The Reserve Bank of New Zealand has confirmed the amount of assets allowed to be encumbered by covered bond issuance will be limited to 10%, with a review of the limit to be held within two years, in a release on responses to feedback to a consultation it launched in January.

The New Zealand central bank said that there was broad agreement among respondents to this approach.

“The Reserve Bank does not consider that a limit based on the face value of the bond would be appropriate as it does not address the primary prudential concern arising from the issuance of covered bonds, namely the encumbrance of assets,” it said. “The Reserve Bank recognises that this approach places the onus on institutions to set issuance levels that include sufficient headroom to reflect the level of risk of downgrade that is inherent in their operations.

“As a result, stronger institutions may feel more comfortable issuing a higher volume of covered bonds. The Reserve Bank considers that this outcome is more appropriate than weaker institutions encumbering a higher proportion of assets to support the same level of issuance as more robust entities.”

The central bank said that the review would consider the level of the constraint as well as “the merits of adopting a more case-by case, or sliding scale, approach to reflect the specific characteristics of the institution”.

The Reserve Bank said that the majority of respondents agreed with its initial assessment, “namely that there were some negative implications associated with covered bonds, but that these would be outweighed by the positives provided issuance levels were reasonably conservative”.

The document can be found here:

http://www.rbnz.govt.nz/finstab/banking/4328294.pdf