Orr goes to war with big beasts of banking

Since Adrian Orr became governor of the Reserve Bank, he has built a reputation of being someone who likes to be liked. Charming and jocular, but possibly sensitive to criticism. But Orr is now in a battle with the bulk of New Zealand’s banking sector in a way that could see him demonised, probably with the focus on lending to farmers. He knows it. Recent days have seen him on a campaign to explain itself.

For several years, the Reserve Bank has been conducting a review of how much capital the retail banks hold as a safety buffer so that, when bad debts rise, as is likely during a future recession, the impact does not cause an entire bank or even banking system to collapse.

This is an incredibly complex argument, because it asks us how often we want to suffer a banking collapse. Everyone wants banks to be safe. Equally, we also want banks willing to take risks and lend money, otherwise the economy will suffer.

Striking the balance is a value judgment. The Reserve Bank seems to hope the impact would be on bank shareholders, but acknowledges banks could reduce lending or push up prices.

Although Orr had said publicly that the Reserve Bank was of the view that the system needed more of a safety buffer, when the proposals were released just before Christmas, the amount of capital banks would need to raise came as a significant surprise. The Reserve Bank’s own estimates could require the ‘‘big four’’ to raise $20 billion.

Publicly, the banks are not commenting ahead of the deadline for official submissions in the middle of next month, but privately, they argue the plans could have a significant impact on both the cost of borrowing and the amount of lending. One bank has shared private estimates that the figure could be as high as $35b (although that appears to assume the banks will take a highly cautious approach to the buffer, beyond the required minimums).

The Reserve Bank appeared to be caught off guard by criticism. Orr personally wrote to a senior journalist after she suggested the proposed capital requirements might be ‘‘gold-plated’’. The

consultation process, he said, ‘‘could have been tidier’’.

An initial document was criticised as being light on details. The original deadline for submissions, March 31, was pushed back by a month, and was extended again yesterday. On April 3, the bank released a major piece of work on how it concluded that banks should be capitalised to withstand a onein-200-year financial crisis. This came after the initial deadline, and the major banks are still complaining that some necessary information has not been provided.

So far, it is mainly an argument playing out in banking circles, but it could spill over into the mainstream. Sources across several of the big banks are warning that the plan could act as a significant constraint on lending to farmers and small businesses, sectors which are as economically important as they are politically sensitive.

Both sectors are considered risky and, when capital requirements go up, the impact will be magnified. One top bank economist said that, even though confidence in the agricultural sector is already lower than it would usually be, given healthy commodity prices, it would be rock bottom if farmers appreciated the impact the Reserve Bank’s plans could have.

The economist acknowledged that this was, at its origin, a problem of the sector’s making. Before the global financial crisis, banks lent heavily to the dairy sector in a way that left a large section of the industry heavily indebted. More than a decade later, some of the problems remain and, while the banks are managing indebted clients, increased capital requirements may prompt them to withdraw support from some, meaning they would be bust.

Orr is well aware that he could be blamed for a constraint in lending, but says banks will ultimately be making commercial decisions. The Reserve Bank has been warning for years that it is nervous about debt in the dairy sector.

He has suggested that the banks are lobbying in their own interest, and the surprise they have expressed about the proposals is because they did not believe it would follow through with its concerns about bank safety.

But he is also taking a far more conciliatory tone than earlier in the year. He has given interviews in recent days hinting that banks may get much longer to raise capital levels, and has insisted the consultation is open and transparent.

So far, Finance Minister Grant Robertson has refused to be drawn in. If the battle spills outside the banking community, the impact of the proposals may be seen to start to bite in 2020, which just happens to be an election year.

Everyone wants banks to be safe. Equally, we also want banks willing to take risks and lend money.