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The Reserve Bank yesterday moved to ensure the financial sector has enough cash on hand to function properly should the credit crunch get worse.
In its twice-yearly Financial Stability Report, it said New Zealand's financial system had so far withstood a severe bout of global market instability, but governor Alan Bollard warned that there were no guarantees the worst was over. While New Zealand's banks had very little direct exposure to the credit crisis, they had been affected by the global tightening in liquidity and availability of funds.
"Banks are now finding that the cost of this funding is going up and in some markets liquidity is still quite restricted."
Banks' difficulties raising funds on overseas markets, which provide about 40 per cent of their total funding, had in turn meant higher borrowing costs for businesses and households and could worsen the economic slowdown if credit conditions get tighter.
To partly address these issues, the Reserve Bank yesterday unveiled a series of measures to improve liquidity by extending the range of securities it would accept as collateral from banks seeking loans to include high-quality residential mortgage-backed securities and debt instruments issued by SOEs and local authorities.
"These could be provided as collateral for loans from ourselves should banks' normal sources of funding be disrupted in the future," said deputy governor and head of financial stability Grant Spencer.
"It's not responding to an existing emergency. It's a contingency that we're trying to cover here."
Bollard said the move was intended as "a lubrication of the system to keep it working smoothly".
"It doesn't relate to fears about capital adequacy in the system. We think that is pretty sound."
Yesterday's report contained a number of messages for the banks, said Spencer, including the instruction that they should lengthen the maturity structure of their debt, even if it cost slightly more to do so.
A month ago ratings agency Moody's warned that there were indications local banks were raising money on international markets on shorter terms, which was "increasing the volume of funding to be rolled over in 2009" and had the potential to affect some banks' ratings.
Moreover, Spencer said banks should diversify their sources of funding across different countries, markets and instruments.
He said the Reserve Bank had been working with the banks to develop a new prudential liquidity policy that was expected to be in place by the third or fourth quarter this year.
Finally, while acknowledging that banks should and were tightening up lending criteria, "they should not be putting up the lending shutters".
"There is a risk that if credit conditions are tightened too much, the slowdown in the economy will be exacerbated, putting additional pressure on households and businesses."
Bollard said the Reserve Bank was particularly concerned that corporates were finding it harder and more costly to source funds from banks.
"We wouldn't want to see overly tight conditions actually limiting the degree of corporate funding and therefore business investment."
MORTGAGE PACKAGES ALLOWED
At present the major banks in New Zealand, unlike their counterparts in the US, do not package mortgages into securities and sell them off, but instead hold them on their own balance sheets.
Under the Reserve Bank's new liquidity measures, however, the banks could package up their best loans into such instruments but would hold on to them as "essentially a back-up basis for liquidity".
If the banks' main sources of funding were to dry up or become unduly expensive, the Reserve Bank would accept these high-quality securities, as well as good-quality paper from local authorities and state-owned enterprises, as collateral on loans to allow them to continue to lend to customers and each other.
The bank's deputy governor, Grant Spencer, said the measures were similar to those put in place by the Reserve Bank of Australia and the Bank of England. The US Federal Reserve had been running a similar facility for some years.
He acknowledged that the move might lead to growth in the still relatively small mortgage-backed securities market in New Zealand, but that was not the primary intention.
As the Reserve Bank did not actually intend buying the securities, it would only be exposed to the underlying assets and their risk if the issuer failed.
"It's still a pretty safe proposition from the Reserve Bank and taxpayers' point of view."
