Strong deposit growth has been driven in large part by the RBNZ’s LSAP programme, which in combination with the wage subsidy injected billions of dollars into the bank accounts of households very quickly.
Although bond purchases under the LSAP scheme are directed to markets, purchases do filter through into increasing deposits in the banking system.
It is this phenomenon, rather than a change in saving behaviour or the like, that has driven the recent run-up in deposits.
This strong deposit growth from the LSAP has also put downward pressure on deposit rates, which itself has helped keep mortgage rates low.
Because this extra cash in the system is mostly sitting in call accounts or relatively short-duration term deposits (a cost of funding for banks not too different from the OCR), banks have not really needed to draw on the FLP for funding, with around $1.6bn drawn from the scheme by mid-March.
Credit supply is expected to be more limited going forward
Although deposit growth will remain supported by the continuation of the LSAP, the impetus to deposit growth will wane as the LSAP is pared back and fiscal stimulus dissipates.
This will naturally reduce the extent to which banks can self-fund. This, in turn, will tend to cool mortgage lending, with banks faced with the decision to either ration lending or raise funds through other means, which would exert upward pressure on mortgage rates.
Depending on how much funding is required, banks might be able to plug the gap with wholesale funding (ie issuing bonds).
This is generally a more expensive source of funding than domestic deposits, but because wholesale funding is a not the dominant source of funding and yields have come down a fair amount, the impact on mortgage rates would likely be relatively small.
Alternatively, if the gap between credit demand and deposit growth becomes very large, banks may need to start competing harder for domestic deposits, and there’s only one way they can do that – higher deposit rates.
That’s a higher funding cost that could lead to higher lending rates.
There’s not much sign of it yet, but it’s a very plausible development.
Savers will be crossing their fingers. Banks can also draw on the FLP, and we do expect take up of the scheme to increase in time. The RBNZ has committed to keeping the scheme in place till mid-2022.
Given that banks know that they have plenty of time to access the scheme, they will likely do so when it better suits gaps in their funding profiles, rather than immediately.
As deposit growth slows, this will also gradually lift the incentive for banks to draw on the FLP.
The FLP is expected to help to bridge some of the gap that may emerge between credit demand and supply as deposit growth slows, and may mean banks do not have to raise deposit rates as soon or by as much.
But the scheme will only account for a small portion of banks’ total funding and banks will want to carefully manage the risk of being too reliant on the scheme at particular time horizons, since they will need to replace the funds with other sources down the track.
This means that any offset to bridge any funding gap or alleviate upward pressure on interest rates is only likely to be partial.
All up, this means that under the scenario where credit demand remains very strong for an extended period, but deposit growth slows, credit conditions are likely to “naturally” tighten.
Credit conditions to weigh, including policy changes
At the same time as bank liquidity is expected to become less abundant, we may see banks become more cautious about riskier lending, given the sheer rise that has been seen in house prices and the apparent unsustainability of current market conditions, particularly if funding is more of a constraint.
We have already seen this start to play out with banks moving pre-emptively to tighten investor loanto-ratio caps ahead of their re-imposition by the RBNZ.
The RBNZ re-imposed previous restrictions effective from March 1, after removing them temporarily at the onset of COVID-19.
They are also proposing tightening restrictions on investors from May 1 (limiting lending with equity of less than 40%).
These changes are helpful in limiting the build-up of financial stability risks and may curb house price inflation to some degree, but they are not expected to have a large persistent impact on the market (similar to when restrictions have been tightened previously), particularly because equity positions have increased so much on the back of recent house price gains.
Figure 9. House sales and prices