Reserve Bank won’t back down

Banks unlikely to jump for joy when they get the message on how much capital they are required to hold

All eyes will be on the Reserve Bank this Thursday when it finally shows its hand on the vexed issue of how much capital banks should hold. Banks currently get most of their money by borrowing it — usually more than 90 per cent — with the rest coming from owners — usually less than 10 per cent.

The central bank is proposing to change the balance by requiring banks to use more of their own money, consistent with similar moves by other banking regulators since the Global Financial Crisis.

The Reserve Bank is proposing to almost double the required amount of high-quality capital that banks will have to hold, with a proposed phasein period of five years.

In last week’s financial stability statement, central bank Governor Adrian Orr said strong bank capital buffers were key to enabling banks to absorb losses and continue operating when faced with unexpected developments.

The proposed changes have met stiff resistance from the big banks, who have said they will raise customers’ funding costs, among other things.

The New Zealand Bankers Association ( NZBA) has argued that an increase in the capital required to be held could make it more expensive for Kiwis to borrow money and lead to reduced economic output.

Citing an economic review, NZBA has said lifting the capital requirements would have economic welfare costs of $1.8 billion a year and that it would disproportionately affect agricultural, small-business lending, and savers.

Should borrowers expect to pay a little bit more? The answer is yes. Cameron Bagrie, economist

Some commentators put the banks’ concerns about higher funding down to scaremongering, but independent economist Cameron Bagrie doubted the central bank would compromise.

“I don’t think the Reserve Bank is going to back down . . . the banks are going to be told to hold more capital and it’s going to be a big number.”

Bagrie said there would be flexibility in terms of the transition period and who bore the cost.

“Obviously, the banking sector says it’s going to be the customers, whereas if you look at the return on equity around the banks and you look at where the risk-free rate is, there is a pretty strong argument that 14 per cent after tax is a little on the high side,” he said. “The number should be closer to 12 per cent.”

Bagrie said bank shareholders should expect to take “a fair bit on the chin” as well: “It’s a big issue and we want that transition to be orderly. Should borrowers expect to pay a little bit more? The answer is yes. Is that going to be a huge sum? No.

“Some of the numbers that I have seen thrown around about interest rates going up by 100 basis points are just scaremongering rubbish.”

The Reserve Bank’s moves are aimed at the banks having more skin in the game, should a crisis eventuate.

Bagrie said the odds of financial crises were greater now the global economy was more interconnected.

“I don’t think we want to go down the route of socialising losses. The

Reserve Bank is right in spirit in terms of what they are trying to achieve.

“What we need is maturity in regard to how we work out where the price is going to fall because there is going to be a cost — no insurance policy is free.

“The cost needs to be spread between borrowers, depositors, and the equity holders in the banks,” he said.

Craigs Investment Partners head of private wealth research Mark Lister said the central bank was firm in its thinking, and independent reviews were supportive of the process.

“There is potential for them to compromise but I suggest that they want to achieve a more sound banking system and I think there is quite sound motivation for them now to do so,” Lister said. “I’m not sure the banks will like to what they hear.”