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Orr's views on bank capital at odds with Super Fund

Tuesday 19th March 2019

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A submission from the New Zealand Superannuation Fund to the Reserve Bank while governor Adrian Orr was still chief executive disagreed with the central bank on just about everything to do with bank capital requirements.

About the only exception was agreement on the need to reduce the unfair capital advantage of the big four Australian-owned banks.

Now Orr is spearheading the central bank’s arguments that New Zealand banks need considerably more capital.

The fund's submission, made jointly with ACC in June 2017, questioned whether New Zealand banks needed more capital than their international peers and said that New Zealand’s lack of deposit insurance meant New Zealand banks’ cost of capital was already higher than their international peers.

Requiring banks to hold even more capital would compound that extra cost, it argued.

On Dec. 14, the Reserve Bank announced a proposal to double the minimum amount of tier 1 capital that the four major banks have to hold from 8.5 percent to 16 percent of risk-weighted assets and to lift total minimum capital from 10.5 percent to 18 percent.

The Super Fund’s head of New Zealand direct investment, Will Goodwin, says he and former ACC head of direct investment Carl Blanchard and staff from the two organisations prepared the submission but Orr was kept informed about it as it was being prepared.

“Adrian was fully consulted and aware of the submission,” Goodwin says.

However, Orr didn’t sign off on the submission – that was left to then chief investment officer and now chief executive Matt Whineray.

Orr declined to comment on the fund's submission for this story.

The Super Fund and ACC bought 25 and 23 percent stakes in Kiwibank respectively from New Zealand Post in October 2016, the Super Fund paying $263 million and ACC paying $231 million.

Their joint submission also argued that the Reserve Bank was relying too heavily on studies suggesting banks should be required to hold more capital and had ignored contrary arguments.

Goodwin says the institutions had wanted to make the central bank “aware that some of the points they made in their discussion paper were a little too narrow. We wanted them to widen their scope.”

It also challenged the Reserve Bank’s view that hybrid securities shouldn’t be allowed to count as tier 1 capital – the central bank’s discussion paper was issued in May 2017, about six weeks after the Reserve Bank raised doubts about whether Kiwibank’s hybrid securities counted as tier 1 capital.

That was despite the central bank having signed off on having no objection to Kiwibank’s hybrid securities when they were issued in 2014 and 2015.

By August of 2017, the Reserve Bank changed its mind again and agreed the two hybrid issues did count as capital, but the exercise had already proved costly for Kiwibank’s shareholders.

They had tipped in $247 million of new capital in April 2017 in proportion to their shareholdings to reassure investors and customers that the shareholders would stand behind Kiwibank.

The Reserve Bank’s May 2017 discussion paper made clear its dislike of hybrid securities, saying that “there is uncertainty about how they will work in practice” and that there may be tax issues and unintended side effects, although it didn't spell out how or why such side effects might occur.

Such securities normally behave like debt but can be converted into equity if a bank gets into difficulties.

The Super Fund/ACC submission says “it is not clear to us what these complexities are." It argues for “a clear bank capital framework in which the market has confidence,” particularly in the Reserve Bank’s processes of “non-objection” that Kiwibank ran afoul of.

“We consider that the Reserve Bank needs to increase its resource to ensure full consideration of the terms of any form of hybrid capital issued in order to provide more of a ‘positive’ assurance than a ‘negative’ non-objection,” the submission says.

It also notes that such hybrids are commonly used by offshore banks and “this could put fully-New Zealand domiciled banks at a competitive disadvantage if their competitors are able to funnel capital issued via convertible instruments into their New Zealand subsidiaries at low cost.”

The cost of selling hybrid securities is about a fifth that of raising equity.

But Goodwin says the Super Fund has moved on, although that seems to mean it and ACC have realised they’re not going to win on the hybrids argument.

“That ship has sailed by now,” Goodwin says. He takes a swipe at Kiwibank’s former chief executive Paul Brock who had argued repeatedly for Kiwibank to be allowed to use internal models for calculating capital.

“Kiwibank has been very direct in pushing its agenda which hasn’t necessarily aligned with where the Reserve Bank was,” Goodwin says.

Actually, Brock had been on very firm ground on the level playing field argument – only the big four banks, which account for about 88 percent of the banking system in New Zealand, are allowed to use internal models, an advantage they have held since 2008.

In February, the Reserve Bank said New Zealand’s largest bank, ANZ Bank, currently has to hold just over half the amount of capital that Kiwibank is forced to hold to back every $100 of mortgage lending, giving ANZ a big cost advantage.

The central bank proposes to level the playing field by allowing the smaller banks to hold slightly less tier 1 capital at 15 percent and by putting a floor under how much advantage the big banks can get, limiting it to 90 percent of the capital requirement using the standardised models the smaller banks have to use.

Goodwin says Kiwibank is becoming a much more important part of the New Zealand banking system – it is the fifth largest bank with total assets of $22 billion, but that’s still a long way behind the smallest of the big four, Westpac, which has $91.7 billion in total assets.

And ACC and the Super Fund are “preferring a more collaborative approach, rather than one that is challenging the Reserve Bank

"We have shifted, very deliberately, our approach” since ACC and the fund bought their Kiwibank stakes.


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