Reserve Bank tools - winners and losers

17:00, May 24 2013

The Reserve Bank has officially got a shiny new kit of "macro-prudential' tools, designed to help shore up financial stability.

Up until late last week the details were murky but the central bank has now lifted the lid on how and when it might use them. These are an alternative to flexing its muscles through lifting the Official Cash Rate, which helps set interest rates consumers pay.

More importantly for consumers, the major banks have also dropped some strong hints about what they would do in response to any changes.

There's no guarantee that governor Graeme Wheeler will actually use the four new tools but if so, we can now see who the winners and losers might be:

1. Core funding ratio

Banks currently have to source at least three quarters of their money from customer deposits and long-term 'wholesale' funding.

This tool could be used to increase that ratio, so that bank funding becomes 'stickier' and more stable. It could also act as a safety valve to bring the ratio down when wholesale funding markets are hard to access.

Who wins, who loses?

Banks that source most of their money from customer deposits, said this tool would likely lead to increased competition, meaning they'd have to offer higher interest rates.

That's good news for anyone with money in the bank.

But the banks also admitted that meeting their profit targets meant they might have to pass the higher costs on to borrowers. The Reserve Bank said "the competitive environment would be critical in deciding this."

2. Counter-cyclical capital buffer

Banks have to hold a certain amount of capital on their balance sheets to counterweight their lending.

When people or businesses are borrowing too much or too fast, banks might be required to bump up their capital to cushion any potential losses.

The Reserve Bank expects the rate to be up to 2.5 per cent of banks' risk-weighted assets, but it may be higher if the situation is bad enough.

Who wins, who loses?

Holding more capital costs the banks money, but it remains to be seen whether the cost would be passed on to borrowers.

The Reserve Bank said banks were keenly aware of protecting their market share, so competition would come into play again.

Two of the banks said they would probably pass costs on through increased low equity fees, rather than higher interest rates.

That's bad news for people who want to take out a mortgage with a small deposit- like most first home buyers.

3. Sectoral capital adjustments

This tool is like a targeted version of the capital buffer. It would force banks to hold more cash against a specific sector where debt was growing dangerously fast- say agriculture, or home loans.

Who wins, who loses?

You'd think that the losers would be those that are specifically targeted, but the banks indicated they'd pass on the extra costs across the board.

Some suggested they would shoulder the costs to protect market share, and two said again, they would probably bump up low equity fees.

4. Caps on loan-to-value ratios (LVRs)

This is the big one that has attracted the most debate.

First home buyers tend to have high LVRs above 80 or 90 per cent, meaning they are borrowing most of the value of the property.

The Reserve Bank is concerned that the banks have been lending too fast into this higher-risk area.

It's preferred solution is to introduce 'speed limits' which would limit the amount of high-LVR lending they could do.

That would still give breathing room for the best creditworthy borrowers to take out big loans.

But the central bank also said it would do a complete clamp-down if necessary, by setting an as-yet undefined cap on the upper limit.

Who wins, who loses?

Lots of submitters were upset about this one, and argued there should be exemptions for the likes of first-home buyers and small businesses.

Some pointed out that housing growth was mostly happening in Auckland and Christchurch, and called for regional caps.

The Reserve Bank said it hasn't ruled out making exceptions, but it expected to apply the rules across the board so as not to weaken the tool's effectiveness.

It said targeting certain geographic regions was doable, but would run into practical difficulties and create distortions.

That means everyone will probably lose out equally if a high-LVR cap is implemented.

It's possible that the reduction in demand might help push house prices down - in which case property investors with more equity could swoop in.

Lower-tier lenders, building societies and others not covered by the regulation may also benefit from an influx of new business.

What does it mean?

The upshot of the new tools is that if they are used, there will be greater costs to banks.

They could choose to shoulder them, but their own admission of the drive to meet profit targets makes this unlikely.

Those borrowers without much equity in their properties will be amongst the worst-off, particularly first home-buyers.

But people with bank accounts and term deposits might be able to cash in on greater competition.

The Reserve Bank has said it's focused on financial stability rather than supply and demand issues like housing affordability.

Higher banking costs are the price we may have to pay to meet that goal.