Former Reserve Bank official criticises equity level proposal
WELLINGTON: The Reserve Bank’s proposals to double minimum bank equity levels will cost New Zealand’s economy $1.5 billion to $2 billion a year without making banks much safer, former longserving central bank official Ian Harrison says.
Worse, he says the bank’s decision to base its policy on ensuring that bank collapses occur only once in every 200 years happened at the last minute, when it realised its initial target of limiting bank collapses to once in every 100 years would have meant New Zealand banks already had sufficient capital to meet that test.
This doubling of the timeframe happened ‘‘on a whim without any consideration of the costs and benefits of the choice’’, Mr Harrison says.
Mr Harrison, who left the central bank in 2012 and is now a consultant, has also worked for the World Bank, the International Monetary Fund and the Bank for International Settlements, which is the central banker for central banks.
He is accusing the Reserve Bank of cooking the books to reach a predetermined outcome.
He cites one of the background papers, a memo by Reserve Bank official Susan Guthrie, dated October 30, 2018, and titled ‘‘Risk appetite framework used to set capital requirements’’, which appears to show the Reserve Bank changed its mind about the target number of years.
That memo notes that ‘‘the decision about how much capital to require of banks is made under conditions of uncertainty’’.
It concludes that ‘‘we believe a reasonable interpretation of ‘soundness’ in the context of capital setting is to cap the probability of a crisis at 1% (or 0.5% if we wish to mirror approaches taken in insurance solvency modelling).’’
In other words, the one in every 100 years was regarded as the target as late as October 30 last year.
Mr Harrison says the Reserve Bank manipulated its models to produce the ‘‘right’’ answer.
‘‘Initially, a 1:100 target was proposed but when this couldn’t generate a capital increase, the target was switched to 1:200 at the last minute,’’ he says.
The Reserve Bank has said New Zealand banks on average hold tier 1 capital of about 12% of riskweighted assets, higher than the 8.5% regulatory minimum. It is proposing to raise that minimum to 16%, a decision based on the onein200year target, with a fiveyear phasein period.
The central bank says the proposals will raise lending margins by 2040 basis points, although in its technical document it has used 40 basis points, and deputy governor Geoff Bascand last week said that this will amount to ‘‘little more than noise.’’
Mr Harrison, whose role at the central bank involved developing an analytical approach to assessing risks, says that cost on a $400,000 mortgage would be $1000 a year more in interest.
Other analysts, notably UBS, have said the cost would be significantly higher than the Reserve Bank’s estimate — UBS says the proposals will effectively add as much as $4880 a year to the interest bill on a $400,000 mortgage.
According to an article in the September 2008 Reserve Bank Bulletin, international ratings agency Standard & Poor’s Corp’s ‘‘AA‘’ ratings of the four major banks actually imply a failure rate of one in every 1250 years, at odds with what the Reserve Bank is saying.
‘‘The bank is now saying that, at current capital ratios, the banking system is ‘unsound’ because the failure rate is worse than 1:200 and that the New Zealand banking system is not too far from ‘junk’ status,’’ Mr Harrison says.
‘‘The international evidence does not support the bank’s contention that the probability of a crisis is worse than 1:200.’’
The reason the four major banks have such high credit ratings is because their Australian parents have the same ratings but Mr Harrison says the Reserve Bank is ignoring the fact that the banking system is mostly foreign owned.
There is little point in the four major New Zealand banks having a higher tier 1 equity ratio than their Australian parents ‘‘because if a parent fails, then it is highly likely that the subsidiary will also fail because of the contagion effect’’.
The Reserve Bank is insisting that tier 1 capital should be solely comprised of equity and clearly regards hybrid securities — securities which normally behave like bonds but which can be converted to equity if necessary — as unsatisfactory.
The central bank has described equity as being the ambulance at the top of the cliff and hybrid securities as the ambulance at the bottom of the cliff. — BusinessDesk