Scroll

Roll out the red tape?

Are the RBNZ capital requirements good for investors?

Investing newsroom
Lyle  McNee, Investment Analyst - Fixed Interest

Lyle McNee
Investment Analyst - Fixed Interest | Email Lyle »

19 May, 2021

Share on Facebook Share on LinkedIn Share by Email

In defense of Red Tape
Red tape has gotten itself a bit of a bad name over the years, originally referencing the red string which bound important legal documents since the early 16th century. Red tape is synonymous with lengthy review and approval processes, resulting in progress moving at what appears to be a glacial pace. It is therefore often muttered with a roll of the eye or heavy sigh. But what if red tape actually deserved a rebrand? Seen more for what it actually is: due consideration to protect people from negative outcomes.

And so, I find myself writing this article in defense of red tape, one instance at least: The Reserve Bank of New Zealand’s (RBNZ) latest regulatory framework for NZ banks. Moreover, as an investor, I can see this regulation presenting new and unique investment opportunities, which is exciting for all of us.

What is happening?
The RBNZ is due to finalise its bank capital requirements in the next few months, placing additional regulation on NZ banks to hold more capital. Banks hold capital to help absorb losses should any loans turn sour. More capital therefore makes our banks safer, permitting banks to continue lending and supporting the economy through economic downturns. Since the fallout of the Global Financial Crisis, this has been a common trend around the world. But the RBNZ is going at least one step further than most regulators, as it looks to create the equivalent of Fort Knox out of our local banking system. In doing so, the RBNZ aims to reduce the probability of a NZ bank crisis to a 1 in 200-year event by adding over $20bn to the NZ banking system over a 7-year transition period

So where is the opportunity?
While increasing the amount of capital which banks are required to hold is important, equally as important is the quality of this capital. The RBNZ is evolving the types of securities which can make-up bank capital, now including subordinated bonds known within the industry as Additional Tier 1 and Tier 2 bonds. Importantly, they are designed to absorb losses only once all the equity in the business has been used up first. So, with between $10bn and $15bn of equity in each of the four major banks we think this offers a considerable buffer before bondholders would have to worry about the safe return of their funds.

Fisher Funds is no stranger to these new types of bank bond structures. We have invested in AT1s and T2s of many offshore banks over the last decade as they play a valuable role in delivering additional income and diversification to many of our investment portfolios. It is this experience which we look forward to putting to good use here in New Zealand. And with over $15bn of bonds likely to be issued over the next decade we see this fledgling asset class as a big opportunity to improve investment outcomes for clients.

The red tape sounds complex and aren’t subordinated bonds just more risky?
New Zealand’s major banks are some of the most profitable in the world, and if they weren’t before, they will soon be some of the best capitalised. Subordinated bonds undoubtedly carry more risk – both in terms of a more volatile price as well as the risk of not being repaid your principal. That is why we would only consider such an investment in the highest quality banks in the world.

Like most, I find most red tape needlessly restrictive.  But what I see here is an exciting investment opportunity.



Is there anything we
can help you with?

Chat to us