The Reserve Bank is seeking feedback on proposed changes to its key capital settings for registered banks and non-bank deposit takers (2025 Capital Review). In this insight, we summarise the proposals in the consultation paper.
If you have any questions on the consultation paper, or the implementation of the Deposit Takers Act 2023 (DT Act) more generally, please get in touch with one of our experts.
Background to the 2025 Capital Review
In 2019, the Reserve Bank published the outcome of a comprehensive review into its prudential capital requirements (2019 Capital Review). These decisions included significantly increasing the quantity and changing the nature of the regulatory capital required to be held by registered banks in New Zealand, with the goal of being able to withstand a "1-in-200 year" economic crisis. The 2019 Capital Review decisions are currently being phased in.
Since the 2019 Capital Review decisions were published, concerns have been raised that the new capital settings are overly conservative by international standards, risk undermining competition in the banking sector and disincentivise lending to certain sectors of the economy.
Last year, the Commerce Commission published the final report on its competition study into personal banking services. One of the Commerce Commission's recommendations was that the Reserve Bank should place greater emphasis on competition in specific upcoming decisions, including in relation to capital settings under the DT Act. Following the Commerce Commission's report, the Minister of Finance issued a new financial policy remit and letter of expectations that placed greater emphasis on competition. The Finance and Expenditure Committee has also recently published the final report on its inquiry into banking competition, which included the recommendation that the Reserve Bank should cease the further planned increases to banks' capital requirements under the 2019 Capital Review.
Against this backdrop, in March 2025 the Reserve Bank announced that it would undertake a review of its key capital settings.
Legislative context
Since the 2019 Capital Review decisions, the Reserve Bank's governing legislation has changed significantly. Under the Reserve Bank's institutional legislation, the Reserve Bank of New Zealand Act 2021, the Reserve Bank board has responsibility for setting risk appetite and for non-monetary policy decision-making. The DT Act will also provide the Reserve Bank with more comprehensive supervisory and crisis management powers. There have been other changes since the 2019 Capital Review decisions, including new macroprudential tools (e.g. debt-to-income ratios), more intense supervision and enhanced stress testing, and there will also be more comprehensive non-capital standards under the DT Act (e.g. a new risk management standard).
In the consultation paper, the Reserve Bank explains that these changes should lower risk in the financial system and that the DT Act changes are a key reason for the Reserve Bank having a higher risk appetite than it had in 2019.
Key proposals
The Reserve Bank is seeking feedback on the following changes to the 2019 Capital Review decisions:
- Removal of Additional Teir 1 (AT1) capital: The Reserve Bank proposes to remove AT1 capital instruments from the capital stack for all deposit takers.
- Reduced minimum Tier 1 capital ratio requirement and prudential capital buffer, increased minimum CET1 capital ratio requirement: The Reserve Bank proposes to decrease the minimum Tier 1 capital ratio requirements for all deposit takers (from 7% to 6%) and the prudential capital buffers (PCB) for Group 1 and 2 deposit takers (from 9% to either 8% or 6% for Group 1 and from 7% to 5% for Group 2). However, the minimum common equity Tier 1 (CET1) capital ratio requirements would increase for all deposit takers (from 4.5% to 6%) as a result of the removal of AT1 capital.1
- Options for Group 1 deposit takers: The Reserve Bank is seeking feedback on two options for Group 1 deposit takers (the domestic systemically important banks):
- Option 1 - No 'Loss-Absorbing Capacity' instruments: The PCB would decrease from 9% to 8%.
- Option 2 – 'Loss-Absorbing Capacity' instruments: The PCB would decrease from 9% to 6%, but an additional 6% of new internal 'Loss-Absorbing Capacity' (LAC) instruments would be required on top of the regulatory capital stack.
- Countercyclical capital Buffer (CCyB): The Reserve Bank proposes to set the long-run level of the CCyB at 1% of risk-weighted assets for Group 1 and 2 deposit takers (rather than 1.5%) to reflect the smaller PCB.
- More granular standardised risk weights: The Reserve Bank proposes changes to certain standardised risk weights to make them more granular and more closely reflect the underlying risk of the relevant credit exposures. In aggregate, the proposed changes to risk weights are expected to reduce the amount of capital required for a given capital ratio requirement.
Removal of AT1 capital
AT1 capital is a form of regulatory capital that banks can currently use to meet their minimum Tier 1 capital ratio requirements. The 2019 Capital Review significantly revised the form of AT1 capital instruments by replacing contingent convertible debt instruments with perpetual preference shares (PPS).
