Reserve Bank of New Zealand urges calm as US banking market confronts latest turmoil

New Zealand’s central bank has expressed confidence in how financial institutions are managing interest rate risk, even as the US reels from the seizure and sale of First Republic Bank.

New Zealand’s central bank has expressed confidence in how its ­financial institutions are managing interest rate risk and fluctuations in asset and liability values, even as the US market reels from the seizure and sale of First Republic Bank.

The Reserve Bank of New Zealand brought forward the release of part of its Financial Stability Report to Monday, as a way of addressing the topic, given investor and customer angst around how banks are managing the higher rate climate.

The US banking system has been marred this year by the collapses of Silicon Valley Bank and Signature Bank, denting confidence in regional institutions and leading to a rush of deposit withdrawals at smaller players, including First Republic. The situation was exacerbated by the Federal Reserve’s aggressive monetary policy tightening cycle, which caught out some banks that made ill-timed bond investments.

First Republic was hard hit by the crisis and US regulators on Monday agreed to sell the bulk of the bank to JPMorgan. The Wall Street Journal had reported that JPMorgan and PNC Financial Services Group were among parties vying to acquire First Republic should the US government seize the institution.

Major Australian banks dominate the New Zealand banking landscape and account for about 85 per cent of lending by deposit-taking institutions in that market. The RBNZ’s report will therefore provide some assurance that Australia’s banks and their New Zealand subsidiaries will not get caught up in a run or instability linked to a timing mismatch between their assets and liabilities.

First Republic was hard hit by the crisis and US regulators on Monday agreed to sell the bulk of the bank to JPMorgan. Picture: Getty Images

The RBNZ’s analysis said lending by NZ banks was typically at variable or short-term fixed-interest rates, “which means the potential losses for banks from interest rate movements are smaller”. It noted that any residual risk was hedged by New Zealand’s banks, which would further mitigate the risk of any losses.

“New Zealand banks also hold fewer bond assets than banks in other developed economies, and these bonds are accounted for at fair market value. As a consequence of banks’ generally prudent risk management, we see little relationship between fluctuations in interest rates and banks’ NIMs (net interest margins),” it said. “This reflects the fact that the yields on banks’ assets and liabilities tend to move together as interest rates adjust.”

The RBNZ highlighted the ­period after the Global Financial Crisis, when it imposed additional requirements on banks to bolster management of capital and liquidity.

“We expanded prudential requirements to address capital and liquidity risk by requiring banks to have robust frameworks for managing interest rate risk,” the report said. “New Zealand banks are required to hold sufficient capital to cover potential losses arising from interest rate risk.”

Interest rate risk reflects the exposure of a bank’s position to rate movements. This is the case as assets such as government bonds with long-term returns, can be funded with liabilities such as deposits that are rate-sensitive.

“For a bank with high exposure to fixed-income assets, rising interest rates may lead to the liquidity problems seen with Silicon Valley Bank,” the RBNZ said. “If banks are unable to raise deposits at higher interest rates and pass costs through to loans, this can lead to sudden short-term liquidity problems.”

Australian Prudential Regulation Authority chairman John Lonsdale in March said the domestic banking system was “among the best equipped in the world” to withstand a financial crisis.

But he said the regulator was mindful of how quickly the demise of SVB had unfolded, given the speed at which money could now be withdrawn or moved.

The RBNZ’s commentary also noted the speed in which a bank could become subject to a wave of withdrawals.

“Silicon Valley Bank highlights how quickly concerns over risk management can undermine depositor confidence in an entity and the banking system as a whole. This can potentially lead to increased deposit outflows and, in extreme scenarios, can contribute to a bank run,” the report said.