This week we have been wondering does the Reserve Bank of New Zealand (RBNZ) see some troubles looming on the horizon?
What caused us to ponder this?
There are undoubtedly plenty of risks to be concerned about.
IMF’s Dire Warning on Global Economy
In the Herald Liam Dann reported on a speech this week by David Lipton, first deputy managing director of the International Monetary Fund. Lipton had a message that wasn’t so rosy:
“His message was clear.
History suggests we are due for another financial crisis and right now the world is no shape to cope with one.
“I see storm clouds building, and fear the work on crisis prevention is incomplete,” he told the Bloomberg Global Regulatory Forum in London last night.
With interest rates still low, central banks simply don’t have the firepower they did in 2008 to deal with a deep recession, he argued.
Trillions of dollars worth of quantitative easing cash (which central banks effectively printed to get though [sic] the GFC) has yet to be reabsorbed – limiting that option as an emergency response.
Meanwhile, public debt has been building in many countries – including the US – seriously limiting the option of using fiscal stimulus to deal with a crisis.
For two years, the IMF had called on governments to put in place policies aimed at just that goal—as we have put it, “fix the roof while the sun shines,” he said.
“It is essential they do what they can now to address vulnerabilities and avoid actions that exacerbate the next downturn,” he said.
…If there’s something positive for New Zealanders to take from all this it is that we have taken some steps to “fix the roof” since 2008.
Our past three finance ministers have stayed focused on reducing core crown debt.
While the Reserve Bank hasn’t made much progress on lifting interest rates it has overseen an improvement in financial stability.
Credit growth has eased (although private debt levels remain precarious) and local banks are funding much more of their debt locally than they did in 2008.
The official outlook for New Zealand’s economy remains solid with GDP growth expected to stay safely north of 2.5 per cent.
But these kind of forecasts will mean little if the world heads into a serious financial crisis.
This IMF speech is just the latest reminder that we may need to batten down the hatches in 2019.”
RBNZ: Banks Should Bear Greater Share of Financial Systems Risks
But it wasn’t the speech by the IMF guy that had us wondering about what the RBNZ sees coming down the road.
Rather it was this press release from the Reserve Bank [emphasis added is ours]:
Reserve Bank proposes that bank owners bear greater share of financial system’s risks
The Reserve Bank is consulting on a proposal to raise the level of capital that bank owners must contribute to their business.
“Insisting that bank shareholders have a meaningful stake in their bank provides a greater incentive to ensure it is well managed. Having shareholders able to absorb a greater share of losses if the company fails also provides stronger protection for depositors,” Deputy Governor and General Manager of Financial Stability Geoff Bascand said today.
The Reserve Bank has been reviewing bank capital rules since early 2017.
“Bank crises happen more often than many people care to remember, and the economic and social costs of bank failures can be very high and persistent. These proposals are designed to make bank failures less frequent. With these changes we estimate the banking system will be resilient to shocks that might occur only once every two hundred years,” Mr Bascand said.
The proposal would see banks’ capital levels increase materially. We are proposing to almost double the required amount of high quality capital that banks will have to hold. In practice, actual changes to the amount that they hold will be less than double and will vary. The increase will depend on their current levels of capital, how much extra they choose to hold above the required minimum, and whether they are a large or small bank. Generally, it will be an increase of between 20 and 60 percent. This represents about 70 percent of the banking sector’s expected profits over the transition period. We expect only a minor impact on borrowing rates for customers.
“While borrowing costs may increase a little, and bank shareholders may earn a lower return on their investment, we believe these impacts will be more than offset by having a safer banking system for all New Zealanders,” Mr Bascand said.”
What is Capital Adequacy?
This video from the RBNZ outlines what capital adequacy is.
Banks Will Need to Fund Higher Capital From Profits
Of course the banks won’t be too happy about this proposed increase in banking capital. Why?
Because if banks are required to have more capital on hand “just in case”, it will have to come from their profits.
The RBNZ realises this too. Stating that the proposal will almost double the required amount of high quality capital that banks will have to hold.
“Generally, it will be an increase of between 20 and 60 percent. This represents about 70 percent of the banking sector’s expected profits over the five-year transition period.”
Not surprisingly the banks are already preparing with an initial blast of P.R. Likely with more to come in the next few months while consultation continues. Here’s just a couple of news items we’ve seen in the past couple of days:
RBNZ proposals will slow credit growth: Kiwibank
“Reserve Bank proposals for banks to hold significantly more cash on their balance sheets will lead to slower credit growth and rising interest rates, Kiwibank economists have warned.”
The ANZ Banking Group says ANZ NZ would need up to NZ$8 bln of new capital to meet RBNZ’s new bank capital proposals
What is the Reserve Bank Preparing For?
The likelihood is that higher capital requirements will lead to higher interest rates for New Zealanders.
But our thoughts are the biggest takeaway from this is not that bank profits will be hit, nor that interest rates may rise.
Rather the key takeaway is just what is the Reserve Bank preparing for?
You don’t have to read much between the lines to conclude that it is a pretty significant banking crisis. Quoting a recent speech by the RBNZ head honcho:
“In making this assessment, our recent work makes the explicit assumption that New Zealand is not prepared to tolerate a system-wide banking crisis more than once every 200 years.”
…”Bank failures also happen more often and can be more devastating than bank owners – and credit ratings agencies – tend to remember. The costs are spread across the public and through time.”
And also repeating from the earlier mentioned press release:
“Bank crises happen more often than many people care to remember, and the economic and social costs of bank failures can be very high and persistent. These proposals are designed to make bank failures less frequent. With these changes we estimate the banking system will be resilient to shocks that might occur only once every two hundred years,” Mr Bascand said.”
So these changes are designed to make the financial system resilient to shocks that might occur only once every 200 years. Quite how the RBNZ can be sure of that we don’t know?
But given European New Zealand is not even 200 years old, this is quite an event the RBNZ seems to be getting prepared for!
We wouldn’t rely on any banking capital changes ourselves. The current fractional reserve banking system means that if an electronic or silent bank run were to occur, banks could be drained of funds in mere hours. An increase in capital does not protect you from such a situation.