Reserve Bank’s bank capital increase proposals

Report shows Reserve Bank’s bank capital increase proposals will be expensive and achieve little

A report by Tailrisk Economics on the Reserve Bank of New Zealand’s proposed bank capital increases, shows that they will cost, using the Bank’s own numbers, $1.5 billion a year, and have a present value cost of $30 billion. A homeowner with a $400,000 mortgage could be paying $1000 more a year.

The higher capital will have few benefits, because serious financial crises are rare, and because the Australian owned banks will likely fail if their parents fail. More capital in New Zealand will not change that. “There might be a savings in government intervention costs” explained Ian Harrison Principal of Tailrisk Economics, “but there is a much cheaper way of achieving that. The Australians and other regulators are requiring banks to issue tier two capital at about one fifth the cost. The Reserve Bank did not even consider the option”.

The capital increase is driven by a 1:200 financial crisis probability test to meet the bank’s ‘soundness’ objective. This figure was chosen over a 1:100 probability, which would not have required a capital increase. This occurred at the last minute, on a whim, without any consideration of the costs and benefits of the choice. “The new risk tolerance approach doesn’t make sense,” said Harrison “policy choices should always require a balancing of costs and benefits, but the soundness test simply ignores the costs”.

The Bank claims that the 1:200 test is supported by modeling of New Zealand bank risk using a variant of the Basel advanced bank model, and by international evidence. “The modeling evidence was clearly manipulated to produce the desired result.” Harrison explained “And the international evidence is flimsy, and when properly interpreted, does not support the Bank’s position” On the basis of this ‘evidence’ the Bank is now saying the banking system is unsound, which is at odds with its view in its latest Novemner 2018 Financial Stability report, and in all previous reports.

The Bank says that it looked at the results of foreign cost benefit analyses, but these studies ignore the cost of higher interest rates for borrowers, because the higher profits are assumed to be just a transfer to domestic investors. In New Zealand these profits mostly flow to foreign shareholders and are a cost to the country. The Reserve Bank has a model that took this into account, but it was ignored.

“It seems that the Bank is determined to push this capital increase through, regardless of logic and facts” said Harrison. “It is time for a genuine consultation and for the Bank to actually listen to, and respond to, alternative evidence and views”

Tailrisk Economics has also fact checked the Bank’s more public statements on the proposals, and has made Pinocchio awards, using a variant of the Washington Post methodology.

Reports available at: tailrisk.co.nz

http://www.tailrisk.co.nz/documents/HowMuchCapitalIsEnough.pdf

http://www.tailrisk.co.nz/documents/PinocchioAwards.pdf

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