Bank farm capital: does it cost the earth?

Loans to the rural sector represent a significant exposure for banks in New Zealand. In 2008, under the Basel II capital framework, the Reserve Bank accredited the four major banks in New Zealand to use their own models of relative riskiness in calculating capital requirements for different types of lending. A condition of accreditation was that banks addressed, to the Reserve Bank’s satisfaction, weaknesses in their modelling of rural capital exposures and potential losses. In this article, we explore the work that has been undertaken since accreditation to seek to strengthen the modelling of risk on bank loans to the rural sector. The primary objective of this work was to ensure that the risk weights used in determining regulatory capital requirements are aligned with the underlying relative risk of the exposures. The finalised risk weights for rural lending will be lower than those used under the previous Basle I regime. We also discuss the impact of recent developments in the sector on bank behaviour, and consider the potential impact of the Reserve Bank’s new requirements, concluding that any impact should be relatively small.