New Zealand's central bank has proposed an increase to the amount of capital banks must hold and analysts have warned it will have a material impact on the Australian banks.

The big four banks all have operations across the Tasman, with ANZ, Westpac, NAB's Bank of New Zealand and Commonwealth Bank's ASB Bank dominating the market.

The Reserve Bank of New Zealand wants the banks to have more "skin in the game" to protect against the kind of banking collapse that is a one-in-200-year event.

"We have proposed that banks come to the table with more of their own chips, and less of other people's, which will reduce the risk of them folding and reduce the risk of the New Zealand taxpayer ever having to step in to save them," RBNZ deputy governor Geoff Bascand said in a speech in February.

As part of its rationale for increasing the capital requirements, the central bank has noted the deep social impact of recessions that are caused by bank crises, including industries being wiped out and widespread job losses.

"I think one of the reasons why New Zealand policymakers have taken this approach is they do see quite a lot of correlated risk there," said JP Morgan senior economist Ben Jarman.

"There's risks that the New Zealand economy bears itself … but there's also this idea that New Zealand is quite strongly tethered to Australia, so any shock that Australia would endure probably would be transmitted to New Zealand."

New Zealand capital requirements to be higher than Australia's

Under the proposal, the minimum "Tier 1" capital requirement for the major banks would rise to 16 per cent — 14.5 per cent of that would need to be common equity Tier 1 (CET1), compared to APRA's requirement of 10.5 per cent CET1 for the Australian banks.

The APRA requirement applies to both the Australian operations and the overall banking groups.

"As the New Zealand number goes up, even though it doesn't impact the group capital, it would reduce the number in Australia, so for APRA that's the real dilemma," CLSA banking analyst Brian Johnson told the ABC.

Mr Johnson said there are a few ways the banks can reach the RBNZ's proposed minimum — with one being to keep more of the profits they currently hand back to shareholders.

"If the New Zealand banks kept their dividend payout ratios at 30 per cent then you would get there organically. That's a real problem when the Australian banks are paying 70 per cent of their group earnings out," he said.

This week, UBS analysts warned the impact of the RBNZ requirements would be larger than they previously expected.

"We believe the capital position for each of the major banks is substantially weaker than the market estimates," the analysts wrote.

They said it could "prevent or materially delay" further share buy-backs at ANZ and the Commonwealth Bank, while NAB could be forced to cut its dividend.

Bank bosses warn of higher rates

At their recent parliamentary grilling, the major bank bosses were asked about the impact of the RBNZ proposal.

"We'll have to face some pretty interesting choices about credit appetite, cost of credit and the like," said Westpac's Brian Hartzer, describing it as a "serious issue".

Commonwealth Bank chief executive Matt Comyn had a similar view.

"The potential impacts of that are a dilution of the returns in the particular business. There's also the potential that it will have an impact on the availability and pricing of credit in the New Zealand market."

CLSA's Brian Johnson said it is unsurprising that the banks are warning of potential higher costs for consumers.

"They've got a vested interest… a lot of what I hear is what a disaster this will be for the New Zealand economy," he said.

"I'm hearing a lot of extreme rhetoric but I think we should put some strength into what the RBNZ is saying, presumably they wouldn't do anything unless they've done a lot of work on it."

The RBNZ has acknowledged the banks will likely try to pass on the costs through higher lending rates and lower deposit rates, but it expects competitive pressures to limit their ability to do so.

Another purpose of their proposal is to level the playing field between the large, Australian-owned banks and their smaller, local rivals.

However, UBS analysts still expect NZ mortgage and business loan rates to rise.

"With the major banks maintaining 86 per cent market share in NZ we do not believe competitive forces will be sufficient to offset such repricing, while credit rationing is also likely," they wrote.

The RBNZ does have scope to cut the official cash rate to offset some of the impact of potential bank rate hikes and has already signalled that its next move is likely to be down.

"If the economy ends up going down that track and mortgage rates are repriced, then more than likely they'll act to cut the cash rate," said JP Morgan's Ben Jarman.

Aussie bank spin-offs would be "gigantic"

Another option would be for the banks to exit their NZ businesses — something ANZ's Shayne Elliott told the House Economics Committee hearing had not formally been discussed.

"It's core to who we are as an institution. We are the largest bank in New Zealand and in fact, on some measures we're the largest company in New Zealand — it's a place we know and love," Mr Elliott said.

While Mr Johnson sees major hurdles if the banks were to spin off the subsidiaries, calling them "gigantic" in the context of the NZ market, he thinks ANZ will need to do something to change its current structure.

In addition to the RBNZ proposal, APRA has proposed a new prudential standard — APS 222 — which will further restrict the exposures of Australian banks to their overseas subsidiaries.

Currently, a foreign subsidiary can equal 50 per cent of the group's Tier 1 capital, but APRA wants to decrease that to 25 per cent from 2020.

"An increase in equity capital invested in a New Zealand subsidiary, in conjunction with APRA's proposal to reduce the limit, will make the Australian banks more sensitive to this limit," S&P Global Ratings noted.

"At the moment, ANZ is just below that level at 21-22 per cent, but if we were actually to do the recapitalisation in one hit, it would rise to 33 per cent," said Mr Johnson.

"The problem that ANZ has got is that if in fact APRA goes through with this proposed standard, I can't see how they can actually keep their New Zealand business as it stands today."

However the banks decide to tackle their Kiwi problem, analysts expect it could lead to lower bank returns and dividends.