Wednesday 5th June 2019
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The Reserve Bank's bank capital proposals focus on the wrong things, are based on cherry-picking international research and won’t necessarily calm investors and depositors when banks come under stress, according to Martien Lubberink, associate professor of accounting and commercial law at Victoria University.
In a submission on the central bank's proposals to require higher capital ratios for New Zealand's largest banks, Lubberink says many of the RBNZ’s concerns about the use of hybrid securities, which normally behave as debt but which can be converted to equity if needed, are unjustified.
He echoes the International Monetary Fund's view that the Reserve Bank should take a more interventionist approach to prudential regulation.
Lubberink has worked for the central bank of the Netherlands where he contributed to the development of new regulatory capital standards and regulatory capital disclosure standards for banks worldwide and for banks in Europe. He has also run courses for the New Zealand central bank.
“High capital requirements per se will not calm investors and depositors,” Lubberink says in his submission on the bank capital proposals, citing how Sweden's oldest bank, Swedbank, lost half its market capitalisation after being found to have laundered Russian funds. That was despite having a high common equity tier 1 ratio of 24.6 percent.
“The Swedbank example thus demonstrates that requiring a high capital ratio will not stop investors and depositors becoming nervous.”
RBNZ’s proposals include increasing minimum common equity tier 1 capital from 8.5 percent currently to 16 percent for the four major banks and to 15 percent for other banks.
Lubberink also cites the example of Deutsche Bank when its shares were sold down in February 2016 because investors feared it would breach its capital requirements.
“It is not obvious that requirements of 4 percent, 8 percent or 18 percent will calm investors once they anticipate a breach,” he says.
RBNZ is also proposing to limit the advantage the four major banks gain from using their own internal risk-weighting models for calculating how much capital they need to no more than 90 percent of the amount of capital the other banks have to carry under standardised models.
In February, RBNZ said ANZ’s internal models resulted in it having to hold slightly more than half the capital of the government-owned Kiwibank for every $100 of home loans.
But Lubberink says the standardised models are no panacea either, citing the example of Britain’s Metro Bank, a new bank founded in 2010. It revealed in January that it had underestimated the risk level of some of its commercial loans by almost £1 billion.
“The idea that there exists a simple measure of solvency is misleading. The same applies to the different ways of calculating risk-weighted assets,” he says.
“The RBNZ proposal fails to acknowledge the vulnerabilities of the current system,” including the growing importance of operational risks and complexities. “Instead of acknowledging operational risk and liquidity risk, RBNZ focuses on a risk that is largely under control: credit risk.”
RBNZ has focused on liquidity risk in the wake of the GFC and the four major banks have gone from relying on short-term offshore wholesale funding to greatly increasing the tenure of offshore debt and relying more on domestic deposits.
“The RBNZ should let go of the idea of the ‘wall of equity’ and accept layers instead,” including hybrid securities, or contingent convertibles – CoCos, as they are known in Europe," Lubberink says.
He estimates the banks will have to raise an additional $25 billion of equity if the RBNZ’s proposals are adopted in their current form. He questions whether the New Zealand market is large enough to accommodate this but says there should be an international appetite for CoCos among institutional investors.
RBNZ’s concerns about CoCos, which cost significantly less than equity, are “not justified by the facts,” Lubberink says.
He cites the examples of Italian and Spanish banks where CoCos were converted and their branches opened their doors again on the next working day.
According to a former Deutsche Bundesbank board member, that happened “admittedly under a new name but otherwise it was business as usual. The fact that it all went largely unnoticed is the most remarkable thing about it.”
Likewise,the notion that recent Italian cases demonstrate the lack of loss-absorbing effectiveness of CoCo capital, which underpins the Reserve Bank’s arguments against them, is "hardly compelling," he said.
"In fact, the RBNZ fails to acknowledge important EU regulations that aim to protect both taxpayers and retail investors. Calling that a failure is inappropriate,” he says.
He is also critical of RBNZ’s lack of coordination with other bodies.
He said there are few signs of coordination between the Reserve Bank and Treasury, or between the Reserve Bank and the Australian Prudential Regulation Authority, despite governor Adrian Orr "asserting that the RBNZ is in a ‘constant dialogue with our Australian colleagues at APRA.’”
“The poor governance raises questions about the sustainability and credibility of the proposals. Will a next RBNZ official introduce another capital review? Will investors and depositors trust the ensuing framework?”
Lubberink’s comments were made before the Reserve Bank announced plans to have its proposals reviewed by three acknowledged international experts, all academics now but with backgrounds at the Bank of England, Federal Reserve and APRA. Each will prepare a report on the proposals which RBNZ has said it will publish.
Lubberink also elaborated on what he sees as cherry-picking of research. The studies RBNZ relies on appear to "reflect a passionate desire to please those with a particular view,” he says, citing a number of other papers the RBNZ “largely ignores.”
Such studies “demonstrate the adverse effect of changes in capital requirements. They find that their sample banks increase capital ratios by reducing their risk-weighted assets and not by raising their levels of equity.” In other words, banks stop or reduce lending.
Another study found “higher capital ratios are unlikely to prevent a financial crisis.” Another found that “increased risk taking is compensating the positive results on solvency arising from higher shareholders’ capital so that the net effect on banks’ probabilities of default is insignificant.”
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