Tougher Bank Capital Rules Could Slice Off from Dairy Profit

NEW ZEALAND - Stricter bank capital requirements would severely dent dairy farm profits if the Reserve Bank goes ahead as planned, warn dairy interests in submissions on the contentious proposals.
calendar icon 5 July 2019
clock icon 4 minute read

"Our initial estimates are that the proposals could – at least in the short term – result in approximately a 10 percent decrease in profit for the agriculture sector," Rabobank New Zealand said in its submission.

The Reserve Bank this week released almost all of the 161 written submissions on proposals requiring lenders to hold more high-quality capital to mitigate the impact of a severe financial crisis. It plans to publish a response and the final decisions on the proposals in November.

The central bank wants to set a tier 1 capital requirement equal to 16 percent of a lender's risk-weighted assets for the big four and 15 percent for all other lenders. The current requirement is for 8.5 percent, a 6 percent minimum plus a 2.5 percent buffer, although the banks' current equity is around 12 percent.

Federated Farmers got ahead of the curve, releasing its submission early and backing the New Zealand Bankers' Association, which has been lobbying for the regulator to rein in its plans.

Members of the dairy sector argue that the capital requirements will lift lending costs and see more conservative lending policies. Agricultural lending stood at $63.5 billion at the end of May, with around two-thirds assigned to the dairy sector.

The proposed increase, together with the increased risk-weighed asset allocations to agricultural debt, will have "a significant adverse impact on the dairy and wider agriculture sectors," said Fonterra Cooperative Group in its submission. Of the dairy group's $7.75 billion of total borrowings, it holds about $1.95 billion of bank debt.

Fonterra said the proposals come at a time when farmers are already struggling with non-debt related costs, reduced access to capital and rising interest rates. “Some farmers are at risk of becoming financially unviable and may eventually be forced to exit dairying.”

This impacts regional economies and puts Fonterra at risk of reduced milk supply and underused and/or stranded assets, it said.

The proposed five-year implementation period is also extremely short, it said.

Fonterra commissioned research showing the extra cost to the average farm would be $50,794, based on interest rates being 125 basis points higher. Because most farms pay interest only, if they shifted to include principal repayments, the extra cost would jump to $155,558 per farm.

Dairy Holdings, which operates 75 farms in the South Island, said some trading banks are already hiking interest rates by up to 50 basis points on fixed term loans and margins above wholesale floating rates when existing debt matures.

It said there is a significant risk of a "perfect storm" where banking margins increase by 100 or more basis points due to extra capital costs and higher customer risk ratings, tighter credit sapping land market liquidity, and a milk price shock triggering a massive deterioration in all asset values.

Dairy Holdings recommends the RBNZ implement the increase in capital costs over a longer period of time than is currently proposed or at least have the option to extend the time period if required.

The Dairy Women’s Network also voiced concern about the impact on farming families and called on the RBNZ to carefully reconsider reducing the requirement of capital from a 200-year shock to 100 years or to transition the change over an extended period of time to allow our farming businesses to adjust.

DairyNZ said not enough work has been done.

"As an organisation, we believe that: the minimum level of a bank’s money coming from its owners should not change until a more robust analysis of the economic impacts associated with changing them has been undertaken."

The industry group's analysis shows “an additional interest cost of $200 per hectare or $31,000 per farm is likely be borne, assuming an increase of 100 bps.”

The total annual cost to dairy farms is likely to be $347 million, or 9 percent of annual dairy farm profit.

If a 100-basis point impact is assumed, it suggests that around 4 percent of farmers will become insolvent, it said.

"Overall, DairyNZ believes that the proposed change in capital-adequacy ratios for New Zealand banks outlined... lacks a credible and transparent evidence base."

Synlait Milk said the proposals have the potential to see more limited access to credit and higher funding costs.

"Whilst we don’t see this having a material direct impact on Synlait (or the institutional banking sector), this will have implications for Synlait’s farmer suppliers," it said in its submission.

"In our view, any moves towards the adoption of increased bank capital requirements should be made with caution, given the likely unintended consequences to certain sectors. As a minimum, we ask that the RBNZ undertake a comprehensive cost/benefit analysis of the proposals as they apply to the agri sector before any further steps are taken."

The central bank has appointed three external experts to independently review the analysis and advice underpinning its bank capital proposals.

The external experts are being asked to decide whether the problem that the capital review is seeking to address has been well specified and whether the Reserve Bank adopted an appropriate approach to evaluate and address it.

They are also being asked to review the inputs to the review and to decide whether the analysis and advice has taken into account all relevant matters, "including the costs and benefits of the different options."

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