Reserve Bank eased capital rules despite expert caution
Monday, 2 March 2026
Changes to bank capital rules approved by the Reserve Bank in December are only likely to benefit Kiwis if banks pass on at least half of the benefit to customers, according to a business case released by the central bank today.
The Reserve Bank announced shortly before Christmas that it would partially wind back reforms initiated by former governor Adrian Orr that were designed to substantially increase the amount of capital that banks need to hold.
The purpose of the original reforms was to make banks more financially secure in the event of a major crisis, but they also had the negative trade-off of raising interest rate margins and had been viewed in some quarters as overkill.
Finance Minister Nicola Willis made clear she was concerned the reforms Orr ordered in 2019 risked going too far by unnecessarily pushing up the cost of lending, and instructed the Reserve Bank to carry out its review.
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The business case for the changes that stemmed from that, released in full today, said the Reserve Bank believed the option it chose in December to loosen the rules would boost economic activity by 0.12% or about $500 million a year.
That was based on the assumption the major Australian-owned banks would fully pass through to consumers the savings the new rules generated, in the form of lower interest rates.
But it estimated that the economy could shrink slightly — by 0.02% — if the banks instead held on to half of the savings.
There was an argument that some of this benefit could be retained by the banks, the Reserve Bank acknowledged.
All three international experts the Reserve Bank commissioned to provide advice on the capital changes cautioned against the new rules the bank approved in December, instead essentially backing the tough stance Orr took in 2019.
That appeared to generate little public attention at the time the results of the review were published in the run-up to Christmas.
Expert arguments
Economics expert Professor Sir John Vickers, the warden of All Souls College at Oxford University, said the reforms Orr ordered in 2019 “still had considerable merit for New Zealand, especially in a world where risks have not diminished”.
While their implementation could be improved, “I would not recommend significant reduction of overall equity capital requirements”, he said.
Thorsten Beck, professor of financial stability at the European University Institute, noted the bank capital rules ordered in 2019 were tighter than in most economies.
But he said that “can be justified” given a higher reliance of the New Zealand economy on its banks, limited diversification benefits by banks within New Zealand and, “more generally, the risks that come with a small open economy”.
In an apparent reference to a view expressed by Willis, Beck said “the argument has been made that it is ultimately for elected officials to determine the risk appetite for bank regulators and supervisors”.
But “given the limited time horizon of elected officials, short-term gains might be preferred, even at the cost of longer-term higher risk,” Beck said in his advice.
“An independent, ‘technocratic’ institution like the Reserve Bank is very well positioned to take … a longer-term view.”
Elena Carletti, a professor of finance at Bocconi University and past-president of the European Finance Association, also called for “cautiousness in revising the 2019 prudential framework”.
New Zealand was not alone in exploring the relaxation of prudential frameworks, but it was “important to note from the outset that this new wave of deregulation attempts is not occurring alongside a reduction in macroeconomic risks”, she said.
The Government had limited capacity to support a failing bank due to legislative constraints, Carletti said.
“As a host jurisdiction, New Zealand is subject to risks related to the presence of significant foreign subsidiaries and potential home/host country divergences and thus it needs to maintain banks that are self-sufficient and resilient to the extent possible,” Carletti also said.
Those and other factors suggested the need for a “cautious approach when considering revising the capital settings”, she said.
Australia alignment
The Reserve Bank acknowledged the three experts whose views it had commissioned agreed the original Orr-era reforms had been sound.
Justifying its decision to reject their recommendations, the bank said it had decided to put more weight on aligning its capital decisions with those of Australia’s regulator, the Australian Prudential Regulation Authority.
The bank was ultimately balancing the benefits to society of preventing bank collapse with “costs to society of regulation, for example, compliance, administrative and efficiency costs”, it said.