KEY POINTS:
New Zealand's major banks, already more cautious on lending due to the credit crunch, may "stamp hard on the brakes" should the crisis worsen, pitching the economy into a slowdown requiring dramatic Reserve Bank action, KPMG warned yesterday.
Presenting the accountancy firm's annual review of the sector, partner Godfrey Boyce said the easy credit conditions enjoyed over the last half decade were now over due to the credit crunch generated by last year's sub-prime meltdown.
New Zealand's major banks, which rely on overseas money markets to fund anywhere between 30 and 50 per cent of their lending, were now paying substantially more for that cash.
Boyce said the banks had initially thought this was a temporary phenomenon and absorbed much of that pressure themselves through lower margins.
By early this year, as the crisis ground on, they were increasingly passing that on to customers including corporates, other businesses and homebuyers in the form of higher interest rates.
Boyce said overseas investors remained gun shy about funding banks including those in Australasia, which had little if any direct exposure to sub-prime, and credit spreads - the premium charged over base rates to reflect the risk environment - had continued to rise.
"Who's to say we've levelled off? We may or may not have, but clearly as each bad news story keeps flowing through internationally, the danger is that they keep pricing up money to New Zealand and that's the concern."
Banks had been able to substitute more domestic retail funding for increasingly expensive wholesale funds, to the tune of an additional $14 billion over the past 14 months, probably at the expense of finance companies and the managed funds industry.
However there were limits to domestic funding available and the more unsure banks were about funding the less they would pursue asset growth or lending.
"We do have the potential for a real hard foot on the brake leading to a credit rationing scenario where the tap's wound right back. The prospect of that is quite a worrying one."
A reduced flow of overseas cash into the economy would impact on commerce and business investment.
KPMG financial services chairman Andrew Dinsdale said there were already clear signs of credit rationing in the finance company market which has been a precursor to tighter lending by banks in previous business cycles.
While the banks were not there yet, KPMG believed funding pressure would continue through this year.
"The US banks are fighting a losing battle to argue that they're through the worst of it."
A substantial amount of sub-prime lending was up for refinancing this year which suggested the flow of bad news from the US would continue.
"We'll see that in terms of those credit margins staying high. The worst-case scenario is investors get even more spooked and form a negative view about Australasia."
Should credit spreads move a further half a percentage point higher "that headline cost of money gets to a really tough level for borrowers, it causes stresses for the banks and embeds their conservatism even more and you see that tap wound off even more".
While the Reserve Bank's official interest rate of 8.25 per cent gives it considerable headroom to cut rates should the economy show signs of rapid slowing, Boyce pointed out the RBNZ had little control over the pricing of overseas funds and would be forced to make deep, fast cuts.
"We'd say you've got to come down say a full two percentage points to 6.25 per cent to get substantial traction."
Such cuts would encourage home buyers to abandon the fixed-rate mortgages they currently favour and move to a floating rate that the RBNZ has more direct control over.
"To be honest 25 to 50 basis points won't get traction."
