Is Reserve Bank's Adrian Orr, Mr Congeniality, ready for a war with farmers?

Tuesday, 16 April 2019

Parts of New Zealand's dairy farming sector are highly indebted, with much of the problem created during a lending boom prior to the global financial crisis.

OPINION: Since Adrian Orr became Governor of the Reserve Bank of New Zealand he has built a reputation of being someone who likes to be liked.

Charming and jocular, but possibly sensitive to criticism.

But Orr is now in a battle with the bulk of New Zealand's banking sector in a way which could see him demonised, probably with the focus on lending to farmers.

He knows it. Recent days have seen Orr on a campaign to explain itself.

* The price of safety: Reserve Bank capital plans could put handbrake on the economy

* Banks asked to take on bigger share of market risk

* Reserve Bank governor links huge bank profits to a lack of investment

* New Zealand's largest bank predicts Reserve Bank will slash interest rates

Reserve Bank Governor Adrian Orr, pictured in his office near Parliament. So far the Government has stayed on the sidelines of the Reserve Bank's plans to require banks to hold more capital.

* The OCR: a tool NZ's most powerful banker uses to get you spending or saving**

For several years the Reserve Bank has been conducting a review of how much capital the retail banks hold as a safety buffer so that when bad debts rise, likely during a future recession, that the impact does not cause the entire bank or even banking system to collapse.

This is an incredibly complex argument, because it asks us how often we want to suffer a banking collapse.

Everyone wants banks to be safe. Equally, we also want banks willing to take risks and lend money, otherwise the economy will suffer.

Striking the balance is a value judgment.

The Reserve Bank seems to hope the impact would be on bank shareholders, but acknowledges banks could reduce lending or push up prices.

Although Orr had said publicly that the Reserve Bank was of the view that the system needed more of a safety buffer, when the proposals were released just before Christmas, the amount of capital banks would need to raise came as a significant surprise.

The Reserve Bank's own estimates could require the 'big four' Australian-owned banks which dominate the sector to raise $20 billion.

Publicly, the banks are not generally commenting ahead of the deadline for official submissions in the middle of next month, but privately, they are arguing the plans could have a significant impact on both the cost of borrowing and how much lending banks do.

One bank has shared private estimates that the figure could be as high as $35b (although that figure appears to assume the banks will take a highly cautious approach to the buffer beyond the required minimums).

Where bank economists are talking, the warnings have tended to be that the impact will be greater than Orr seems to believe.

On Tuesday, economists at ASB published a report predicting that the impacts were likely to add at least 50 basis points (half a percentage point) to borrowing costs by 2023, could lower deposit rates and may permanently knock 1.1 per cent off New Zealand's gross domestic product.

The Reserve Bank appeared caught off guard by criticism. At the start of the year Orr personally wrote to a senior journalist after she suggested the proposed capital requirements might be 'gold plated'.

The consultation process, in Orr's words 'could have been tidier'.

An initial document was criticised as being light on details. The original deadline was pushed back by a month, and was extended again on Tuesday.

On April 3, the bank released a major piece of work on how it concluded that banks should be capitalised to withstand a one in 200 year financial crisis (as opposed to one in 100 or one in 500).

This came after Reserve Bank's initial deadline for submissions (March 31) and the major banks are still complaining that some necessary information has still not been provided.

So far it is mainly an argument playing out in banking circles, but it could spill over into the mainstream.

Sources across several of the major banks are warning that if the bank pushes ahead with its plan it could act as a significant constraint on lending to farmers and small businesses, sectors which are as economically important as they are politically sensitive

Both sectors are considered risky and when capital requirements go up the impact will be magnified.

One top bank economist said that even though confidence in the agricultural sector is already lower than it would usually be given healthy commodity prices, it would be rock bottom if farmers appreciated the impact that the Reserve Bank's plans could have.

The economist acknowledged that this was, at its origin, a problem of the sector's making.

Prior to the global financial crisis banks lent heavily to the dairy sector in a way which left a large section of the industry heavily indebted.

More than a decade later, some of the problems remain and, while the banks are currently managing indebted clients, increased capital may prompt them to withdraw support from some clients, meaning they would be bust.

Orr is well aware that he could be blamed for a constraint in lending, but says banks will ultimately be making commercial decisions. The bank has been warning for years that it is nervous about debt in the dairy sector.

He has suggested that the banks are lobbying in their own interest and the surprise they have expressed with the Reserve Bank's proposals is down to the fact that they did not believe it would follow through with its concerns about bank safety.

But he is also taking a far more conciliatory tone than earlier in the year.

He has given interviews in recent days hinting that banks may get much longer to raise capital levels and insisted the consultation is open and transparent.

So far Finance Minister Grant Robertson has refused to be drawn in.

If the battle spills outside the banking community, the impact of the proposals may be seen to start to bite in 2020, which just happens to be an election year.