Review of key capital settings questions and answers

The money that banks – or deposit takers as we refer to them – get from their owners is known as ‘capital’. It is part of a deposit taker’s funding that first absorbs losses if it becomes distressed. The more capital a deposit taker has, the lower the chances are that losses will be borne by depositors (people and businesses who have money in their bank accounts). Or in other words, the more capital a bank has, the less likely it is that customers’ deposits – the money people and businesses keep in their accounts – will be at risk in the event of a major shock.

Capital requirements set out the minimum investment that owners of a deposit taker must make in their business. Capital requirements that are set too low risk a deposit taker failing when it faces a shock. On the other hand, capital levels that are too high can increase costs unnecessarily. 

Capital ratio requirements set the minimum amount of capital a deposit taker must have to fund the loans it makes and other banking activities. It is expressed as a percentage of a deposit taker’s ‘risk-weighted assets’. Risk-weighted assets are used to determine the minimum amount of capital needed by banks and financial institutions to reduce the risk of insolvency. Deposit takers are required to have more capital for riskier loans, as these are more likely to generate losses.

Currently, there are 3 ‘tiers’ of recognised capital in New Zealand:

• Common Equity Tier 1 (CET1) capital is the highest quality of capital, as it is permanently available to absorb a deposit taker’s financial losses. CET1 includes shareholders’ investment (ordinary shares) and the deposit taker’s retained earnings.
• Additional Tier 1 (AT1) capital, which includes perpetual preference shares, is the second highest quality of capital behind CET1.
• Tier 2 capital, which includes some subordinated debt, is capital that can generally absorb losses only after a bank has failed. It is therefore considered lower quality than Tier 1 capital (CET1 or AT1 capital).

Our 2019 review of New Zealand’s capital framework led to the decision to increase the quantity and quality of capital that banks were required to have by 2028.

We focused on simple, but conservative, capital requirements. However, concerns were raised, including through recent inquiries, that the 2019 capital settings may be undermining or impacting competition and efficiency and that the 2019 review underestimated their impact on the New Zealand economy.

Therefore, on 31 March 2025, we announced a targeted review to test whether we have our capital settings right. We want capital settings that support a stable financial system, which enables a productive and sustainable economy, and ultimately promotes the prosperity and well-being of all New Zealanders.

See the 2025 Review of key capital settings: Terms of Reference (PDF, 86KB).

These new settings will reduce the overall cost of deposit takers’ funding, which we expect to see passed on as benefits to New Zealanders through increased lending and reduced rates, which the Reserve Bank will monitor closely. We also expect the changes for the smaller deposit takers will allow them to compete more effectively.

We have reduced CET1 capital requirements relative to the settings we selected in the 2019 review, but our requirements remain relatively conservative compared to international standards.

A key aspect of the new settings is the introduction of Loss Absorbing Capacity (LAC) for the largest deposit takers – a new tool that can help recapitalise a distressed deposit taker. This means:

• more use of subordinated debt instruments (Tier 2 + LAC) for the largest banks, and
• changing our approach to those subordinated instruments (e.g. adding conversion and write-off features), to make them work more efficiently with the Australian Prudential Regulation Authority’s (APRA’s) rules and better able to support the recapitalisation of a distressed Group 1 bank.

The proposals also include a variety of technical adjustments summarised in the decision document and, following Australia, eliminate AT1 capital.

The proposals introduce more proportionality into capital requirements relative to current settings, particularly by introducing more granular and lower risk weights in the standardised approach that is used by mid-sized and smaller deposit takers.

We must take into account the proportionality principle when developing standards for deposit takers under the Deposit Takers Act 2023. Rather than taking a ‘one-size-fits-all’ approach to prudential regulation, we consider differences in the deposit-taking sector. Our approach to proportionality is set out in the Proportionality Framework.

Ensuring we understand the impacts of the capital requirements is important to make sure we have calibrated the capital settings correctly for New Zealand and is core to our role as regulatory stewards.

We expect to monitor the impacts and publish our findings every 2 years as we have been doing under the 2019 Capital Review.

We intend to monitor:

• Trends in the amounts and prices of different capital instruments issued, and whether costs of capital are tracking in line with our expectations.
• Trends in lending rates (by sector), banks’ profits and return on equity.
• Changes in observed risk weights and comparisons between modelling and standardised outcomes.
• Lending trends across Groups – including the extent to which market share is changing.

While we expect competitive impacts to be relatively limited, monitoring these impacts will help assess the extent to which any of the changes affect market dynamics from a competition perspective.

