Elephant in RBNZ’s bank capital room
Big four banks passed stress tests with ease, so what’s the problem?
The most surprising thing about the Reserve Bank’s proposed new bank capital rules is nobody has attempted to explain why we shouldn’t believe the results of the RBNZ’s own stress-testing of the major banks.
One would think if RBNZ planned to force the big four to near-double their minimum equity as proposed, it would first have to show why current equity levels are inadequate.
RBNZ governor Adrian Orr came closest to it early this year in responding to a news story examining public stress test results in light of RBNZ’s bank capital proposals.
“We emphasise in our public articles that stress testing results should not be read at face value,” he said. “Both the significant modelling uncertainties, and the fact that the banks know how/when the stress situation ends, limits the value of stress tests.”
Such caveats would always apply to any kind of economic modelling, but that doesn’t stop economists — or the RBNZ — doing their darndest to try to make sense of the economy with them. Everyone knows reality will never precisely match the models, but they at least give an idea of what might happen, and where the vulnerabilities might lie.
The puzzling thing about the RBNZ’s last comprehensive stress test, in 2017, is why its results are supposed to be so unbelievable as to require a doubling of bank capital.
The central bank “kitchensinked” that test, throwing every dire circumstance imaginable into the mix.
All four major banks, which account for about 88 per cent of NZ’s banking system, sailed through that test.
One of the independent experts who reviewed the RBNZ proposals, James Cummings of Macquarie University, notes that “the capital ratios of major banks decreased to around 125 basis points above minimum requirements” as a result of that stress test. In other words, none of the four came even close to eating into their statutorily required capital, and even had a reasonably healthy margin to spare.
To recap, these were the dire circumstances the banks were required to model: House prices plummeting 35 per cent, commercial property faring even worse with a 40 per cent fall in values, unemployment leaping to 11 per cent and the Fonterra payout to farmers averaging $4.90 per kilo of milk solids, below break-even for the average dairy farmer.
On top of that, it overlaid an industry-wide scandal over mortgage lending, such as customers successfully suing the banks for poor lending practices and failure to follow the Responsible Lending Code.
“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,” the Reserve Bank concluded at the time.
It did add the proviso that no stress test can predict the impact of a severe downturn.
But note that phrase “like previous stress tests.” New Zealand’s big four banks, ASB, Bank of New Zealand, ANZ, and Westpac, all owned by Australia’s big four banks, have passed many tests, all with capital to spare. They were acknowledged as among the world’s strongest banks through the GFC, although Orr is now effectively trying to rewrite history.
The notion that those banks “sailed” through the GFC and saved NZ’s economy “is just wrong. They didn’t sail through. They were last cab off the rank. They were 100 per cent government guaranteed. New Zealand had about a $120 billion underwrite for the banks”, Orr told Radio NZ.
He didn’t mention that the banks paid insurance premiums for that guarantee, which was forced on the New Zealand Government by the
We emphasise in our public articles that stress testing results should not be read at face value. Adrian Orr, early this year
Australian government.
And the truth is the local banks didn’t have a capital problem then. They had a liquidity problem.
That was because credit markets worldwide seized up almost completely for a time and, back then, the big four banks had borrowed short in wholesale markets to lend long on mortgages and other loans in the mistaken belief that global financial markets would always remain liquid.
Orr says the RBNZ had to buy $8b of bank assets “overnight, almost blind” to provide bank liquidity and savagely cut interest rates.
The minimum tier one capital requirement for banks pre-GFC was 4 per cent of riskweighted assets. It’s now 8.5 per cent and the RBNZ wants to raise that to 16 per cent for the four major banks and 15 per cent for the smaller banks.
In NZ during the GFC, house prices fell about 15 per cent, and then recovered rapidly.
The unemployment rate peaked at 6.7 per cent.
So, are RBNZ’s bank capital proposals a solution in search of a problem?