By Rebecca Howard
June 26 (BusinessDesk) - The Reserve Bank's proposal to almost double the minimum amount of tier 1 capital banks have to hold is positive but must be gradually phased in, the International Monetary Fund says.
"In general principles, we think the proposal is right. A substantial increase is needed," said Thomas Helbling, division chief in the IMF's Asia and Pacific department. "The principle of having a substantial increase in capital is commensurate with some of the elevated systemic risk in New Zealand's banking system."
The IMF said those risks are tied to the dominance of the four large banks with similar concentrated exposure to mortgages, business models and funding structures.
The Reserve Bank is currently consulting on a proposal to lift the minimum common equity requirement to 16 percent of risk-weighted assets from 8.5 percent currently for the four major banks. The smaller banks would have to hold 15 percent. The equity actually held by the banks currently averages about 12 percent.
Helbling said the IMF is waiting for the outcome of the consultation and the final decision but said the lift "is a range that people have mentioned where ultimately regulation should go to reduce risk."
Somewhere between 15 to 23 percent, the "benefits in reducing risks of financial or banking crises and reducing the potential burden on tax payers are far greater than the potential economic costs," he said.
Representatives from the banking sector have warned the move will jack up the cost of mortgages and say the central bank has failed to provide a comprehensive cost-benefit analysis.
Westpac Bank, for example, said the cost of the proposals will shave 1.3 percent points of New Zealand's annual gross domestic product. Groups like the Institute of Finance Professionals have questioned whether the proposals will even achieve the Reserve Bank's goal of making banks safer and say they will lead to a decline in bank deposit rates.
Helbling, however, said many of these issues can be ameliorated if the proposals are phased over a five-year period, as the RBNZ is proposing.
"We know from episodes of more immediate bank capital increases in a very short time period you worry about the impact on credit. But if it is gradual and banks may not have to go to the market then some of these more disruptive factors would be smaller, if any," he said.
He noted the starting point in the consultation was a five-year phase-in, which he said was a "good" amount of time. "We don't want to be too specific on the years, but it should be gradual," he said.
"It should take into account the capacity of banks to generate more capital to retain their earnings, for example, which is a very country-specific factor and I am sure will be taken into account in the consultation and the review by the external experts."
On Tuesday, the Organisation for Economic Cooperation and Development also weighed in on the issue when it presented a review of the New Zealand economy.
It noted it is difficult to compare the proposal against the requirements of other nations due to differences in the asset risk weightings used and the different economic context.
However, the proposal "would take Tier 1 capital requirements beyond those applying in other OECD countries," it said.
Higher capital requirements do reduce the risk of banks becoming insolvent but "they can also reduce economic activity by increasing lending rates due to a higher cost of funding for banks."
While the OECD agreed there is a "strong case for higher capital requirements" it underscored that there is "considerable uncertainty" around the appropriate end-point.
"The effect on lending spreads, bank credit availability and credit activity pushed outside the banking sector, to credit unions, for example, needs to be carefully monitored."