Thursday 23rd May 2019
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The Reserve Bank has provided insufficient material and analysis of its “dramatic” bank capital proposals, and they warrant “a level of scrutiny proportionate to the magnitude and breadth of its potential impacts on the wider economy,” says the Institute of Finance Professionals.
INFINZ, which represents more than 1,650 treasury professionals, investment analysts, fund managers, bankers, lawyers and academics as well as students, laments the lack of parliamentary oversight of the Reserve Bank or other checks and balances.
It says in its submission on the proposals that the Reserve Bank should have started with a cost-benefit analysis, something the central bank admitted in April that it hasn’t yet done.
“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 says.
Especially for non-specialist stakeholders, including small businesses, industry bodies and the public at large, a cost-benefit analysis is a “prerequisite to informed participation in the consultation process.”
The Reserve Bank is proposing to near double minimum tier 1 capital from 8.5 percent currently to 16 percent for the big four banks and 15 percent for the smaller banks.
INFINZ notes that “government guidance requires that a cost-benefit analysis ‘evaluates different policy options’ to improve decision-making” and that the guide to cabinet’s impact analysis requirements says “systematic impact and risk analysis” should be undertaken before substantive regulatory change is formally proposed.
“Because the impacts of the proposal will flow far beyond the community of regulated banks, it is vital that such dramatic changes to regulatory settings are subject to rigorous and independent scrutiny,” its submission says.
On Monday, the Reserve Bank said it is in the process of appointing external experts to independently review the analysis and advice underpinning its proposals.
INFINZ says a number of independent analysts are suggesting borrowing costs could rise by between double and triple the Reserve Bank’s own estimates of a 20-40 basis point increase. And that doesn’t include broader impacts on economic activity, such as credit rationing.
“Lending may be tilted toward asset classes with low risk weights, such as housing, at the expense of lending to the productive economy, which carries higher risk weighting,” the submission says, citing small to medium sized enterprises, rural borrowers and the construction sector which are heavily reliant on bank lending and lack access to other sources of borrowing.
The proposals will also lead to a decline in bank deposit rates, which “may put pressure on those – such as retirees – reliant on savings returns, drive savers to higher yielding investments which are more complex and risky …. and operate as a further disincentive to saving – already a significant policy issue.”
INFINZ also questions whether the proposals will even achieve the Reserve Bank's goal of making banks safer.
It notes that New Zealand is one of only six countries whose banking systems have never suffered a financial crisis, including the similarly structured Australian and Canadian banking systems, despite the relatively high levels of credit in each country.
“Based on empirical literature and experience, there are substantial reasons to doubt that much higher levels of common equity capital actually deliver the lower probability of financial crisis inferred from overseas empirical studies,” it says.
And the higher equity levels may exacerbate New Zealand’s weak levels of investment and therefore productivity.
“The efficacy of significantly higher capital requirements in reducing the probability of financial crisis has been challenged in recent empirical studies,” it says and the INFINZ submission goes on to list those studies.
One of them concludes that “if anything, higher capital is associated with higher risk of financial crisis.”
Other factors, such as funding structure and high credit growth were found to be far more significant.
The New Zealand banking system has already adjusted to its previous high dependence on short-term wholesale funding by dramatically increasing term funding and increasing domestic deposits and the Reserve Bank has curbed housing credit growth, previously a major concern, by introducing loan-to-valuation restrictions.
INFINZ cites a study of United States banking crises between 1840 and 2010 which shows such crises were far more common when banks held much higher capital levels than they have since World War II – in fact, the only crisis since then was the GFC and there were eight US crises between 1840, when banks held higher than 50 percent equity ratios, and the 1930’s great depression.
INFINZ is also calling for “a joined up” consideration of bank capital levels and the current stage two review of the Reserve Bank Act.
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