A bank capital land-mine awaits
An arcane plan to force banks to hold an extra $20 billion of capital could cripple the housing market, slow the economy and up-end the Government's Kiwibuild plans, says Bernard Hickey.
The Government, the housing market and the wider economy will have to navigate this year around a land mine put in their path by the Reserve Bank. This potential explosion inside the housing market may be avoided or deflected, but if the big four banks want to hold the Government hostage they could go on a lending strike and ramp up mortgage rates in a way that slams house prices and the wider economy.
It's all about an arcane part of financial regulation that most voters and home owners will never have heard of, let alone politicians and business leaders: capital requirements.
The biggest story in the political economy at the end of last year that didn't get a lot of attention was the Reserve Bank's proposals in mid-December for New Zealand's banks to double their tier one capital levels over the next five years.
That would force the big four banks to put aside almost $20 billion in fresh capital, which would be the equivalent of retaining 70 percent of their profits each year for the next five years.
The proposals are not confirmed policy yet and the big banks will be working hard behind the scenes to soften the blow. The shock of it is still reverberating. Ratings agency Fitch described the changes as "radical", as Pattrick Smellie reported here before Christmas.
Without changes to the policy, Fitch estimated bank funding costs would increase by up to 40 basis points, which would in theory have to be recouped through higher mortgage rates and/or lower deposit rates.
UBS estimated the capital changes would add between 80 basis points and 125 basis points to mortgage rates, as BusinessDesk reported on Newsroom Pro just before Christmas.
It even helped lead economists for ANZ, the biggest bank, to change their forecasts for the Official Cash Rate. They saw the OCR cut three more times to 1.0 percent over late 2019 and early 2020, as BusinessDesk's Rebecca Howard reported here on Newsroom Pro just before Christmas.
The debate over the capital changes looks set to rage (in the most central bankish way) behind the scenes between the Reserve Bank and banks through 2019.
This could all play out in a couple of ways. The banks could either keep growing mortgage lending at their current annual rate of around six percent and just slash their dividends to their parents in Australia. Or they could slash their lending growth and even start deleveraging to reduce the need for extra capital.
Will the banks go on strike?
This is shaping up as one of the major tensions behind the scenes in Government, banking and the economy in 2019.
If the banks go on 'strike' by tightening their lending criteria with mortgage brokers then the Government faces a severe economic headwind and a big headache in its relations with the Reserve Bank. This would be similar in a way to the headache and conflict the previous Government had over the loan to value ratio restrictions in 2013. John Key fell out of love with Graeme Wheeler through 2013 and 2014 because of it.
New Governor Adrian Orr has made his biggest move yet with the capital proposals. He is likely to come under pressure from the banks on one side and the Government on the other if lending starts slowing and the housing market begins to drop substantially.
Will house prices fall? Look at Australia
Anyone wanting a sneak preview of what that might look like just needs to check out Australia's sliding house prices. The Hayne Royal Commission's revelations of bank misconduct and an associated toughening of regulation by APRA has dramatically reduced lending growth in Australia, which in turn has put house prices under pressure. The slowdown is also forecast to slow economic growth there from three percent to two percent.
House prices are already edging lower in Auckland, but a more severe downturn in 2019 would add an economic and political downdraft that would complicate the Government's plans for 2020, including whether or not to adopt some form of capital gains tax.