One of the main functions of the Reserve Bank of New Zealand is to promote actions which 
help to make our financial system more stable. The new set of tools which are set out in the latest Memorandum of Understanding between the Bank and the Minister of Finance, is to assist in this.
The main goal is to minimise the impact of any sudden changes to supply of money in the banks and any sudden changes to asset prices. Obviously there are still some wounds from the last Global Financial Crises around the globe and these changes may help us in the next one.
Of the four main instruments; the restrictions on high LVR lending is quite interesting.
Restrictions on high LVR lending
Note that these tools are not in place to contain house prices in Auckland and Christchurch, they are there to assist towards greater stability in the financial system.
“Quantitative restrictions on the share of new high loan-to-value ratio (LVR) loans to the residential property sector. These include:
– Restrictions on the share of new high LVR lending that banks may undertake
– Outright limits on the proportion of the value of the residential property that can be borrowed to create a minimum equity buffer for the lender” (Reserve Bank)
The Reserve Bank will give at least two weeks notice before they use this tool.
The possible impact
If this instrument was used by the Reserve Bank it could mean less borrowers with a low deposit are able to buy. It could also mean that a borrower with a smaller deposit could pay more to get the mortgage. The days of a second mortgage could return with more opportunities for finance companies to assist in bridging the gap between the bank and the purchase price.
I also think that if this type of restriction was in place for a while there could be additional pressure for the banks to promote other types of loans to continue to grow their books. Low Doc lending could be one example of this.
Countercyclical capital buffer
“The countercyclical capital buffer (CCB) framework is an additional capital requirement that may be applied in times when Excess private sector credit growth is judged to be leading to a build-up of system wide risk.”(Reserve Bank)
Basically the banks could be asked to increase the amount of capital they have to hold when the market gets busy which could be later released when the market slows down.
The Reserve Bank will give at least 12 months notice before they use this tool.
The possible impact
This could mean a greater competition for capital and again an increase in the cost of borrowing. This could impact the cost for all borrowers.
This could help in a downturn as the bank would be able to reverse any requirements and in turn promote lending.
Adjustments to the core funding ratio
“The baseline core funding ratio requires bank to source at least 75% of their funding from retail deposits, long-term wholesale funding or capital.
A CFR tightening would increase system resilience by increasing the use of stable funding and could also lean against the credit cycle”
Basically this will give the Reserve Bank the ability to increase or decrease the amount banks must hold as retails deposits, long term wholesale funding or capital.
The Reserve Bank will give at least 6 months notice before they use this tool.
The possible impact
The tightening in this could later be loosened to enable banks to maintain a flow of credit when there is a significant deterioration in external funding market conditions. This could mean better returns for term deposit holders during those times that the bank sees fit to increase this requirement.
Sectoral capital requirements
“Adjustments to sectoral capital requirements would require banks to hold extra capital against a specific sector or segment in which private sector credit growth is judged to be leading to a build-up of system-wide risk.
The Reserve Bank will give at least 3 months notice before they use this tool.
The possible impact
The intention of this tool could be great to contain certain markets while not hindering the borrowing to another. Such as cooling affect on the housing market while farm lending continues.
Increase in costs would be likely for the certain sector but banks could choose to pass the costs of holding this extra capital to other sectors.
Interesting instrument and is used for a longer period may create asset bubbles in certain sectors.
