Banking chief compares the NZ case with the US
With interest rates rising so fast, many New Zealanders are asking why they can’t take out a 30-year fixed-rate home loan like people can in the US.
Antonia Watson (pictured above), CEO of ANZ Bank New Zealand, said that while that’s an understandable question given how low rates were until quite recently, that’s actually “more complicated” than wanting to have “a home loan rate with a ‘2’ in front of it locked away for 30 years.”
“The fundamental reason is the US is different – to New Zealand, Australia, and almost all other major economies,” Watson said. “Almost none offer the multi-decade, fixed rate loans the US does.”
The ANZ CEO offered a very simple scenario to help illustrate how it all works.
“A bank borrows $100 from a depositor’s savings account (deposit accounts are actually loans to banks),” Watson said. “That deposit has a floating interest rate. The bank then lends it to a customer at a 1-year fixed rate. That means if interest rates go up, the bank pays the depositor more – but still receives the same amount from the borrower.
“If interest rates go up sharply, the bank might end up paying the depositor more than it receives from the borrower, thus making a loss. If that loan has a fixed rate of longer than one year that loss becomes even bigger.”
The banking chief said the “mismatch” right there is a risk. To avoid large-scale losses such as what has been witnessed in the US recently, “banks generally manage the interest rate risk by ‘hedging’ it as much as possible.”
“This means we take all our interest rate risk, match it off where possible (for example, one-year fixed mortgages could be matched with one-year term deposits) and hedge the risk that is leftover, the mismatch, in wholesale markets,” Watson said.
So, why can’t Kiwis do 30-year fixed home loans like they do in the US?
“The major difference, particularly in a small economy like New Zealand, is that interest rate risk for these longer terms is particularly tricky to manage given the lack of depth in our wholesale markets,” Watson said.
“The duration of an interest rate is a risk – if it is set for three months, a year, it is much less risky than 10 years or 30 years. Just think how much things change over decades.”
That means not all interest rate risk can be hedged in New Zealand. And if it isn’t hedged, a bank may be exposed to trouble when rates change.
“In the US, there are investors prepared to ‘buy’ that long-term risk off banks,” Watson said. “US banks typically on-sell their mortgages to two government-sponsored funding vehicles – Fannie Mae and Freddie Mac – which adds yet another dimension to the US housing market we don’t have here.
“These institutions have been set up by US governments specifically to hold these long-term loans, protecting banks and the broader financial system. Again, New Zealand is not big enough to have the same institutions.”
A 30-year fixed-rate loan also poses more risk for borrowers, she said.
“Rates can fluctuate wildly over such a long period and there are usually costs associated with paying out a loan early,” Watson said. “These could be significant as rates can move a long way in five, 10, 15 years from when the loan was first drawn.”
Another reason is that it’s rare for a Kiwi’s circumstances to remain unchanged for three decades.
“For example, a change in relationship status, illness, or even just wanting to downsize could mean a customer wants to break their loan early,” she said. “Currently, around one in 200 fixed loans are repaid early each month.
“So, while it’s a valid question to ask why we can’t have 30-year home loans in New Zealand, hopefully this provides some context.”
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