RBNZ sounds alarm bells on bank funding and currency

Concerns about bank funding risk have caused the Reserve Bank to defer increases in the core funding ratio.

The decision was announced this morning in the central bank's latest biannual Financial Stability Report - a report which says risks have increased since the last one (in May) and that New Zealand banks will face higher funding costs (and will have to push up interest rates) if the situation continues to deteriorate.

The risk of a "sharp deterioration" in the New Zealand currency also appears to have increased, the report says.

"Sharp depreciation would likely occur if global conditions deteriorate and investors seek to reduce exposure to risky positions such as carry traders in the NZ dollar."

The increases in the CFR, which are aimed at ensuring New Zealand banks hold more long term funds on their balance sheets, have been gradually introduced since 2010.

The ratio was due to be increased from 70% to 75% in July next year. However the risk of a global financial lockdown triggered by the economic crisis in the Eurozone coming to a head means this has been deferred until January 2013.

In his introduction to the report, Reserve Bank governor Alan Bollard said risks of a Greek default, and resulting contagion to other countries, has increased. "The outlook for the global economy has also deteriorated with weaker-than-expected growth, together with elevated financial market volatility in response to the sovereign debt strains in Europe," Dr Bollard said.

New Zealand is better placed to weather the crisis than it was in 2008, he said. At the time the amount of 90 day offshore funding was more than 50% of GDP: it has since fallen to about 35%.

Banks have, the report notes, increased their capital buffers and lengthened the maturity profile of wholesale funding over the past few years.

"However...New Zealand banks continue to raise a substantial portion of their funding from offshore capital markets.

This implies that, if global funding markets remain difficult, the cost of offshore funding for the New Zealand banks will eventually increase, putting upward pressure on interest rates for domestic firms."

The reliance on funding from offshore is due to New Zealand's poor savings rate. The report also notes the recent credit downgrades, but adds that the increase in long dated interest rates was small because the downgrades had been expected.

"Over the longer haul, lower credit ratings are likely to increase the cost of borrowing at the margin and may also reduce the country's overall borrowing capacity, particularly if there is a widespread flight to safe haven assets in global financial markets."

The downgrades, and the rising financial market turbulence, heighten the need to reduce both government and private debt, the report says.

"In light of the elevated risks of further disruption to global financial markets, the Reserve Bank is supportive of the government's stated intention to return the fiscal position to surplus in coming years.

"A stabilisation of government debt levels would help to further moderate New Zealand's external vulnerabilities, providing some offset if the private sector's current cautious attitude to debt accumulation turns out to be temporary."