Reserve Bank proposal ‘risky’
Independent advice provided to the Government last year warned that the Reserve Bank’s plan to boost bank capital risked damaging the economy.
A nine-page memorandum was provided by consultant, and former chief economist of Deutsche Bank NZ, Ulf Schoefisch. It concluded that the regulator’s proposal to strengthen the country’s commercial banks ‘‘appears unnecessarily risky’’ and ‘‘appears to have been informed by low quality information’’.
The advice was provided in midMarch, 2019 to David Parker, then Economic Development Minister, and Carolyn Tremain, chief executive of the Ministry of Business, Innovation and Employment.
The memo suggested that the Reserve Bank’s proposal to strengthen banks through higher capital requirements caused concern within the Cabinet.
A spokesman said Parker discussed the issues raised in the memo with his colleagues and ultimately, ‘‘he was satisfied that the RBNZ was dealing appropriately with the issue’’.
The memo released under the Official Information Act (OIA) said the Reserve Bank’s plan to force the country’s banks to hold more of their own money against their lending risk could cost the economy more money than it saves in averting banking crises.
Banks are expected to pass on the cost of stiffer regulation to their customers. The ultimate effect on the economy has been disputed, but the memo warned there was a risk of significant harm.
‘‘The optimal bank capital issue can be analysed in an insurance framework. Essentially the insured party (the New Zealand public) is paying a premium in terms of lost economic activity to cover a risk. The level of premium affects the degree of risk and the optimal outcome should be where the cost matches the benefit of not suffering a loss,’’ the memo said.
‘‘Instead of pursuing this systematic analytical approach, the RBNZ began by, rather arbitrarily, defining a public risk preference for a banking crisis limited to occurring once in 200 years.’’
The memo said there was no detailed explanation why 200 years had been chosen.
‘‘It is difficult to avoid the impression that the RBNZ commenced its analysis with a biased view. It appears that the conclusion had been reached that a marked increase in capital requirements was desirable.’’
It also said the Reserve Bank underpinned its case for higher capital requirements with international studies that ‘‘do not appropriately reflect the New Zealand specific risks and costs’’ and in-house modelling that suffered from ‘‘data limitations’’.
A Reserve Bank spokesman said Parker did not share the Schoefisch advice with the regulator.
He noted that in its final determination on capital levels, the Reserve Bank amended its original proposal ‘‘to reflect feedback received over the consultation period to achieve a high level of resilience at lower potential cost’’.
‘‘Our analysis showed that the benefits of the changes greatly outweigh any potential costs,’’ he said.
In October 2019, it released the assessments of three independent international experts it engaged to review its analysis and the advice underpinning the plan to tighten capital rules.
Those assessments were broadly favourable and supportive of the Reserve Bank’s approach, though one shared a concern of Schoefisch, that new rules for banks could provide a market opportunity for non-bank competitors not subject to the same level of regulation. The result could introduce greater financial system risk.
Over the course of 2019, Finance Minister Grant Robertson emphasised the legislated independence of the Reserve Bank and its policy making, even as some interested parties including the banks and business groups as well as academics pointed to shortcomings in the Reserve Bank’s approach and plan.
The new rules
The memo was delivered to Parker in the midst of a rancorous consultation process over the bank’s plan to require commercial banks to hold significantly more capital than previously required.
During that time bank governor Adrian Orr frequently crossed swords with parties opposed to the changes.
Last December, the Reserve Bank finalised new capital rules. Large banks were required to increase their total capital to 18 per cent of riskweighted lending, up from the current minimum of 10.5 per cent.
But, in a softening of the original proposal, they were allowed more flexibility in the instruments used to raise some of the required funds. The transition period was also lengthened from five to seven years.
That plan is now in doubt. In March, the Reserve Bank delayed the start date to phase in the policy from July 1 to July 1, 2021 because of the economic uncertainty tied to Covid-19 and credit availability. The bank will consider further delay, ‘‘should conditions warrant it next year’’.
From amemo provided by economist Ulf Schoefisch