Cash rate increases boon to banks’ profitability – Fitch

Central bank rate increases push up returns on bank assets, report says

Cash rate increases boon to banks’ profitability – Fitch

The Reserve Bank of New Zealand’s (RBNZ) expected increase of the official cash rate (OCR) would be a boon to the profitability and earnings of the country’s banks, Fitch suggested in its latest assessment.

The credit agency said it expected the central bank to “to begin raising interest rates at its meeting on August 18,” adding that the increase “may be positive for banks’ profitability and earnings due to increased returns on bank assets, particularly loans.”

Fitch, however, said that it might take time for banks to feel the positive impact of the rate hikes in their earnings as many residential mortgages are on fixed-term interest rates.

“Banks have already started raising mortgage rates in anticipation of future rate hikes,” Fitch told Interest.co.nz. “However, more than half of banks’ mortgage customers have fixed-rate terms of more than six months.”

“Rate hikes could encourage banks to increase traditional lending and reduce liquid asset holdings, though the higher cost of borrowing will also affect demand for credit,” the agency added. “We expect credit growth to remain strong in the next year, largely driven by residential mortgage issuance.”

But Fitch also predicted growth in mortgage lending to “decelerate modestly” due to higher rates and tighter regulations, including loan-to-value ratio (LVR) restrictions and possible debt-to-income curbs. In other sectors, the credit agency said business lending might pick up as strong economic conditions could encourage borrowing for investment.

“If banks are able to raise lending and returns on interest-earning assets, the positive effect on profitability will be partly offset by higher funding costs,” Fitch said. “Banks’ on-call deposits have grown considerably over the last 12 months due to strong liquidity support provided by the RBNZ, as well as a shift from term deposits to on-call accounts. However, we expect deposit growth to moderate as the RBNZ continues to unwind its monetary stimulus.”

The credit agency said this could prompt banks to rely more on wholesale funding, with the degree of reliance gradually returning to “pre-pandemic levels over the next two years.”

Fitch added that higher interest rates could adversely affect asset prices, particularly house prices, as low interest rates have largely kept debt servicing costs manageable.

“Rising interest rates may weigh on borrowers’ ability to service loans,” Fitch said. “This, combined with tighter mortgage lending restrictions, could lead to slower growth, or declines in house prices over the next two years. However, the fact that the robust economic outlook and tightening labour market are factors likely to drive rates higher should support borrower servicing capacity and limit the risk of a significant deterioration in asset quality.”

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