Will Farmageddon flow from the Reserve Bank's plans to require some seismic strengthening of banks' balance sheets?
Some of the submissions it has received in its review of bank capital requirements make sobering reading, especially about the impact on the dairy sector.
So first, some numbers. Bank lending to the agricultural sector has climbed from $12 billion in 2000 to $63b now — two-thirds of it to the dairy sector. It works out at $8300 per cow.
Dairy farmers' average mortgage is a little under $5 million. Dairy products provided 27 per cent of New Zealand's goods export income in the year ended May.
How much interest margins — the gap between what banks pay and what they charge — will widen if the Reserve Bank's current proposal goes ahead is a point of contention, with estimates ranging from the banks' own 20 to 40 basis points to as high as 125 basis points.
Dairy NZ reckons that a full percentage point on interest rates would cost the average dairy farmer $31,000 a year and leave nearly 4 per cent of them unable to cover the mortgage.
Interest rates are only one of the risks farmers face. There is also the normal risk that export prices and/or the exchange rate turn against them, the prospect of an end to an entirely free ride on methane and nitrous oxide emissions, and the disease Mycoplasma bovis.
In its submission, Federated Farmers says historically low interest rates have been very helpful for farmers coping with high debt levels in a challenging environment. "Any large increases in interest rates will cause stress for many farmers and severe distress for some," it says.
"As well as higher costs of borrowing, Federated Farmers also expects banks to become more conservative in their lending and apply more restrictive lending conditions ... especially for agricultural lending."
Dairy Holdings Ltd, which has 75 farms in the South Island, says that all the major trading banks have indicated directly to it that they intend to fully pass on to the customer all the increased costs associated with increased capital requirements.
"In fact some trading banks are already enforcing a lift of up to 50 basis points onto fixed term loans and margins above wholesale floating rates as existing facilities mature, over [and] above what they were charging prior to the capital adequacy debate starting."
But the starkest warnings come from KPMG. Its global head of agribusiness, Ian Proudfoot, says KPMG's best estimate is that the big four Australian-owned banks and Rabobank will seek to reduce lending to the farm sector, mainly dairy, by between 15 and 25 per cent and increase margins across their remaining agri-lending by between 100 and 125 basis points.
It will, he says, effectively crash the farm land markets and cause the failure of the most weakly capitalised dairy farmers.
"It will destroy the accumulated capital position of New Zealand's ageing farmer population at a point where the sector needs them to sell their farms to young farmers with new skills in managing the changing risk profile," he says.
"Even more importantly it will prevent or seriously delay capital spend by good dairy and other farmers needed to lift farm economic, environmental and animal welfare performance at a time investment in these areas is critical."
Hang on, though. Can it really be that an increase in mortgage interest costs that would fall well within the normal variability of interest rates, have such dire consequences?
If so, how come the dairy sector is as debt bloated as it is?
Consulting economist (and former Treasury and MAF official) Peter Fraser is a trenchant critic of the industry structure.
His argument, laid out in a recent lecture entitled "Apocalypse Cow" and available on the website of Victoria University's Institute of Governance and Policy Studies, goes like this: it was a fateful mistake for the Dairy Industry Restructuring Act in 2001 to give Fonterra effective monopsony power to set milk prices.
For all the arcane complexity of its capital structure, it is essentially a farmer-owned co-operative. As such, it has a powerful incentive to maximise the payout to farmer suppliers, at the expense of starving the company of capital that might enable it to add the kind of value to milk that its international peers manage.
It is a model which favours volume growth over value-add.
A higher-than-optimal payout has encouraged a lot of dairy conversions, including in environmentally improbable places like the Mackenzie country, and intensification more generally.
Expectations of a high payout get capitalised into land prices. That is great for those selling up and exiting the industry.
For farmers who have to get up to their nostrils in debt to buy a dairy farm, not so much.
To be fair, high prices for dairy land have also reflected the ability to socialise the cost of environmental externalities like greenhouse gas emissions, along with the absence of a capital gains tax. They could also be seen as a local instance of the global phenomenon of extraordinarily low interest rates driving high debt levels and inflated asset prices.
All this leaves the Reserve Bank with a dilemma.
The banks' willingness to provide all that debt to the dairy sector, its structural challenges notwithstanding, arguably illustrates the moral hazard of being too big to fail, as the taxpayer support provided during the global financial crisis made clear. It strengthens the case for tighter capital requirements.
But on the other hand, the importance of the dairy sector to the wider economy and the fact the starting point of debt levels is what it is, suggests the Reserve Bank should go easy with the pace of reform.
The Australian regulator Apra has decided, after consultation, to scale back its increase in capital requirement from the proposed 4 to 5 percentage points to 3 percentage points, and to allow it to take the form of Tier 2 capital — debt financing in normal times, which turns into equity only if a bank faces losses which wipe out its shareholders' equity.
That may be a signpost to where the RBNZ should go.