Monday 8th April 2019
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The Reserve Bank proposal to almost double the amount of capital the big four banks have to hold was made without undertaking a cost-benefit assessment of the change.
“This paper does not provide a cost-benefit assessment of the proposal to increase bank capital but has been prepared in order to provide further information to those who wish to provide feedback during the consultation process which ends on May 3,” the bank says in a background paper released last week.
“The Reserve Bank will carry out a full cost-benefit assessment for a Regulatory Impact Statement to help inform and describe final decisions in the review,” it says.
“The concepts discussed in this background note will be an important component of that cost-benefit assessment,” it says. “The full assessment will also consider any submissions received during the consultation period, as well as looking at alternative scenarios to look at risks around estimates of costs and benefits.”
The Reserve Bank has estimated its proposals will mean the big four banks - ANZ, ASB, Bank of New Zealand and Westpac - which make up about 88 percent of New Zealand’s banking system, will have to find another $20 billion in capital over a five-year phase in period.
Former Reserve Bank official Ian Harrison, whose work is referenced in the latest background paper and who has already made public a lengthy critique of the central bank’s bank capital proposals, says the lack of any cost-benefit analysis is “hilarious” as it should have been the first thing the bank did.
“You’re meant to do the cost-benefit analysis to find out what you want to do – that’s how it’s meant to work.”
He’s also surprised that the Reserve Bank keeps coming up with new information to support its original announcement of the bank capital proposals and release of consultation documents back on Dec. 14.
The Reserve Bank published an updated consultation document on Jan. 25 and then further documents on Feb. 22 as to why it wants to increase bank capital requirements. Deputy governor Geoff Bascand reinforced the bank’s messaging in a speech on Feb. 26.
“If you say it often enough, people will believe it,” Harrison said, arguing the proposals lack serious justification. “The tree god is probably the main driver of this – the tree god just knows.”
Reserve Bank governor Adrian Orr has frequently likened the Reserve Bank to Tane Mahuta, the Maori god of forests and birds.
The Reserve Bank also asserted in its latest paper that bank shareholders "do not take the societal impacts of bank failure into account and thus banks have insufficient capital from a societal perspective.”
While it may be true that bank shareholders don’t take such matters into account, that doesn’t necessarily mean that banks have insufficient capital.
All New Zealand’s banks have more tier 1 capital than the current minimum of 8.5 percent, with the Reserve Bank estimating it averages about 12 percent.
KPMG partner John Kensington, who heads the accounting firm’s banking and finance team, agrees the Reserve Bank should have included a cost-benefit analysis in the consultation document and that it’s significant the central bank hasn’t done one yet.
“You need to have that analysis there because the average person doesn’t have the ability to do that," Kensington says.
If borrowing costs were only marginally increased by the proposals, most people wouldn’t care, but if the impact is going to be substantial, as some analysts have calculated, that would certainly colour most people’s submissions, he says.
Without that information, it’s as difficult to argue with the central bank’s proposals as it is to argue against motherhood and apple pie.
“You tell me a business that would not benefit from having more capital. It’s a lay down misere that more capital is a good thing,” Kensington said, using a card game analogy meaning an easy win.
But how much that additional capital would cost is crucial information.
The Reserve Bank has said its proposals would add between 20 and 40 basis points to borrowing costs and will get “lost in the noise,” but broking firm UBS has said the likely increase will be 86-to-122 basis points.
That’s enough to increase the interest bill on a $500,000 mortgage by as much as $6,100 a year.
While the central bank has rubbished UBS’ work as “an outlier,” UBS calculates that even if the RBNZ’s own much lower assessment proves correct, that would still raise the annual interest cost of a $500,000 mortgage by $2,000 a year.
“A number of our clients when we’ve been talking to them have come up with numbers nearer to UBS,” Kensington says.
KPMG audits New Zealand’s largest bank, ANZ Bank, as well as SBS, TSB, Co-operative Bank, Bank of India, Heartland and the Commercial Bank of China.
Kensington points to newspaper reports in Australia that the owners of the big four banks are contemplating floating or part-floating their New Zealand subsidiaries, should the Reserve Bank proposals go ahead in their current form.
He suggests another avenue to raise the additional capital would be for the banks to sell loan books, such as their rural loan books.
“To be fair to the big four and all the New Zealand banks, they understand and have been very tolerant of farmers” and have nursed customers through situations such as the recent dairy downturn, and the disease that hit kiwifruit orchards some years ago.
“If they were to sell to US or Chinese banks, would those parties understand the cyclical nature of farming and would they be prepared to give farmers as much latitude?” Kensington asks.
All the history and relationships the banks have built up from lending to farmers through generations would disappear if they sold their loan books to, say, Bank of Scotland, or any other international bank.
Kensington suggests lending to the construction industry, where banks have been hurt recently as firms including Arrow International, Orange-H and Ebert have gone into receivership, is another area that could be badly impacted by the Reserve Bank’s proposals.
The Reserve Bank is proposing that the big four banks should have to hold tier 1 capital equivalent to at least 16 percent of their risk-weighted assets.
It also wants Tier 1 capital to be pure equity, rather than hybrid-type securities that usually behave as debt but which can be converted into equity if required, and which are about a fifth of the cost of pure equity.
Since the global financial crisis, the minimum tier 1 capital has already been raised from 4 percent of risk-weighted assets to 8.5 percent.
The central bank is also proposing to limit the benefit the big four banks get from using their own internal models to calculate how much capital they need.
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