Reserve Bank orders banks to increase capital by $20 billion

New Zealanders can expect to pay approximately $5 more a fortnight on a $100,000 mortgage as commercial banks are ordered to increase the capital they have in their reserves.

That is one of the estimated effects from the Reserve Bank's much-anticipated decision on how much capital banks should hold so they can ride out future financial crises.

"More capital in the banking system better enables banks to weather economic volatility and maintain good, long-term, customer outcomes," says Reserve Bank Governor Adrian Orr.

Banks' total cash reserves will increase from a minimum of 10.5 percent to 18 percent for large banks, and to 16 percent for the rest.

Banks currently hold approximately 14.1 percent capital.

The Reserve Bank says the changes are significant, as they will increase the amount of capital in the banking system by approximately 50 percent.

That means banks will have to raise around $20 billion to meet the new requirement.

However, banks have seven years from July 2020 to reach their new capital requirements rather than the five years initially proposed.

Smaller banks will only need to increase their capital to 16 percent rather than the 17 percent originally suggested.

This is because their failure would have less impact on the economy than the failure of the big four banks - ANZ, BNZ, ASB and Westpac.

In a cost-benefit analysis of its decision the Reserve Bank found the benefits of having a safe and efficient banking system far outweighed any costs - including higher lending rates and lower deposit rates.

"Banking crises cause not only harmful economic costs but also distressful social issues, such as the general decline in mental and physical health brought about by higher rates of unemployment. These effects are felt for generations," says Orr.

Those effects were apparent during the Global Financial Crisis starting in 2007, which highlighted the need for banks to be better equipped to handle periods of financial stress.

These proposed changes to banks' minimum capital requirements lessens the likelihood of a 1-in-200-year financial crisis from 1.8 percent to 0.5 percent.

Leeann Watson, chief executive of the Canterbury Employers' Chamber of Commerce, says the decision to increase capital is "disappointing".

"This decision means that New Zealand's main four banks could have to obtain around $15-$20 billion from offshore investors, which is a significant amount when you compare the total capitalisation of the New Zealand sharemarket at around $150 billion," says Watson.

"For local businesses on the ground, there is a very real threat that the potential multi-billion-dollar costs will be passed on to customers, not shareholders - and that this would adversely impact businesses that just aren't in a position to absorb that kind of hit."

The additional costs to borrowers could make lending more expensive and unobtainable for businesses already struggling to access capital, says Watson.