Every element of bank balance sheets – from the deposit base through wholesale funding to liquidity requirements and asset management – is about to become more contestable or more uncertain, requiring a strategic response.
Customer deposits are the bedrock of bank funding in New Zealand, accounting for almost 65% of bank lending as at March 2022 and providing a traditionally static source of revenue.
Depositor compensation should reduce the risk of mass capital flight but, as discussed earlier, we expect deposit bases will become much more dynamic and competitive on a day-to-day basis due to a more supportive regulatory environment for consumer led technological developments.
The current inflationary environment will incentivise customers to seek out higher returns just as new technologies and regulations make it easier for them to switch funds among banks, or to exit the banking system entirely. And younger generations, accustomed to making and changing investments at the push of a button, are unlikely to bring much loyalty to their banking relationships.
New bank products that can keep deposits within the bank ecosystem will become vital.
Bank non-equity funding source (locally incorporated banks)
To the extent that deposits become more volatile, and as the RBNZ-mandated capital requirements ratchet up to 16-18% by 2028, wholesale funding sources (both domestic and international) will become increasingly important.
These markets are typically a deep source of capital but an increased reliance on them will make New Zealand banks more susceptible to downturns in overseas markets and the lessons of the Global Financial Crisis, reinforced by very recent experience, will be front of mind.
- Some of the biggest unknowns and divergences from international practice in the Deposit Takers Bill relate to the treatment of creditors - from the absence of statutory bail-in, to the interplay between the depositor compensation scheme and bank resolution, and the lack of clarity around the framework for the RBNZ’s preferred open bank resolution (OBR) process; and
- The RBNZ has indicated that it will be making further changes to the design of regulatory capital, potentially brought forward by the recent international bank crises, adding further uncertainty.
The fallout from Credit Suisse’s merger with UBS, beyond the direct losses suffered by AT1 bond holders, is a general loss of confidence in regulatory capital investments.
Credit Suisse’s AT1 products were designed to be written-off in exactly the circumstances that ultimately occurred, and appear to have functioned as intended - but they were valued similarly to ‘contingent convertible’ instruments.
We expect a very strong investor focus in future on how products will shake out in a crisis.
This can be partially addressed by issuers in disclosure, but clear legislation, definitive central bank guidance, and approaches comparable to international norms, are likely to be highly valued. At this stage it is too early to tell how the RBNZ and other central banks will view these considerations.
Liquidity and assets
The RBNZ is considering imposing limits on banks’ ability to use mortgage loans (securitised as Residential Mortgage Backed Securities, or RMBS) and other highly rated bonds to meet the RBNZ’s liquidity requirements.
Banks would instead be required to hold significant additional government bonds which, in the New Zealand market, could substantially increase demand for such securities, may reduce the ability for other issuers to fund through the bond market (shifting reliance back to bank funding), and effectively tying bank credit quality even closer to New Zealand’s country credit.
Whether the Silicon Valley Bank collapse will give the RBNZ pause for thought is yet to be seen - SVB’s failure provided an extreme scenario of the risks that can be created by over-investment in a single fixed interest asset class.
The effect of the above trends in combination will be to bring into sharper focus the need for efficient asset use generally – including who to lend to (borrower risk) techniques such as netting, central clearing and credit default swaps.
Banks will continue to seek out new and alternative income-producing assets that do not require deposits or regulatory capital to sit behind them, such as fintech investments.
There are inherent difficulties attached to fitting new business lines into the highly regulated New Zealand bank model (often leading to divestments). But the various change factors at play or in prospect for the industry will require new approaches that improve the customer experience, so that they are not motivated to seek out alternative providers.