NZ’s handbrake on the economy
Reserve Bank Governor Adrian Orr says he likes to walk to the office at the Beehive end of Wellington. But his bank policies are more akin to flooring it up The Terrace with the handbrake on.
On the one hand, the central bank has instituted a parade of novel policies to help lubricate lending in an effort to offset the economic damage of both the coronavirus, and the Government’s response to it.
It’s buying tens of billions of dollars of government bonds from the trading banks to encourage them to lend to households and businesses. It’s also lending directly to banks in a separate effort to ensure they have sufficient funds to lend out. And at the same, it’s dropped the OCR 75 basis points to a new record low of .25 per cent in order to push down the cost of borrowing.
It’s tough to argue against the current urgent need to make funds available to borrowers with decent long-term prospects. And it’s important to help mitigate at least the short-term pinch that might otherwise destroy sound businesses.
On the other hand, the Reserve Bank is still holding stubbornly to a contentious plan to strengthen the banks it regulates that is simultaneously pushing up borrowing costs and constricting lending. It’s an incongruity that the bank’s recently announced policy delay will do little to mitigate.
In March, the bank said it would postpone for at least 12 months the start date for new increased bank capital requirements (there’s a seven year phase-in period).
The policy change finalised last year means the banks must build a much fatter buffer of their own money against the stresses of a financial crisis. For the big banks, their total capital must rise to 18 per cent of risk weighted lending (16 per cent for smaller banks), much higher than the current minimum of 10.5 per cent. The phase-in will now begin on July 1, 2021.
It’s reasonable to assume the New Zealand economy will still be struggling with the effects of the pandemic this time next year. The recession is liable to be deep and long-lasting, and it will almost undoubtedly push unemployment and bankruptcies higher than they have been in more than a generation.
But there is very little to suggest the banks will delay readying themselves for the looming capital change.
Geof Mortlock is a Wellington-based financial consultant who works for international institutions including the IMF and the World Bank. ‘‘[Banks] are typically lending for one, two, three years, sometimes, of course, a lot longer as with mortgages. So they’re lending in the context of, where does our capital position sit 12 months from now, two years from now, three years from now . . . they’re always looking well ahead of one year, typically it’s up to four years.’’
That means, Mortlock says, banks will adjust lending even now, in anticipation of the new rules.
It’s hard to imagine how the timing could be worse. Capital levels are risk weighted against loans, meaning banks will be reluctant to lend to riskier sectors and businesses. And this comes at a time when the banks already have many reasons for more cautious lending: profit and retained earnings are pinched by narrowing interest margins; banks anticipate rising loan losses and loan loss provisions as the economy sours; and, there is massive economic uncertainty around government policy, especially the border closure, due to the pandemic.
‘‘If [the banks] were going to be putting the brakes on lending anyway because of the recession [they’re] doubling pressure on the brake pedal because of the expectation that capital ratio is going to ramp up dramatically,’’ Mortlock says. He reckons a postponement would need to be three to four years to avoid that effect.
Martien Lubberink, associate professor at Victoria University in Wellington and the country’s foremost academic expert in bank capital, is sceptical that even a longer reprieve would make much difference to bank behaviour.
‘‘Even if the Reserve Bank postpones for longer . . . banks are very unlikely to kick the can down the road for themselves when they know they’re going to have to meet the new requirement eventually.’’
Regulators in Europe, he says, are even finding that banks are unwilling to dip into their capital buffers ‘‘because they know that what they deplete they’ll have to catch-up on later’’.
The Reserve Bank’s financial stability report of last month noted New Zealand’s financial system is currently ‘‘well positioned’’ to weather this economic storm. Despite that, Governor Orr is loath to see his signature effort at bank strengthening eroded.
But that won’t mask the policy inconsistencies he’s creating in the meantime. Like a racing car driver, as Mortlock put, with a foot on the throttle and braking all the while, ‘‘there’s a lot of skidding and smell of burning rubber, but you don’t get very far’’.