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RBNZ largely ignores 2017 PwC report on NZ banks' capital

Thursday 7th March 2019

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A 2017 paper by accounting firm PricewaterhouseCoopers suggests New Zealand’s major banks already effectively hold more capital than the Reserve Bank wants them to hold in the future.

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.

Nevertheless, the Reserve Bank is now proposing to double the minimum amount of tier 1 capital that the four major banks have to hold from 8.5 percent to 16 percent of risk-weighted assets and to lift total minimum capital from 10.5 percent to 18 percent.

Commissioned by the New Zealand Bankers Association, the PwC report says the way New Zealand banks measure capital is more conservative than banks in other countries and, if their common equity levels were measured on a like-for-like basis, tier 1 capital would already be above 16 percent.

The New Zealand banks’ reported capital at the time PwC wrote its report under Reserve Bank rules was 10.3 percent.

But adjusting for “national discretions” applied to calculating capital, it was actually six percentage points higher at 16.3 percent, PwC says in its report.

That was published on Nov. 15, 2017, about eight months after the Reserve Bank began the current review of bank capital and was clearly an unwelcome contribution to the debate from the central bank’s viewpoint.

The PwC study was no once-over-lightly effort; its 56-page report included its acknowledgement that there are inherent limitations in trying to compare the capital positions of banks in different jurisdictions.

But “the fact remains that investors do make judgements regarding the financial strength of banks and attempt to moderate for local variations,” it says.

“This study accepts the inherent limitations and, by stating the assumptions and judgements made, seeks to promote greater understanding of the relative strength of the New Zealand banking system.”

PwC did look at “a significant volume of published materials,” including the rules and guidance published by individual prudential regulators, publications put out by the Basel Committee for Banking Supervision, previous comparative studies done by the Australian Banking Association and the Australia Prudential Regulation Authority as well as looking at individual bank disclosures.

The Reserve Bank’s December 2017 memo explains PwC’s findings.

“PwC’s major finding is that by switching to internationally comparable rules, the average common equity tier 1 ratio of New Zealand’s four largest banks would rise from 10.3 percent to 16.3 percent and the total capital ratio would rise from 13.2 percent to 20.6 percent,” the Reserve Bank memo says.

“This would make New Zealand banks’ capital ratios relatively high by international standards. This would remain true, PwC concludes, if banks here switched to the rules applying in Australia, Canada, Germany, Japan, Singapore, Switzerland, the United Kingdom or the United States, rather than a quasi-pure international standard,” it says.

The memo acknowledges that the Reserve Bank itself has in the past argued that New Zealand’s regulatory framework is relatively conservative but it says the size of the increase in capital PwC arrived at “is surprising” and examines a number of reasons why PwC’s study might be upwardly biased.

The memo sought the central bank’s financial system oversight committee’s views about how the bank should respond to PwC’s report and “an important consideration is the relevance of the findings to the capital review.”

It suggests international comparisons are futile and argues that PwC answers the wrong question.

“It makes little sense to calculate what the capital requirement would be for a portfolio of New Zealand mortgage exposures if it was instead a portfolio of Swiss mortgage exposures; it is not a portfolio of Swiss mortgage exposures and New Zealand is not like Switzerland.” The emphasis is the memo writer’s.

Yet little more than a year later, the Reserve Bank is now trying to sell its own international comparisons in an attempt to persuade people that its proposals are not out of kilter with the rules governing the rest of the world’s banks.

Evidently believing opposition to its proposals was gathering steam, last month deputy governor Geoff Bascand delivered a speech with accompanying slides citing figures produced by the Basel Committee and ratings agency Standard & Poor’s.

The central bank says these figures show New Zealand will go from having the lowest bank capital requirements compared to 14 other countries, including Australia, Singapore, Hong Kong and Nordic nations including Finland and Norway, to being at the median after its proposals are implemented.

The Reserve Bank memo notes that the Australian Bankers Association commissioned PwC to carry out a similar exercise in 2014.

“That exercise concluded that moving to internationally comparable rules would increase the capital ratios reported by large Australian banks from 8.8 percent to 12.7 percent, roughly a four percentage point increase,” the memo says.

“APRA conducted its own comparison and concluded that the increase was more like three percentage points,” it says.

The memo also contains a clue as to why the Reserve Bank didn’t conduct a similar review: “Another consideration is the amount of time and resources we are prepared to commit to analysing the PwC report.”

APRA is also requiring Australian banks – and Australia’s big four banks own New Zealand’s big four banks – to raise their capital levels, but unlike the Reserve Bank, it isn’t requiring the additional capital to be common equity.

The big four New Zealand banks’ Australian parents are currently required to have 6 percent tier 1 capital and 1.5 percentage points of that can be hybrid securities. These are securities that are essentially debt but which can be converted to common equity if required.

The cost of selling hybrid securities is about a fifth of the cost of raising common equity.

Australian banks’ total capital, including tier 2 capital and a capital conservation buffer, must be at least 11.5 percent.

A release on APRA’s website dated Nov. 8 shows it’s proposing to leave its Tier 1 capital minimum at 6 percent but that systemically important banks, or the parents of New Zealand’s big four, should hold up to 19.5 percent of total capital and it expects most of the increase will be in the form of hybrid securities.


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