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RBNZ's poor policy process puts its credibility at risk: former official

Wednesday 15th May 2019

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The Reserve Bank’s third discussion paper on its bank capital proposals points to a lack of robust policy process, is an embarrassment to New Zealand and undermines the central bank’s credibility, according to a former Reserve Bank official.

The central bank “has had to resort to some bizarre arguments to make the unworkable work in an increasingly desperate attempt to shore up some unwise decision-making,” says Ian Harrison in his critique of that third paper which was issued in April.

The bank capital proposals were announced on Dec. 14 last year and after a couple of extensions, the consultation period is set to end on Friday.

“The fact that the bank has had to produce a third paper in itself points to problems with the bank’s policy-making processes,” Harrison says.

The Reserve Bank has said that it wants to reduce the chances of a banking crisis to a one-in-200 year event, a number Harrison says appears to be “decided on a whim”.

“There were serious holes in the analysis which forced the bank to do a lot of back-filling. But, rather than improving, the quality of the analysis has got worse.”

Harrison notes that the paper even gets basic sums wrong: “The bank says that the square root of the New Zealand correlation of 0.64 is 0.39. The square root of 0.64 is actually 0.8.”

He published an earlier paper in March which estimated that the hit to the economy the proposals would cause is $1.5-2 billion a year without making banks much safer.

The Reserve Bank wants to increase the minimum tier 1 common equity the big four banks have to carry from 8.5 percent to 16 percent. It also wants to reduce the advantage the big four Australian-owned banks get from using their own internal models for calculating how much capital they need to 90 percent of the result using standardised models.

Only the big four banks - ANZ, ASB, BNZ and Westpac - are allowed to use their own models.

Slides accompanying a speech given by deputy Reserve Bank governor Geoff Bascand showed 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 the Australian-owned bank a huge cost advantage over its smaller government-owned rival.

Harrison says the central bank “missed the fact that they have already increased bank capital by 20 percent by requiring advanced bank capital to be 90 percent of that required under the standardised approach.”

While the advantage the big four banks get from their internal models differs by bank, Harrison says the Reserve Bank’s papers have treated the whole banking system as a single bank in its modelling.

Another flaw is that the central bank is ignoring the fact that the big four New Zealand banks, which account for about 88 percent of New Zealand’s banking system, are foreign owned, he says.

These banks share their parents' “AA-“ credit rating – international ratings agency Standard & Poor’s puts each of the four banks’ “stand-alone profile” at “BBB+” or four notches lower.

The reason for using internal models was that banks should be able to calculate the actual risks within their loan books, rather than using the “one-size-fits-all” approach of the standardised models, which are necessarily set higher.

Harrison was working at the Reserve Bank when the change to internal models was approved, in line with new international rules known as Basel ll – the big four banks began using them in 2008.

“The Reserve Bank required banks to use higher model inputs to boost the risk weights. This did not reflect an assessment that New Zealand was objectively intrinsically more risky than foreign jurisdictions in a way that should impact on risk weights,” he says.

“Rather, it was due to a lack of confidence in the Basel model and in the very low risk weights it was producing.”

Accounting firm PricewaterhouseCoopers produced analysis in November 2017 that was commissioned by the New Zealand Bankers' Association which showed that the way New Zealand banks measure capital is more conservative than in other countries.

That analysis showed, on a true like-for-like basis, the New Zealand banks were carrying six percentage points higher capital at 16.3 percent that the stated average 10.3 percent level then.

The banks have since increased their capital to an average of about 12 percent, the Reserve Bank has said.

That paper was essentially rubbished by a Reserve Bank official at the time in a three-page memo, but the central bank has never conducted any detailed analysis of its conclusions.

Harrison says that the central bank has overstated the likely societal impacts of a banking crisis and has ignored international evidence that didn’t suit its purpose.

“Overseas evidence can be manipulated to demonstrate almost anything,” he says.

He concludes that these papers trying to justify the Reserve Bank’s proposals have put its reputation at risk.

“Bank risk analysts are appalled at what they are seeing. The bank may not particularly care, because they are playing to a different audience: politicians, the general public and the media who don’t understand the subject area,” Harrison says.

“But people who do understand the analysis will eventually read it and their assessments will leach out, putting New Zealand’s international reputation at risk. APRA (the Australian Prudential Regulation Authority) is probably aghast. They may have to deal with the Reserve Bank in a stress situation.”

Harrison, who left the central bank in 2012 and is now a consultant, has also worked for the World Bank, the International Monetary Fund and the Bank for International Settlements, which is the central banker for central banks.

His role at the central bank involved developing an analytical approach to assessing risks.


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