The previous review in 2019 was anchored to a risk appetite that ensured there was sufficient capital in the system to avoid capital being fully depleted in a shock once every 200 years. This review has moved away from using this metric. While it is common in insurance regulation to refer to a 1-in-x year event, it is not commonly used internationally as a measure of banking capital requirements.

Our full risk appetite framework is available in Appendix C of the Decision Document (PDF, 686KB). This sets out our approach to prudential policy for the deposit taking sector.

We have a low appetite for events that could materially damage financial stability (often referred to as systemic risk), but we do not operate a zero-failure regime. We have a moderate tolerance for risks that may lead to the failure of regulated entities where the impact is understood, manageable, and will not materially damage the financial system.

Our prudential policy settings are:

• Simple – focusing on key risks to New Zealand and only adopting international requirements to the extent they are relevant to New Zealand’s financial system.
• Strong – we set requirements that minimise the likelihood of failure and rely less on mitigating the cost of failure, should it occur.
• Proportionate – requiring relatively higher requirements for large, systemically important entities.
• Efficient – we operate a transparent framework, that seeks to minimise compliance costs and recognises the importance of the trans-Tasman regulatory framework.

To inform this review, we commissioned international management consultancy firm, Oliver Wyman, to benchmark the capital levels of New Zealand’s largest banks against international peers. Their report found our New Zealand banks’ current Tier 1 capital levels are relatively high by international standards, but that we are fairly typical on metrics of wider loss absorbency (once LAC or international equivalents are included).

Three independent internationally recognised experts – Professors Thorsten Beck and Elena Carletti and Sir John Vickers – reviewed and challenged our analysis. They met with New Zealand stakeholders and had detailed discussions with Reserve Bank staff and Board members. They wrote independent reports that have been published as part of this release. Their contributions have brought a high level of rigour, challenge, and international expertise to the process.

We released a substantial consultation paper in August. This included the detailed Oliver Wyman comparison of New Zealand capital levels to international peers.

The analysis in the consultation paper was refined based on stakeholder feedback, engagements with the Treasury and APRA, and the reports from the international experts. This led to final analysis and recommendation, including a quantitative cost benefit analysis, that supported a decision made by the Reserve Bank Board.

We received a range of feedback from submitters and our external experts, which differed on some key areas of the consultation. The Reserve Bank’s decisions were based on the purposes and principles set out in our legislation, the Financial Policy Remit issued by the Minister of Finance, and on our risk appetite.

There were some broad themes in the feedback that came from different groups of stakeholders.

• Firstly, large deposit taking submitters liked the introduction of LAC, but wanted lower settings (an APRA-like 18.25% total requirement, instead of our 21%).
• Secondly, the experts and some other submitters, who questioned the benefits of reducing CET1 capital and/or were sceptical about the effectiveness of LAC.
• Finally, smaller banks, which sought increased proportionality, including through having more granular and lower risk weights under the Standardised approach.

Following consultation and considering all the feedback we received, we made decisions that we consider the best fit for New Zealand, consistent with the legislative framework for financial stability in New Zealand, including our Financial Policy Remit.

The experts considered that the 2019 review was sound and that New Zealand should have strong capital settings. We agree, but we have updated our risk appetite following consideration of new evidence and consultation paper submissions. Ultimately, we are balancing the:

• benefits to society of preventing or managing the failure of regulated entities
• costs to society of regulation, for example, compliance, administrative, and efficiency costs.

As such, we think that it is appropriate to modernise our capital requirements and place a slightly greater emphasis on our tools and ability to resolve an entity in distress by requiring internal LAC. This is supported by our cost benefit analysis.

In making that choice, we put more weight on aligning our capital decisions with APRA’s approach, including consideration of how the loss absorbing resources of the larger New Zealand banks will work if we ever need to coordinate with Australia in stabilising a large trans-Tasman bank. We also sought to mitigate some of the risks associated with LAC instruments seen in other markets, by limiting them to internally issued instruments between the subsidiary and parent, rather than issuing them into the market.

We intend to consult on detailed rules (for example, LAC requirements) later in 2026. Some other changes will be implemented by changing rules for banks and non-bank deposit takers. The Summary of Submissions (PDF, 920KB) provides an indicative roadmap for all deposit takers. The LAC requirements should be finalised by late 2028, but there will likely be a phase-in period after that. We want to ensure that regulated firms have adequate time to plan their transition to the new settings.