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Financial stability and due scrutiny

Published in Insights, The New Zealand Initiative’s newsletter, 17 May 2019

During the Global Financial Crisis, many banks around the world failed spectacularly (though fortunately none in Australia or New Zealand). Some financial institutions were bailed out at enormous costs to taxpayers. Others went under, causing severe disruption to their economies.

To prevent such a scenario ever playing out again must be a constant worry for any financial markets regulator and central bank.

This is why the Reserve Bank of New Zealand (RBNZ) published proposals last December to increase the amount of capital banks must hold.

The idea is straightforward: Higher capital buffers would act as shock absorbers during the next financial crisis. They would stabilise the banking system, prevent bank runs, and reduce the risk of costly bailouts.

The RBNZ would not fulfil its role as our prudential regulator if it did not consider such scenarios and policies.

Fortunately, New Zealand is showing no signs of financial instability. The ratings of our banks are investment grade, and the four big banks passed the RBNZ’s latest stress test last year.

Since there is no urgency, there is time to give the RBNZ’s capital proposals careful scrutiny.

As with any insurance policy, higher capital requirements come at a price. Here, the costs are reduced bank profits (which may not concern ordinary New Zealanders). But they also include slower economic growth and higher mortgage rates, which would affect everyone.

The RBNZ’s consultation began in December last year and was initially to conclude in March. It has since been extended until today. But only in early April did the Bank deliver the first fragments of an analysis of costs and benefits.

Though a welcome first step, it is just a precursor to a full cost-benefit analysis, which the Bank has now promised for a time after the consultation period.

We believe it would be desirable and indeed legally necessary for the RBNZ to allow the public and itself more time. A consultation exercise without a cost-benefit analysis is pointless.

We at the Initiative have explained our concerns to the RBNZ’s Governor Adrian Orr, and we have appreciated his frank feedback.

We understand the RBNZ’s concern for financial stability. We now hope it will also share our concern for establishing a better and more informed process for consultation based on the cost-benefit analysis it is about to prepare.

It is in this spirit that we have made our submission to the RBNZ’s capital requirements consultation.

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