The lead-up to Christmas is proving to be a busy time for policymakers in New Zealand. Last week saw the Reserve Bank hand down its final decisions on its long-running review of bank capital, which saw only modest changes from the original proposal. This Wednesday the Government delivers its half-year fiscal update, which has been enlivened by the promise of a big lift in infrastructure spending.
The final outcome of the RBNZ's bank capital review was broadly as we expected: a modest softening compared to the initial proposal, but banks will still have to increase their levels of capital significantly over the coming years. The current requirement is 10.5% of risk-weighted assets; this will be increased to 18% for the four largest banks and 16% for the smaller local banks, to be phased in over a seven-year period.
The stated aim of the capital review was to ensure that banks could endure up to a 1-in-200-year shock to the system. While major bank failures are rare, they have the potential to inflict significant harm on the economy, so there's value in taking out some additional insurance against such a risk. But like any insurance policy, this comes with an ongoing cost during normal times. Higher required levels of capital will increase banks' overall cost of funding, resulting in higher interest rates on loans, reduced lending, and a lower level of economic activity than otherwise.
The RBNZ has estimated that the effects of the new bank capital requirements would increase bank lending rates by 0.2% relative to the OCR. Our own analysis suggests that the impact could be twice that much.1 Either way, these estimates relate to the end of the phase-in period in 2027, so they don't suggest a need to adjust the OCR lower in the near term. Indeed, the RBNZ's most recent projections show that it expects to be hiking rates long before then. The more likely response on the monetary policy side would be to keep the OCR low for longer.
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