Reserve Bank plan 'has significant negative consequences for our country': banks

Sunday, 19 May 2019

Financial Markets Authority chief executive Rob Everett and Reserve Bank governor Adrian Orr deliver the findings of their joint review into the conduct and culture of banks in New Zealand. First published in 2018.

New Zealand's banks are calling for the Reserve Bank to rethink its plan to require them to hold more capital to help withstand financial shocks, claiming it risks putting 'a handbrake' on the economy.

As well as setting the official cash rate (OCR), the Reserve Bank is tasked with maintaining a healthy banking sector. In December it proposed that retail banks should be required to hold enough capital to withstand a one in 200 year financial crisis.

Banks were expecting the Reserve Bank to propose some increase in capital levels, but not on the scale governor Adrian Orr proposed.

Such a move would require New Zealand's banks to raise more than $20 billion to sit in reserve, a move which would make the banks safer, but also more expensive to run, which could ultimately impact customers.

* Banks asked to take on bigger share of market risk

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Submissions on the banks proposals closed on Friday.

Previously the banks have largely avoided public comment on a plan which is leading towards a standoff with their regulator.

The New Zealand Bankers Association's (NZBA) submission, shared exclusively with Stuff, calls for the Reserve Bank 'to rethink its proposals to avoid putting a handbrake on our economy'.

It has published reports claiming the impact of the plan are 'significantly' larger than the Reserve Bank claimed.

'While we absolutely support a strong and stable banking system that's able to withstand significant shocks, that shouldn't be at the expense of everything else,' NZBA chief executive Roger Beaumont said.

'Our banks are already well-capitalised and strong by international comparisons,' with research undertaken by former Treasury secretary Dr Graham Scott showing 'that the Reserve Bank has significantly underestimated the negative consequences for our country,' Beaumont said.

The NZBA has published a report by research organisation Sapere led by Scott which dismisses the Reserve Bank's claims that the impact of the plan would be 'minimal'.

Sapere warns the cost of the plan to the economy outweigh the benefits by $1.8 billion a year.

While the authors conceded the figures was based on a number of uncertainties, 'none would reverse the result and produce a net economic benefit.'

Under the Reserve Bank plan, the New Zealand arms of the Australian banks would be some of the absolutely best capitalised banks anywhere in the world, PwC analysis showed.

The submission represents the position of all New Zealand incorporated banks, the 'big four' Australian-owned banks, ASB, ANZ, BNZ and Westpac as well as Kiwibank and smaller New Zealand banks such as SBS, TSB and the Co-operative Bank.

The Reserve Bank's plans would require the major banks to hold more capital because any solvency issues could have a far wider impact.

While this led to speculation that the New Zealand owned banks may see the proposals as a relative advantage, NZBA said all were affected.

'All banks are going to have to increase their capital holdings and that has an impact and that will be relative to the size of the bank,' Beaumont said.

'So an increase in capital for a small bank has a very big impact on them.'

Meanwhile, an analysis by PwC claimed that New Zealand banks were already in the top quartile in terms of capital.

Governor Adrian Orr has described the impact on customers of the highly profitable sector as 'minimal' and that while bank shareholders would face higher costs, the organisations might see lower borrowing costs as they would be perceived as being less risky.

Governor of the Reserve Bank of New Zealand, Adrian Orr lowering the official cash rate.

Reserve Bank papers also pointed to the cost to wider society from come from financial shocks.

In the face of claims that the plans could see interest rates rise significantly for borrowers, Orr said he expected to see 'competitive' behaviour in the banking sector.

But the bank may be headed for a showdown with corporate New Zealand, both for the impact of the plan and the way it has conducted consultation.

One Wellington think-tank, the New Zealand Initiative, said the process left it open to court challenge.

How much is enough?

The Reserve Bank began consulting on bank capital two years ago.

At the time, NZBA produced a report which claimed New Zealand's structurally significant banks (the four Australian banks) had healthy capital levels which put them among the top quarter of banks around the world.

In the past, the Reserve Bank appeared to agree, with stress tests conducted by the central bank suggesting that even a severe drop in house prices likely to do little more than slow dividend payments to their Australian owners.

In the second half of 2018 the Reserve Bank began saying publicly that it was coming to the view that the banks would need to raise more capital, without giving details.

On the day that the Reserve Bank's consultation on the capital plans closed, the bank censured ANZ for not following the rules under which the large Australian-owned banks are allowed greater autonomy to determine precisely how much capital they need to hold. Deputy governor Geoff Bascand (pictured) said the episode 'highlights a persistent weakness with ANZ's assurance process'.

Shortly before Christmas, the bank revealed plans which caused shares in the Australian owners to fall, as the market gulped at the likely impact, with the banks needing to raise billions of dollars.

Orr has said he would expect the Australian bank's owners to absorb much of the impact of the plan, which would come into force over a long period.

But across the industry banking figures said the impact would be shared by shareholders through lower returns, as well as less money being lent in particular to more 'risky' sectors and higher overall borrowing costs.

