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RBNZ's Spencer calls for permanent macro-prudential framework

Tuesday 13th March 2018

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Reserve Bank acting governor Grant Spencer says the government should consider a permanent structure for macro-prudential tools, which he attributes as helping the regulator meet its policy objectives. 

There are currently four instruments in the central bank's toolkit, including loan-to-value ratio restrictions. In a speech entitled 'Getting the best out of macro-prudential policy', Spencer told the Institute of Finance Professionals New Zealand in Auckland, that he supports retaining the existing four and adding a debt-to-income or debt servicing instrument, which is currently under review. He stressed the speech was "my own views and are not a formal Reserve Bank position".

Spencer said no matter what instruments are used, "I believe the upcoming review should consider a structure for macro-prudential instruments which allows them to be 'off' or 'on' through time, but where they remain established within banks’ reporting and compliance system." 

The government is carrying out a review of the Reserve Bank Act to ensure the current monetary policy framework is the most effective.

Spencer said the instruments relate to risk metrics that the central bank expects lenders to monitor, whether or not they are subject to ceilings or floors. If they remained permanent, macro-prudential policy would adjust back to ‘neutral’ or non-binding settings when no heightened risk is present and no policy constraint is intended, he said. 

Against that backdrop, banks would no longer need to add or remove the operational framework as policies are turned on but would just need to adjust the settings of existing policies. 

"The public would become increasingly familiar with the policies and the potential for changes to settings. Policy changes would become easier to implement and to communicate. In principle, macro-prudential policy would follow a more transparent and systematic process that looks more like our monetary policy process," he said. 

Spencer also said it makes sense to integrate the current memorandum of understanding on macro-prudential tools into the Reserve Bank Act.  

Guiding principles for macro-prudential in the MOU include the principle of supporting monetary policy where possible and being fully consistent with micro-prudential policy, he said. 

"The objective and guidance from the MOU should be lifted into the act and potentially enhanced, for example with the principle that macro-prudential policies should be applied uniformly across all banks."

Spencer said the review should consider establishing a financial policy committee (FPC) for decisions relating to both micro and macro-prudential policy. The committee would need to be held accountable for its micro and macro-prudential decisions.  

"I would expect an FPC to have overlapping membership with the MPC (monetary policy committee), at least including the governor. However, it would likely include internal financial policy experts who do not sit on the MPC," he said. 

Spencer noted that external people could be included on the FPC, "although the complexity of the subject matter, the high volume of prudential decisions, and the need to avoid conflicts of interest would severely limit the number of viable candidates."

He said he has been closely involved in the Reserve Bank’s development and implementation of macro-prudential policy and is keen to see macro-prudential policy continue to develop as a credible and sustainable policy over the longer term. 

Spencer said "macro-prudential rules have significantly improved the resilience of banks’ balance sheets to potential housing market shocks" and a debt-to-income instrument is a "natural complement" to the LVRs. 

"While we stated at the outset in 2013 that LVRs would be temporary, I believe there is a case to consider maintaining a policy infrastructure of this sort, with policies being adjusted through time between binding and non-binding settings," he said. 

The LVRs were first introduced as a temporary measure October 2013 due to growing risks in the housing market against a backdrop of swiftly rising prices and highly leveraged lending by banks. Further pressures - particularly in Auckland - led the RBNZ to refine the LVR policy in 2015 and again in late 2016. It recently began a staged easing of the process but Spencer said "we remain cautious in the face of ongoing housing shortages," adding they have been a "qualified success". 

According to Spencer, the share of outstanding mortgages with an LVR greater than 80 percent has steadily dropped as a result of the LVR policy, from 21 percent in September 2013 to 7 percent in December 2017. Recent Reserve Bank estimates suggest banks’ credit losses from a severe housing downturn could be reduced by around 20 percent, he said.

Regarding other tools, Spencer said the counter cyclical capital buffer is likely to remain as part of the Basel 3 framework and is commonly used internationally, including as a signalling device. While it has not been used in New Zealand, it could be given closer consideration when the Reserve Bank comes to look at minimum capital ratios as part of its broader review of bank capital requirements. 

The core funding ratio is an existing (micro) prudential policy instrument, requiring banks to have at least 75 percent of their funding in 'core' instruments such as retail deposits. While not yet used as a macro-prudential tool, it could easily and usefully be activated in response to an increase in system-wide liquidity risk, he said.

The sectoral capital ratio has not been used to date "but would seem a potentially useful additional buffer against increasing risk in a particular sector such as housing or dairy. "

Spencer will be acting governor until the end of March when Adrian Orr takes the helm at the central bank. 


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