Will Reserve Bank try to skew bank lending towards businesses and away from housing?

Monday, 5 October 2020

ANALYSIS: The Reserve Bank is unlikely to please everyone if it unveils a new weapon to tackle the economic doldrums created by Covid-19 as expected next month.

The bank has signalled that it could implement a “Funding for Lending” scheme before the end of the year to help bring down retail interest rates.

The scheme will see it create new money on its computers, which it will offer to banks – quite probably at a zero or negative interest rate – to on-lend to borrowers.

The Reserve Bank has argued the new tool may be needed to encourage banks to further lower their retail interest rates, given they already have very little room to cut the rates of interest they pay bank depositors.

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That constraint on the banks will become even more restrictive if the Official Cash Rate is cut below zero, as expected some time after mid-March.

The European Central Bank lent banks another €174.5 billion to support their loan books last month, adding to a massive €1.3t issue in June.

But one of the tougher choices the Reserve Bank will face is whether to tailor its Funding for Lending scheme to encourage some types of lending more than others.

The EU’s European Central Bank (ECB) has operated a similar scheme and has so far this year lent almost €1.5 trillion (NZ$2.7b) to hundreds of European banks at interest rates as low as negative 1 per cent.

But the ECB appears to be skewing the lending away from the mortgage market and more towards encouraging banks to provide other types of loans to businesses and consumers.

The Financial Times reported in June that to get the best, negative 1 per cent interest rate, banks need to loan businesses and households at least as much as they did last year.

Otherwise the rate they are “charged” by the ECB is negative 0.5 per cent.

But it also reported that the lending volumes on which the ECB bases its calculation specifically exclude residential mortgages, meaning banks can lend less money to home buyers than last year and still qualify for the negative 1 per cent rate.

That’s important as it would make it advantageous for banks to shift a greater proportion of their lending towards business loans that encourage investment, away from mortgage lending.

Whether New Zealand’s Reserve Bank might go down the same track with its Funding for Lending scheme remains to be seen.

On the one hand, the bank is acutely aware that the wealth effect of high house prices and low mortgage rates encourages home-owners to go out and spend, which is something it is keen to support right now.

That might dissuade it from trying to alter the mix of bank lending.

But on the other hand, the Reserve Bank has recently started showing more sensitivity to the argument that the low OCR and its $100b quantitative easing programme have pushed up house prices, advantaged the wealthy, and ultimately made housing less affordable.

Reserve Bank governor Adrian Orr appears to be moving apace to provide additional monetary stimulus.

ANZ chief economist Sharon Zollner doubts the Reserve Bank will use its Funding for Lending scheme to heavily skew the lending market.

“There are trade-offs,” she says. “The more strings they attach, the less take-up there will be, and the less impact they will have on retail interest rates.

“The danger is if you try and hit too many targets with one stone, your stone might fall between the two.”

Overseas there has been a tendency for such lending schemes to start off with conditions which were later shed, she says.

The Reserve Bank hasn’t sounded much alarm so far that the housing market appears to be the “form of credit responding most vigorously to low interest rates”, she points out.

“That is what you would expect at this point in the cycle. Businesses are too worried to go on a big investment binge, even if money is virtually interest-free.

“Perhaps later they could skew it, but right at the moment I think they are quite realistic about what they can hope to achieve,” she says of the Reserve Bank.

Businesses are anyway reporting at the moment that access to credit isn’t high on their list of concerns, she notes.

But that does perhaps call into question what the point of any stimulatory monetary policy may be.

Infometrics economist Brad Olsen is thinking along similar lines to Zollner.

He says that while the Reserve Bank could follow the ECB’s approach, he doubts it would be that specific about targeting what it wanted lending to be used for.

The low take-up of the Government’s Business Finance Guarantee Scheme was a warning in that regard, he says.

“The prescription from the Reserve Bank and from Government was so strict and cumbersome that the banks said ‘look, we will find another way’.”

Instead, he expects the Reserve Bank to be more “indirect” in its approach to the finer details of the Funding for Lending scheme – settling perhaps for sending some signals about where it would like the money to go.