More capital in the banking system better enables banks to weather economic volatility and maintain good, long-term, customer outcomes," Orr said.
"More capital also reduces the likelihood of a bank failure. Banking crises cause not only harmful economic costs but also distressful social issues, such as the general decline in mental and physical health brought about by higher rates of unemployment.
"These effects are felt for generations."
Banks currently get most of their money by borrowing it - usually over 90 per cent - with the rest coming from owners - usually less than 10 per cent.
The capitalisation levels are sufficient to withstand a one-in-200-year shock to the financial system, according to Reserve Bank.
In last week's financial stability statement, Reserve Bank Governor Adrian Orr said strong bank capital buffers were key to enabling banks to absorb losses and continue operating when faced with unexpected developments.
The proposed changes have met with stiff resistance from the big banks, who have said they will raise customers' funding costs and could see them restrict lending to certain areas like agriculture and small businesses.
The New Zealand Bankers Association (NZBA) has argued that an increase in the capital required to be held by New Zealand banks could make it more expensive for New Zealanders to borrow money and will lead to reduced economic output.
Citing an economic review, NZBA has said lifting the capital requirements would have economic welfare costs of $1.8 billion a year and that it would disproportionately affect agricultural, small business lending, and savers.
The RBNZ announced its proposal to increase the level of regulated equity in mid-December last year, shocking the market as to the size of the proposed increase.
The changes are designed to make the banks safer and more able to stand up to a financial shock.
But questions have been raised about whether the cost of doing so is worth the benefit and the central bank has been criticised for not providing a cost benefit analysis as part of the consultation phase.