In mid-April, ASB chief economist Nick Tuffley said the bank's central estimate was about a 50 basis points (0.5 percentage point) rise in interest rates by 2023 if the Reserve Bank's plans were adopted.

'Interest rate impacts will also be uneven across the economy,' Tuffley wrote.

The Reserve Bank's estimates have suggested the impact would be less than ASB, while a report by UBS warned the impact could be more than 100 basis points.

On May 9, Orr told MPs that the impact would be 'barely noticeable' at a monetary policy interest rate profile 'despite what you are hearing on the outside'.

When NZ First MP Mark Patterson suggested that one of the major risks to the farming sector might be the Reserve Bank's actions, Orr shot back.

'You say we are part of the problem? No, we are not. We didn't lend to farmers, we aren't farmers who borrowed sitting there in those situations.

'And we've been talking about the very high pockets of debt levels in the agriculture sector for a long, long time.'

During 2019, as opposition to the plan has begun to surface, Orr has said repeatedly that the plans could be adopted over a longer time period.

While the NZBA made no attempt itself to calculate the interest rate impact (such a move would almost certainly raise competition concerns), Beaumont said others were making claims that the impact would be material and affect some more than others.

'Lots of independent commentary that has said quite clearly … that small businesses and rural lending, because of the risk factors in those portfolios are likely to be more impacted.'

Banking figures privately acknowledge New Zealand banks lent large sums to the dairy sector during the 'white gold' period in the early 2000s.

This created a debt headache which banks have had to carefully manage ever since in order to avoid dropping farm prices, which could in turn lead further farms to appear overly indebted.

Some observers have claimed the standoff between the banks and their regulators on the issue of bank capital is becoming tense.

On Friday, the Reserve Bank heaped sharp criticism of ANZ New Zealand, the country's largest bank (chaired by former prime minister Sir John Key), when it emerged that the bank had breached the rules which allowed it to calculate precisely how much capital it needed to hold based on its lending profile.

This is a privilege only the four Australian-owned banks enjoy because of the supposed sophistication of their operations.

'ANZ's directors have attested to compliance despite the approved model not being used since 2014,' deputy governor Geoff Bascand said.

'The fact that this issue was not identified for so long highlights a persistent weakness with ANZ's assurance process.'

The Reserve Bank insisted the timing of the statement was based on the release of ANZ's quarterly disclosure statement, which just happened to be the same day its capital consultation process closed.

But it did not miss the opportunity to link the incident to the capital plan which it said was driven in part by the 'proven weaknesses' in the current framework.

The way the Reserve Bank has conducted its proposals has also come under scrutiny. The initial paper released in December contained little analysis or explanation as to why the Reserve Bank had landed on the need for the banks to withstand a one in 200 year crisis.

Since then the deadline for submissions has been extended twice, while the bank has been criticised for not conducting a comprehensive cost benefit analysis. Orr has acknowledged the process 'could have been tidier'.

While the Reserve Bank has said it will do the analysis when it has the responses of the banks, it has continued to come under fire.

Earlier this month, BusinessNZ urged the bank 'at a minimum' to pause the plans and conduct a comprehensive cost benefit analysis before proceeding.

The New Zealand Initiative, a Wellington-based think tank, said the bank had primarily focused on the safety of the banking system, rather than placing equal focus on its efficiency.

'The RBNZ would be acting unlawfully if it implemented its bank capital proposals on the basis of the decision-making framework it has adopted.'

The initiative added that the failure to conduct a full cost benefit analysis of the plan was 'inconsistent with good regulatory practice and is liable to judicial review'.

The NZBA-commissioned report by Sapere said that the Reserve Bank's proposals focused on credit crisis, when generally in New Zealand when central authorities needed to step in to help the banking system, it tended to be because of poor management or governance, not an external shock.

Sapere wrote that this should be taken into account by the Reserve Bank because it meant that even with higher capital requirements, the central bank may not be able to stand back in the way it might assume.

Michael Reddell, a former top advisor at the Reserve Bank who now writes a blog dominated by severe criticism for its former employer, was typically blunt in his submission.

'Having chosen, apparently by not much more than a stab in the dark, a desired outcome, the attempts to provide substantive insightful supporting analysis seemed half-hearted at best.'

Because of the impact the plan could have on consumers, there is risk that it becomes a political one.

Finance Minister Grant Robertson, who appointed Orr not long after Labour and NZ First formed a coalition, has so far stayed out of the argument.

National's finance spokeswoman Amy Adams has been making comments warning about the possible impact of the plan, telling the National Party's South Island conference it would make it harder and more costly for small businesses to borrow.

'Everything I'm seeing is that it's going to both push up lending costs and restrict lending availability for some borrowers, and those borrowers are highly likely to be in the rural and SME [small and medium sized businesses] sectors, at a time when both of those sectors are under pressure in any event,' Adams said on Friday, warning of a 'potentially pretty significant' impact on the economy.

'I continue to be of the view that the governor hasn't made a case, not necessarily that some increase in bank capital is required, but that an increase of those scale is required.'