Thursday 18th July 2019
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Motherhood and apple pie top most people’s lists of things that are unquestionably good.
We don’t normally question the cost – many mothers would say, far too much! – but if the pie cost $5, that would look fair enough.
But what if it cost $100? Or $1,000. If it cost $100,000, my guess is that most people would decide they actually didn’t want that pie.
Bank capital is in a similar category. Few would dispute that more bank capital is better than less as a general principle.
And that’s exactly what many of the 161 submitters on the proposals told the central bank, “particularly …. the general public,” deputy governor Geoff Bascand noted on the day the submissions were publicly released.
But the Reserve Bank is still withholding a key piece of information: what the proposals will cost the economy generally and individual bank customers in particular.
In other words, it hasn’t released a cost-benefit analysis of its proposals, which include near doubling the minimum tier 1 common equity the four major banks have to hold from 8.5 percent to 16 percent of risk-weighted assets and to 15 percent for the other banks.
And that renders any opinions members of the public might have on the matter moot.
If, for example, Westpac is correct that the proposals will mean homeowners with an average mortgage in Auckland will be paying about $6,000 a year more in interest, it’s unlikely that many Aucklanders would still think the proposals are an unquestionably good.
The Reserve Bank explicitly acknowledged the lack of a cost-benefit analysis in a background paper released in early April.
“This paper does not provide a cost-benefit assessment of the proposal to increase bank capital,” it said, adding that one would be produced later.
But in late May, Reserve Bank governor Adrian Orr disputed that fact when he appeared before Parliament’s Finance and Expenditure Committee, insisting that the central bank had just called it something else.
“I’ve said on the record many times, but it doesn’t land on ears that want to hear it,” Orr told the committee. “I’m getting tired of hearing the same thing over and over again and it just isn’t true,” he said. “We’ve used a net benefits framework” in coming up with the bank capital proposals “which you could call a cost-benefit framework in anyone else’s language.”
Orr also said RBNZ will include a cost-benefit analysis in its regulatory impact statement, but that’s something the central bank is legally required to produce.
It’s certainly true that the central bank has made a number of assertions about what its proposals will cost, but these have been simply assertions and haven’t been backed by any analysis.
For example, in February, RBNZ deputy governor Geoff Bascand said bank lending rates might rise by 20-40 basis points. But that was a bald statement only, and he asserted that level of increase would get lost in the “noise” of the various factors determining lending rates.
Harbour Asset Management was among those who took issue with that, saying that a 50-70 basis point increase was more likely, while UBS has said the increase could be anywhere from 85-125 basis points – the upper end of that range would deliver Westpac’s $6,000 a year increase in interest payments on a $500,000 mortgage.
UBS published several reports showing its analysis, while Harbour's view was informed by Australian broking firm CLSA.
A number of submissions from those best equipped to be able to assess the proposals’ costs note the lack of supporting analysis.
INFINZ, which represents more than 1,650 treasury professionals, investment analysts, fund managers, bankers, lawyers and academics as well as students, lamented that RBNZ provided insufficient material and analysis, particularly on the likely impact on economic growth.
“We submit that a rigorous cost-benefit analysis needs to be undertaken before decisions are made, not just in the Regulatory Impact Statement required to be prepared following the decision,” INFINZ said in its submission.
Economic consulting firm Nera – which acknowledges Westpac provided funding but says the analysis and views are solely those of its authors – said none of the RBNZ’s papers “present any evidence that the existing capital requirements are inadequate.”
RBNZ also failed to justify its choice of aiming for a one-in-200 year probability of a banking crisis, Nera says. In fact, an RBNZ paper from November last year, just a month before the central bank formally announced its proposals, showed it was then working on avoiding a one-in-100 year crisis.
Accounting firm KPMG’s submission focused on the impact on the agriculture sector and urged RBNZ “to prepare/release its own analysis,” clearly indicating its view that RBNZ hadn’t done that.
Victoria University associate professor Martien Lubberink also took issue with the central bank cherry-picking the international literature and citing only papers supporting its proposals.
Bascand noted the day the submissions were released that the International Monetary Fund and the Organisation for Economic Co-operation and Development support RBNZ’s proposals.
“Not so fast, I would say,” Lubberink posted on his Cetier blog, pointing out that the OECD’s support comes with important warnings and that the IMF also criticises aspects of the proposals and RBNZ’s failure to conform to international standards.
And Lubberink noted RBNZ’s failure to note a report from the Basel Committee which reviewed the same academic studies RBNZ examined but which came to very different conclusions, including that the probability of a banking crisis rapidly diminishes once capital ratios exceed the 10 percent mark – New Zealand’s banks all carry more than the regulatory minimum with an average of about 12 percent of risk-weighted assets.
As Lubberink notes, the outcomes a cost-benefit analysis would produce are highly dependent on the underlying assumptions, which highlights the political mistake RBNZ made in failing to produce one.
It might be unscrupulous to decide what outcome you wanted your cost-benefit analysis to produce and then work backwards, but at least RBNZ would have staved off such criticism if it had done that.
And it’s fair to say RBNZ has concentrated far more on the politics of its proposals than on analysis.
As Bascand said when releasing the submissions, increasing the amount and quality of capital can be reasonably expected to mean that banks can survive all but the most exceptional shocks.
“We think the costs of doing so are outweighed by the benefits - someone’s cost is for society’s broader benefit.”
An added benefit in making the political argument from RBNZ’s point of view is that the shocking revelations of misconduct stemming from Australia’s royal commission into financial services have helped make bank bashing fashionable.
Being owned by Australia’s big four banks in itself puts New Zealand’s four major banks at a political disadvantage.
ANZ Bank, New Zealand’s largest, is probably regretting having former Prime Minister and National Party leader John Key as its local subsidiary’s chair as well as sitting on the parent’s board because he’s an obvious target for a Labour Party-led government.
RBNZ has frequently pointed to how profitable the big four banks are for their Australian parents. That’s indisputable; ANZ alone reported an almost $1 billion net profit for the six months ended March.
But there are countervailing benefits.
For example, New Zealand gets the benefit of the Australian banks’ credit ratings – Standard & Poor’s gives the big New Zealand banks “AA-” ratings, the same ratings as their parents.
That’s because it believes the Australian parents are “highly likely” to support their New Zealand subsidiaries “under any foreseeable circumstances.”
Without such parental support, S&P says ANZ New Zealand’s rating would be “BBB+,” or two notches above the lowest investment-grade rating. So that means ANZ New Zealand gets a four-notch advantage, lowering its cost of capital and therefore, in theory at least, its lending rates.
All in all, the most notable aspects of the RBNZ’s justifications for raising bank capital are what it leaves out.
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