Because PPS are equity instruments, distributions on PPS include imputation credits. This makes PPS unattractive for overseas investors who do not have New Zealand tax liabilities. PPS also fall outside many investment mandates. Banks have raised concerns about the capacity of the domestic capital markets to absorb the volume of issuance that would be required for banks to fully utilise their AT1 allowance.
There are also growing concerns internationally about the effectiveness of AT1 capital to absorb losses on a going concern basis (e.g. that the signalling risk of not paying a discretionary distribution or not redeeming the instruments at the earliest opportunity could exacerbate rather than stabilise a stress situation). This led the Australian Prudential Regulation Authority (APRA) to announce last year that it will phase out AT1 as eligible regulatory capital in Australia.
The removal of AT1 capital instruments will reduce flexibility for deposit takers in terms of how they meet their Tier 1 capital requirements, which may mean they have to hold more CET1 capital than they otherwise would. The Reserve Bank is seeking feedback on transitional arrangements for legacy AT1 capital instruments.
LAC instruments
LAC instruments would be pre-positioned debt instruments that could be written down or converted into ordinary shares to absorb losses and recapitalise a deposit taker. Unlike CET1 capital instruments, which are going concern capital, LAC instruments would be gone concern capital that absorb losses once a deposit taker reaches certain trigger points. Regulatory capital instruments and LAC instruments would together represent the 'Total Loss-Absorbing Capacity' of a deposit taker (i.e. the total funds able to absorb losses before depositors and other creditors).
The consultation paper provides that the Reserve Bank's current intention is for LAC instruments to take a form similar to Tier 2 capital instruments and to be issued internally by Group 1 deposit takers to their parent banks. Under Option 2, Tier 2 capital instruments would also be required to be issued internally. These changes are intended to provide a legal mechanism to ensure the down-streaming of new CET1 capital during a group-level resolution.
During the 2019 Capital Review, the Reserve Bank was concerned about contractual bail-in features. However, the Reserve Bank considers these may be mitigated if the Tier 2 and LAC instruments are held internally (e.g. avoiding the risk that external investors do not appreciate the risks associated with these instruments) and through the design of the instruments. Under the DT Act, the Reserve Bank will have specific powers to issue bail-in standards and to direct a deposit taker to trigger the terms of a bail-in instrument.
The treatment of internal LAC and Tier 2 instruments under APRA's regulatory regime will be important for Group 1 deposit takers and their Australian parents (particularly in relation to the deductions that may be required under APS111). The Reserve Bank has said that it is consulting with APRA on the treatment of LAC and Tier 2 instruments under APRA's regulatory regime.
Capital settings and crisis management are closely interrelated topics. It may be difficult for Group 1 deposit takers to fully assess the relative merits of Options 1 and 2 without clarity on the Reserve Bank's preferred resolution strategy. Last year, the Reserve Bank consulted on how it will operationalise its crisis management powers under the DT Act, including whether its approach to resolution should include a bail-in resolution tool to absorb losses and recapitalise a deposit taker that has failed. Bail-in could be contractual, structural or (if the DT Act were amended) statutory. In the consultation paper, the Reserve Bank provides that it is still considering the role of bail-in in its crisis management framework.
In the consultation paper, the Reserve Bank suggests that its preferred option for Group 1 deposit takers is a group-level resolution strategy. This represents a significant change in approach given the Reserve Bank has long sought to preserve its ability to resolve the Group 1 deposit takers on a standalone basis (e.g. as evidenced by the Outsourcing and Open Bank Resolution policies).
The Reserve Bank is not proposing LAC requirements for Group 2 and 3 deposit takers, given their lower systemic importance and the alternative resolution tools available. However, the Reserve Bank provides in the consultation paper that it may revisit this when developing resolution plans for deposit takers.
Standardised risk weights (residential mortgage, corporate, agricultural and personal lending)
The Reserve Bank has proposed changes to certain standardised risk weights to introduce more granularity for different exposure classes and better align risk weights with the underlying risk. The changes proposed are largely technical changes. These changes will be most relevant to deposit takers that use the standardised approach to calculate risk-weighted assets. However, they will also be relevant to IRB-accredited banks, given their risk-weighted assets are subject to an output floor calculated by reference to the standardised requirements.
Other technical decisions
The Reserve Bank has also published a summary of the submissions it received on its consultation on the capital standard, together with some largely technical policy decisions, including:
- Lower minimum capital base: The Reserve Bank has decided to reduce the minimum capital base requirement from $30 million to $5 million.
- Retain IRB modelling output floor: The Reserve Bank proposes to retain the IRB modelling output floor at 85% but will finalise its approach as part of the 2025 Capital Review decisions.
- Capital overlays: The Reserve Bank intends to include scope for the use of sectoral capital requirements and entity-specific capital overlays in the capital standard.