Reserve Bank confirms backtrack on bank-capital tightening
Wednesday, 17 December 2025
The Reserve Bank has confirmed it will partly undo reforms initiated by former governor Adrian Orr that were designed to substantially increase the amount of capital that banks need to hold.
The purpose of the original reforms was to make banks more financially secure in the event of a major crisis, but they also had the negative trade-off of raising interest-rate margins and had been viewed in some quarters as overkill.
Read about the thinking behind Orr’s reforms here.
Finance Minister Nicola Willis, who had previously questioned Orr on the rules, ordered in January they be reviewed and the Reserve Bank initially indicated under acting governor Christian Hawkesby in August that it was likely to accommodate the concerns.
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The new rules, like the ones they replace, are complex — in part because they will apply to banks differently, depending on their size.
That is to reflect the fact that a failure of a bank would have different implications for the health of the financial system, depending on whether it was large or small.
In the key change, the Reserve Bank has decided that the largest Australian-owned banks will normally need to retain enough so-called “Common Equity Tier 1”(CET1) capital — the highest quality of capital — to cover 12% of their risk-weighted loan books.
That capital can be made up of equity contributed by shareholders and retained profits.
The reforms implemented by Orr would have required them to build up CET1 to 16% of their loan books by 2028.
Changes have also been announced to the way loans are risk-weighted for the purpose of the capital-ratio calculations.
The Reserve Bank said it expected the cost of crises to “worsen under the new rules but still remain within our risk appetite”, and lower banks’ lending rates by between 7 and 19 basis points — relative to what they would otherwise have been in 2028.
Its “central estimate” was the new settings would raise annual economic activity (GDP) by 0.12%, but said that could fall anywhere between a 0.02% drop and a 0.19% gain.
“Overall, we expect the higher costs of crisis to be smaller than the benefit of lower lending rates.”
Willis welcomed the changes.
“Higher costs for banks translate to higher lending costs for New Zealanders and, potentially, less lending to the agricultural and other important sectors,” she said.
“The new requirements announced today remain prudent and strike a better, more graduated balance between risk and competition.”
Smaller deposit takers will be allowed to maintain lower capital ratios than the big banks; in some cases CET1 ratios of 10%.
In addition to their CET1 requirements, the big four banks will be required to hold specified ratios of so-called “Loss Absorbing Capacity” (Lac) instruments — debt owed to their Australian parents — that they would be able to write off or convert to share equity if they fell into distress.
Those instruments would let the Australian banks recapitalise their New Zealand subsidiaries “under a range of crisis scenarios, recognising however that there will always be uncertainty in how a crisis will unfold in practice”.
Relative to the current settings, the new risk-weightings appear to give banks a greater incentive to make a higher proportion of their overall lending to less risky mortgages and loans to farms — meaning, those with a low Loan to Value Ratio (LVR).
The bank was not immediately able to clarify how the relative incentive to lend to small businesses would change.
Willis said she believed, overall, the new settings would encourage more lending to “the productive economy”.
Co-operative Bank chief executive Mark Wilkshire said they would “ease some of the constraints that have limited growth for smaller banks”.