Negative official rates and FLP a downer for bank profits

Summary

• RBNZ had confirmed in September that the bank would launch its FLP programme by the end of 2020 before it slashes its OCR prior to March 2021.
• Banks fear that the step of taking the official cash rate to negative in as early as February 2021 by RBNZ could destroy their profits.
• Banks believe that competition amongst banks would motivate them to reduce mortgage rates, but there is a level up to which banks can lower the deposit rates, which could result in restricted net interest margins.
• RBNZ’s FLP programme could only help banks to an extent as smaller banks rely more on funding from deposits than larger Australian-owned banks.

Last month, in September, RBNZ (Reserve Bank of New Zealand) announced that the term funding for the FLP (Funding for Lending Programme) would be ready by the end of 2020 before it cuts OCR (Official Rate Cut) prior to March 2021, as there was a need for long-term monetary support to help the economy sail through the coronavirus pandemic. The bank also confirmed to keep OCR at 0.25%.

RBNZ had earlier indicated its preference to launch both FLP and negative OCR at the same time due to the consequences of negative OCR on bank earnings.

ALSO READ: Funding for Lending (FLP) a big boon for NZX Banks

RBNZ’s FLP is a cheap loan provided to banks to aid borrowing. The idea behind the move is that if RBNZ provides cheap money, banks would pass on the decline in their funding costs to their consumers.

However, the effectiveness of the programme remains with the banks on the extent to which they trickle down the full benefit received to borrowers.

Further, the demand for lending could be reduced by increasing unemployment and uncertainty as well.

Banks worry about the erosion of profits due to negative OCR

Frictions were evident between RBNZ Governor and the big 4 NZ banks’ bosses over the move to take OCR to negative zone, as early as February 2021 by the regulator at Finance Professionals New Zealand virtual conference.

Major banks are worried about their profits due to negative OCR and by what amount will FLP help them.

Liz Kendall, senior economist at ANZ, stated that competition between banks would prompt them to reduce mortgage rates, but there was a specific floor to abide by to lower deposit rates. Banks would struggle to retain customers, and a large part of their funding would be at risk if they reduce the deposit rates too much.

ALSO READ: Banks raise an alarm as RBNZ Governor prepares for Negative Interest Rate

Subsequently, banks cannot cut the deposit rates as much as the mortgage rates resulting in compressed interest margins. This could result in banks responding by tightening up of lending, which would be against the move of RBNZ to reduce OCR to encourage borrowing.

At this point, RBNZ’s FLP could help these banks by lending at a low rate without being dependent on deposits as a source of funding.

However, FLP cannot help entirely as smaller banks rely more on funding from deposits than the larger Australian-owned banks.

Kiwibank’s senior economist Jeremy Couchman also stated that banks could suffer some pain by the RBNZ’s move.