ADVERTISEMENT

Ravaged Australian Banks Face a Fresh Challenge in New Zealand

Ravaged Australian Banks Face a Fresh Challenge in New Zealand

(Bloomberg) -- Australia’s big-four banks are bracing for another dose of bad news Thursday when New Zealand announces how much they will have to increase capital buffers at their subsidiaries in the country.

The central bank in Wellington wants lenders to boost their high-quality capital so they can withstand the sort of massive shock that comes along once every 200 years, arguing this will strengthen New Zealand’s economy. Reserve Bank Governor Adrian Orr will deliver the final verdict at 12 p.m. local time Thursday.

Read more: RBNZ Wants Banks to Double Capital Buffers for Massive Shock

Ravaged Australian Banks Face a Fresh Challenge in New Zealand

More onerous capital requirements will add to the headwinds facing the big banks, which are already grappling with rising customer-compensation costs, a slowing economy and record-low interest rates. For investors, the tougher rules increase the odds of further cuts to the once-steady stream of dividends that have made the banks a mainstay of portfolios.

The Australian banks have said they may need to consider whether to shrink or sell their New Zealand operations if the proposal to raise Tier-1 capital to 16% proceeds. They have also raised the specter that the cost of credit could rise or they will curb lending to risky areas such as the crucial dairy industry, hurting the economy.

Read more: Australian Banks May Review N.Z. Units Under Capital Proposals

The decision comes at the end of a year Australia’s big-four banks would rather forget. It was book-ended by a report into financial industry misconduct that lashed the banks for a runaway culture of greed, and last week’s resignation of Westpac Banking Corp. CEO Brian Hartzer after the lender was accused of the biggest breach of anti-money laundering rules in Australian history.

“The proposed rules add to the existing pressure on profitability and dividends,” said Tim Roche, Fitch Rating’s head of Australia and New Zealand financial institutions. “There is general pressure on profitability across the board right now, with slow credit growth, low interest rates and increased scrutiny impacting fee income.”

Big Buffer

The Reserve Bank has proposed that banks raise Tier-1 capital to 16% of risk-weighted assets over five years. That’s up from about 12% now and almost double the current minimum requirement of 8.5%. While Orr has said he’s open to giving lenders more time to implement the changes, he’s signaled little desire to compromise on the proposed level of capital.

While comparing capital buffers internationally is difficult because of varying regulatory rules, at 16% New Zealand’s proposal is among the more stringent. The minimum requirement in Australia is 10.5%, while the internationally-recognized Basel III standards mandate a 6% buffer. In Europe, regulators can then set add-ons for particular banks.

New Zealand’s four biggest banks are all units of Australia’s major lenders, which together hold about 90% of deposits. Australia & New Zealand Banking Group Ltd. and Westpac operate under their own brands, while Commonwealth Bank of Australia owns ASB Bank and National Australia Bank Ltd. controls Bank of New Zealand.

To meet the new requirements, Westpac, National Australia and ANZ Bank would each need to deploy an additional A$4 billion ($2.7 billion) to A$5 billion into their New Zealand operations, according to Macquarie Group Ltd. analysts. Commonwealth Bank already has enough capital, the analysts said.

Separately, new rules from Australia’s prudential regulator have effectively made it uneconomical for the big lenders to transfer capital around their units, making it increasingly likely banks will need to retain local earnings to meet the new requirements.

That’s potentially a big hit. In 2019, New Zealand units contributed between 12% to 22% of profit at the Australian banks. Over the past five years, the New Zealand units have paid about a combined NZ$22 billion ($14.2 billion) in dividends to their Australian parents, according to analysts at Morgan Stanley.

Ravaged Australian Banks Face a Fresh Challenge in New Zealand

That means they could have to retain up to five years of local earnings to build up their capital buffers, money that would have otherwise flowed through to profit and dividends.

Ravaged Australian Banks Face a Fresh Challenge in New Zealand

Orr has accused the Australian banks of scaremongering and downplayed fears they will pull back on lending.

The central bank estimates the impact of raising extra capital will have only a minimal effect on borrowing costs, increasing the spread between deposit and lending rates by 20-40 basis points. But other analysts have suggested banks may have to raise home-loan interest rates by as much as 1.25 percentage points to maintain current rates of return.

“Some of the analysis has been poor,” Orr said in an interview in April. Making banks safer will reduce both the cost and overall level of debt they need, while competition will limit the impact on customers, he said.

Still, any increase in mortgage rates could put pressure on the Reserve Bank to further reduce its official cash rate, already at a record-low 1%.

“How much of the impact will be front-loaded or spread over the transition period is very difficult to know,” said Sharon Zollner, chief New Zealand economist at ANZ Bank in Auckland. “It will result in some degree of tightening in financial conditions. There are a lot of headwinds for the economy at the moment and we can add this to the list.”

To contact the reporters on this story: Emily Cadman in Sydney at ecadman2@bloomberg.net;Matthew Brockett in Wellington at mbrockett1@bloomberg.net

To contact the editors responsible for this story: Marcus Wright at mwright115@bloomberg.net, Peter Vercoe, Edward Johnson

©2019 Bloomberg L.P.