Kiwi Central Bank Lobs Market Hand Grenade

Australia New Zealand High Resolution Sign Flags Concept

I really don’t need another headache in the market right now. New Zealand is not helping on that front.

Apparently, the central bank over there wants to make its banking system ‘safer’. The collateral damage to this poor idea could be Australian bank shares.

That’s not going to help the Aussie market push into new highs. It could also mean lower dividends if you’re a retiree.

Today’s Profit Watch picks over the case…

Let me say this from the get-go: This has come out of nowhere for me. I happened to be perusing the ABC News daily email this morning. Down the list of stories my eyes went…yes, the election…other flim-flam…

Danger! Land mine!

What’s this? The New Zealand central bank wants to raise the capital requirements of the banks. This is how much money the banks must hold against their loan books to absorb defaults.

Australia’s ‘Tier 1’ capital requirement is 10.5%. New Zealand wants it to go to 14.5%. That’s a big lift.

Don’t dismiss this. Australia’s big four banks all operate over there. And this change — if it goes through — will lower their returns on equity for these NZ subsidiaries.

It also means they’ll have to find the extra money from somewhere. One analyst says NAB could have to cut its dividend to cover it.

The New Zealand central bank probably thinks it’s doing a good thing. One of the staff there points out the social cost of bank collapses and the implied liability that hangs over the taxpayer if they need to bail out the financial system.

Both those points are true. But the regulators have been fiddling around with capital ratios for three decades…

Regulators: It doesn’t work, but do it anyway

They don’t prevent bank collapses. If they did, Lehman Brothers would still be operating on Wall Street. Its capital ratio was in rude health in 2008 — right before it went bankrupt.

I wouldn’t mind if this was good public policy. But I don’t think it is.

This new rule is more likely to hurt the Kiwi economy because it could retract the amount of credit the banks can lend — and lower the overall growth rate of New Zealand.

The central bank should pay attention to where banks are directing their lending if it wants to prevent bank losses and the economic recession that goes along with them. That would prevent loans going bad on a wide scale in the first place.

The really deep bank collapses/recessions from history are usually associated with real estate busts.

You can stop these by taking away the incentive to speculate on real estate in the first place. You can also block banks from creating credit against property.

The real estate market would be a lot less inflated if borrowers were forced to source their debt from non-bank sources.

All this is important because banks create credit when they make loans. This brings new money into the economy.

But much real estate ‘investment’ is not productive and therefore doesn’t generate an income stream to service the debt. The more this happens, the more fragile the economy becomes until you get something like 2008.

There’s diddly-squat chance of any of these real changes happening. So central banks and governments fiddled with periphery concerns like capital ratios.

It takes no massive change to the cultural or political landscape and therefore achieves mostly nothing.

Can’t ignore this if you own bank shares

So now we have another niggle when it comes to the Aussie market. I’m not saying this is a disaster. But Aussie banks already face low credit growth at home. This isn’t helping them.

The consultation process appears to end in May for this. I don’t have a date yet for when the banks would need to implement the change.

Based on current trends, it’s quite possible that they might need to do all this at the worst possible time in the business cycle, as well.

I’ll keep monitoring this. It doesn’t change my immediate outlook: Cautious optimism. There are still so many positive developments happening at the individual company level for the stocks I track.

For example, one of the stocks in my recent report just revealed its quarterly cash receipts are up 250% in the first quarter. It’s another reason I pay no attention to the glum media headlines at the moment.

I say make the most of this kind of momentum while it’s there.

Callum Newman,
Editor, Profit Watch