Big Banks, Farmers, and Capital Requirements: 2025 Season Finale?

Tomorrow's RBNZ decision might look like an ending, but in bank regulation, the show never really stops

Tomorrow, the Reserve Bank of New Zealand will publish its final decisions on the 2025 capital review. This review began earlier this year in response to concerns that the 2019 capital requirements, which aimed to make banks hold significantly more capital by 2028, may have been too conservative, potentially undermining competition and economic growth.

What the RBNZ Will Decide

The RBNZ’s decision has two key components that work together to reshape how much capital banks must hold.

The first component involves changes to risk weights, which form the denominator in capital ratio calculations. The RBNZ is proposing more granular standardised risk weights that would reduce capital requirements by approximately 5% across the system. The changes are particularly significant for small and medium enterprises and agricultural firms.

The second component involves the numerator, the amount of capital to meet the ratio requirements. For the major banks, classified as Group 1, the RBNZ has presented two distinct options.

Option 1 maintains a simpler structure similar to the current framework but with reduced requirements. It would have a CET1 capital requirement of 14% (up from the 13.5% envisioned in the 2019 plans), while total capital would drop to 17% (down from 18%). In all, this represents a capital reduction of approximately $7 billion, or about 11%, compared to what was decided in 2019.

Option 2 introduces Loss-Absorbing Capacity, or LAC. Under this option, the CET1 ratio requirement would drop to 12%, but banks would be required to hold an additional 6% in LAC. While total loss absorbency would actually increase to 21%, the composition would shift away from equity capital toward debt instruments that can be written down or converted in resolution. Both options eliminate the AT1 capital instruments that have been part of the framework, with this option expected to reduce CET1 by around $7 billion (around 14%) compared to the 2019 Capital Review.

The reviewed capital framework is expected to reduce bank funding costs, which could translate into lower lending rates for borrowers. But don’t expect miracles—the RBNZ itself has made clear that capital settings, while important, aren’t the main drivers of economic growth or banking competition.

Who Actually Benefits?

The proposed changes will benefit the Big Four banks most directly. While the lower risk weights are ostensibly designed to help small and medium enterprises and agricultural firms, the actual price of credit is determined by many factors—supply and demand dynamics, risk, and bank profitability targets all play a role. Whether farmers and small businesses actually see lower borrowing costs remains an open question, one that will only be answered when we see what banks do with their newfound regulatory relief.

An Obsession with Requirements

Second, there’s the obsession over capital requirements rather than the actual capital ratios that banks report. Regulators focus on minimums, but banks pay attention to the risk-return relationship and the expectations of investors and credit rating agencies. It is well documented that small banks, who are more vulnerable during a crisis than large banks, feature higher capital ratios to meet these market expectations. See an earlier post here.

What has actually happened to bank capital ratios reveals this disconnect. The big banks (D-SIBs, blue, in the graph below) have hardly increased their capital ratios since the end of 2023, when the National led government came to power and signalled a more bank-friendly regulatory approach. Meanwhile, smaller banks (green) have continued to build capital, even in the months following the announcement of this capital review (!) The pattern is clear: regulatory minimums matter for the big banks but carry less weight for smaller institutions.

This observation reinforces a broader point: the relentless focus by pundits, press, and politicians on capital requirements plays directly into the Big Four’s hands. They sail close to the wind and will take advantage of any possible regulatory relief. See my awesome explanatory video on the Formula 1 racing analogy and capital requirements here.

Premature in a Time of Global Simplification

The RBNZ has abandoned its previous risk appetite parameter of one-in-200 years and replaced it with the notion that New Zealand’s capital framework should be comparable to international jurisdictions. This pivot toward international alignment comes at a curious moment. In recent weeks, the Financial Stability Institute at the Bank for International Settlements has published work revisiting the regulatory capital stack, highlighting its complexity and the limitations in the loss-absorbing capacity of some components. The ECB has released a comprehensive simplification agenda for European banks that proposes reducing the number of capital stack elements and improving the quality of going-concern capital. The Bundesbank and Bank of England have made similar moves toward streamlining their frameworks.

In this context, the RBNZ’s review looks premature. By locking in decisions now, New Zealand risks falling behind international developments rather than keeping pace with them.

Call it a season finale if you like, but smart money says we’re already being set up for the sequel.