Reserve Bank’s plan to cost farmers up to $8m/year more

The Reserve Banks’ plan to require banks to hold more reserves could cost farmers up to $800m a year in extra interest:

Estimates of the impact on interest rates range from the Reserve Bank’s own stab of 20 to 40 basis points up to the 120 bps estimated by the local arm of Swiss investment bank UBS, Federated Farmers says.

Multiplied across the agricultural sector’s $63 billion debt pile that would see farmers slugged for anywhere between $120m and $800m in extra interests costs annually.

“For farmers an increase in costs along the lines of the Reserve Bank’s modest estimate would be unwelcome enough while the worst-case scenario would be devastating,” the federation wrote to the Reserve Bank.

The bank wants trading banks to increase the minimum amount of capital they hold against loans from 8% to 16% within five years.

The increase is designed to ensure the banks have the capital needed to survive the write-downs on loans the Reserve Bank estimates would come with a one-in-200-years downturn.

Officially, the cost to the banks of meeting the new capital minimums is being put at $20b but banking sources believe it could be billions more. . . 

Ensuring banks survive a crisis is sensible but the Reserve Bank’s plan would require far greater reserves than ought to be needed and that will add high and unnecessary costs to loans.

Westpac NZ chief executive David McLean said shareholders in the banks’ Australian parent companies will not stump up that sort of money unless they can see a return.

In all likelihood that means interest rates would have to rise to offset the decrease in returns that would come with holding higher amounts of capital against the same amount of lending.

“We think the middle of that 80 to 120 basis points range is where it might come out but that is an average across all lending and it may fall differently across different portfolios of lending,” McLean said.

The increase is likely to be at the higher end of that range for agricultural lending because of the higher risk weighting applied to lending against farms, which historically experience bigger ups and downs in values and are seen as a riskier form of security than houses.

Because agricultural lending soaks up more capital per dollar lent the returns are lower for the banks’ shareholders relative to other types of lending where less capital is required. . . 

Should borrowers have to pay the price for safeguarding banks against a one in 200 year downturn?

The ANZ is warning farmers that if the Reserve Bank’s plan is implemented it will increase the cost of borrowing.

That in turn will increase the cost of production resulting in lower profits from farming and/or higher prices for food and fibre.

The Australian-owned companies which dominate the banking sector in New Zealand weathered the global financial crisis, why force them to hold such high reserves?

2 Responses to Reserve Bank’s plan to cost farmers up to $8m/year more

  1. Simon Edwards says:

    Hi, mistake in your headline on the bank capital story. $800 million in extra costs to farmers, not $800 billion.

  2. homepaddock says:

    Thanks – I’ve corrected it.

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