Proposed bankcapital requirements ‘radical’

AUCKLAND: Stresstesting banks has become de rigueur for central banks since the global financial crisis and New Zealand’s banks have passed repeated tests over several years with flying colours.

In addition, New Zealand’s major banks are required to conduct their own stress tests and share those results with the prudential supervisor, although the results are not made public.

The last time the central bank conducted such a test itself was in 2017, when it looked at the big four banks in conjunction with the Australian Prudential Regulation Authority (APRA). The banks passed doomsdaytype scenarios with ease and capital to spare.

The scenario the Reserve Bank used was dire: house prices plummeted 35%, commercial property fell 40% in value, unemployment shot up to 11% and the Fonterra payout to dairy farmers averaged $4.90 per kilo of milk solids for three years.

On top of that, the regulator overlaid an industrywide scandal relating to bad behaviour in mortgage lending.

‘‘Like previous stress tests, this exercise suggests the major New Zealand banks can, as a group, absorb large losses in a downturn while remaining solvent,’’ it concluded at the time.

Of course, it added the proviso that no stress test could predict the actual impact of a severe downturn in real life.

But note that phrase ‘‘like previous stress tests’’.

New Zealand’s big four banks, ASB Bank, Bank of New Zealand, ANZ Bank and Westpac, all owned by Australia’s big four banks, have passed many such tests with apparent ease.

They were acknowledged as among the world’s strongest banks through the GFC.

To put the latest test’s scenario in a reallife context, New Zealand house prices fell about 15% after inflation, less than half the test scenario, through the GFC and the unemployment rate peaked at 6.7%.

The last time house prices in New Zealand fell anywhere near the magnitude of the test scenario was in the second half of the 1970s during the oil price shock. The price fall was about 40% in an economy that was arguably very different — rampant inflation, no floating currency and Robert Muldoon’s rule by fiat with price freezes and carless days, for example.

The last time New Zealand’s unemployment rate was above 11% was in 199192 following then finance minister Ruth Richardson’s ‘‘Mother of all Budgets’’, but the houseprice fall later that decade was less than 3%.

As for a dairy downturn, the Reserve Bank ran a stress test in late 2015 to find out what would happen if the dairy payout fell to $3 kgMS and remained under $5 until the 201920 season and land prices fell 40% over that period.

Its conclusion: ‘‘The banking system is robust to a severe dairy stress test.’’

It is against that backdrop that the Reserve Bank has suggested the big four banks should have to effectively double their tier 1 equity capital during the next five years.

That will mean increasing their tier 1 capital by $12.8 billion and replacing another $6.2 billion of preference shares because they will no longer count as tier 1 capital.

The central bank estimates the four banks could get there by retaining about 70% of their average $4.4 billion of annual earnings over the next five years.

Reserve Bank governor Adrian Orr and his predecessors had been foreshadowing the idea that the banks needed to hold more capital, so the market was well prepared. Nevertheless, the magnitude of what is thought necessary is shocking.

International ratings agencies are not given to hyperbole. Fitch said the proposals were ‘‘radical’’ and went ‘‘well beyond the international norm’’.

Banking journalist Tony Boyd wrote in the Australian Financial Review that the move would inevitably raise borrowing costs and Mr Orr risked forcing New Zealand companies to seek alternative sources of capital outside the banking systems.

Boyd said New Zealand did not have a great record of protecting depositors in nonbanks, pointing to the $6 billion of finance company losses.

APRA ‘‘already supervises the big four Australian banks, which all operate in New Zealand with group level capital requirements’’, he said.

‘‘Orr is clearly not satisfied with this oversight, even though APRA is well known for having capital requirements tougher than those in most Western countries and no depositor in Australia has lost money.’’

However, Adam Creighton, writing in The Australian, described Mr Orr’s move as ‘‘a breath of fresh air’’ that came ‘‘out of the blue’’.

He was writing in the context of the scandals emanating from Australia’s royal commission into financial services.

Former Reserve Bank official Michael Reddell is concerned about the apparent lack of consultation with APRA ahead of the midDecember release of the proposals.

‘‘It seems surprising to me that the Reserve Bank could propose something so radical without a genuine prior discussion with the regulator of the banks who dominate the New Zealand financial system,’’ he blogged.

The Reserve Bank estimates the Australianowned banks account for about 88% of New Zealand’s banking system.

‘‘Searching the Reserve Bank’s consultative document for references to APRA, it seemed telling that the bank referred a couple of times to the possibility of aligning with APRA standards around the idea — questionable — of introducing new capital requirements so far in excess of those APRA imposes,’’ Mr Reddell said.

‘‘There is a suggestion that the governor has a bit of chip on his shoulder about Australia and Australian banks. Whether that is true or not, if the indications of lack of prior consultation are correct, it isn’t good enough.’’

Macquarie Equities has suggested the new requirements are so onerous that it could lead to the Australian banks selling some or all their New Zealand subsidiaries. If that meant the banks became listed on NZX, many a New Zealander might think that would be a jolly good thing.

But a paper put out by the Federal Reserve Bank of Philadelphia last year suggests that one outcome of requiring banks to hold more capital would be ‘‘a much more concentrated loan market’’.

It would mean ‘‘large banks grow larger, putting pressure on small banks to merge or close. As large banks’ market power increases, they extract higher profits by raising loan rates, which tighten credit and depresses the economy’s output.’’

Clearly, New Zealand’s bank ing sector is already highly concentrated.

On the other hand, if the tier 1 capital requirement before 2007 had been 6% rather than its actual 4% minimum, ‘‘large US banks would have had enough capital to cover their losses at the peak of the 200809 crisis’’, the paper says.

Still, it’s an awful long way from 6% to the 16% level our central bank is proposing.

The Reserve Bank’s consultation paper does make it clear that deciding optimum levels of bank capital is a balancing act.

‘‘If banks in New Zealand fail, some of us might lose money and some of us might lose jobs,’’ it says. It notes the proposed changes might lead to higher borrowing costs and lower returns to bank shareholders.

‘‘However, there would also be indirect costs . . . that would negatively impact the wellbeing of all New Zealanders. In the end we would all bear the cost of bank failures in one way or another,’’ it says.

‘‘This is why we want to make the chances of this happening very small.’’

But it’s an open question whether the Reserve Bank has the balance right. —

❛ There is a suggestion that the governor has a bit of chip on his shoulder about

Australia and Australian banks