UBS weighs in on Reserve Bank rules, says mortgage rates could soar

Tighter NZ bank rules could drive interest rates higher, UBS says. Photo/Getty Images.

UBS has added its voice to the growing number of finance firms to oppose the Reserve Bank's proposals for banks to lift their capital ratios.

The Swiss diversified financial services company said the proposed capital ratio changes for New Zealand banks would make them among the highest in the world and could lead to increase of 80 to 125 basis points in mortgage interest rates.

UBS, in a research note on the Australian banking sector, said the Reserve Bank's announcement to sharply increase the banks' minimum capital requirements was a surprise to investors and one that may lead the big four Aussie banks, who dominate the local banking scene, to cut their dividends.

"While we are firm believers in strong, well-capitalised banks, we believe the proposals by the Reserve Bank to lift New Zealand bank capital requirements to the highest in the developed world appear excessive," UBS said.

"This begs the question – is New Zealand's proposed bank-capital-initiative worth it and what are the risks?

UBS said shareholders will expect a return on the $15 billion potential capital injection required to meet proposed new standards.

"We disagree with the Reserve Bank conclusion that "this will only have a minor impact on borrowing rates for customers".

"Equity is expensive, with a cost of capital of about 11 per cent, and we think shareholders will demand at least this return," it said.

"We estimate banks will need to reprice their NZ mortgage books by about 80 basis points to 125 basis points," UBS said.

UBS said the Reserve Bank's capital proposals appeared to be unnecessary and potentially damaging.

"We believe the Reserve Bank's endeavours to strengthen the banks could come at a significant cost to the NZ economy as they appear to be materially underestimating the likely mortgage repricing," UBS said.

"We see these proposals as expensive and unnecessary."

"That said, if the Reserve Bank proceeds with its capital proposals, it may be the final catalyst for dividend cuts at the Aussie Majors."

In a separate report, Craigs Investment Partners said an increase in required capital ratios would reduce the return on equity, which would affect the profitability of the New Zealand businesses.

"With reduced profitability, we would expect to see New Zealand banks pull the pricing lever to offset and that a portion of the higher capital requirements will be borne by borrowers through higher borrowing costs," Cragis said.

"We expect this would result in a reduction in system credit growth which would have implications for the housing market and overall economic growth."

Australian financial services group Macquarie last month predicted mortgate the rate rises could be as much as 90 to 140 basis points if the four major Australian-owned banks had to raise an additional $18.9 billion.

"The RBNZ paper suggests that the pricing response is likely to be immaterial," it said then.

"While, theoretically, this may be conceivable, in practice we believe it is highly unlikely," Macquarie said.

The Reserve Bank said in December that it would consult the market on its proposals.

"Insisting that bank shareholders have a meaningful stake in their bank provides a greater incentive to ensure it is well managed," deputy governor and general manager of financial stability Geoff Bascand said then.

"Having shareholders able to absorb a greater share of losses if the company fails also provides stronger protection for depositors," he said.

The bank has been reviewing bank capital rules since early 2017. Possible rule changes would take place over the next five years.

Submissions on the proposals close on March 22.