The New Zealand central bank is aiming to increase the amount of capital New Zealand Banks must hold.
Why would they want to do this?
Does the Reserve Bank of New Zealand (RBNZ) see some troubles looming on the horizon? Read on to find out…
IMF’s Dire Warning on Global Economy
In the Herald in December, Liam Dann reported on a speech 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 had an initial blast of P.R. Here’s just a couple of news items that followed the RBNZ announcement:
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
Then more recently:
“The Reserve Bank’s new capital proposals could force Kiwis to pay $1.9 billion-$2.7 billion more for their mortgages each year, investment bank UBS has warned. Swiss investment giant UBS has taken aim at the proposals in a highly critical note. It believes New Zealand borrowers could be hit with rate hikes due to the costs associated with the new proposals, which were first mooted by the central bank last month.”
The RBNZ have stated that interest rates may increase. Although not to the extent that the banks are warning. In a simple summary aimed at the everyday man or woman called “Safer banks = safer society” the RBNZ state:
“Interest rates (borrowing and lending) could change – but we don’t expect by much. Lending margins above borrowing cost are likely to expand by 20-40 points.”
The RBNZ also has a short 2 page “Non-technical summary: How much capital is enough?”.
“The Reserve Bank is proposing this change to reduce the chances of banks failing in New Zealand. If banks in New Zealand fail, some of us might lose money and some of us might lose jobs. However, there would also be indirect costs on all of society that may be harder to see that would negatively impact the well-being of all New Zealanders. In the end, we would all bear the cost of bank failures, in one way or another.
This is why we want to make the chances of this happening very small – so small that a banking crisis in New Zealand shouldn’t happen more than once every two hundred years.”
For more on this topic see: Bank Failure: Could it Happen in New Zealand?
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.”
Did you get that? 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!
Public Submissions on RBNZ Bank Capital Increases
The RBNZ stated:
“In general, submitters support the Reserve Bank’s objective to ensure that New Zealand’s financial system is safe, acknowledging the economic and well-being impacts of banking crises. Many submitters, particularly from the general public, support the proposed higher capital requirements for banks. A number of submitters observe that higher capital requirements could lead to higher borrowing costs for New Zealanders. Some submitters, in particular banks and business groups, question whether the proposed increases are too large and too costly.
Central to the measures proposed in the consultation paper are increases in regulatory capital buffers for locally incorporated banks. The changes include requiring bank shareholders to increase their stake so that they absorb a greater share of losses should their bank fail, improving the quality of capital, and ensuring banks more accurately measure their risk.
Increasing the amount and quality of capital can be reasonably expected to mean that banks can survive all but the most exceptional shocks, Mr Bascand says. “We think the costs of doing so are outweighed by the benefits – someone’s cost is for society’s broader benefit.”
The RBNZ will now release its response to these public submissions in November 2019.
Then the implementation of any new bank capital rules will start from April 2020. With a transition period of a number of years before banks are required to meet the new requirements.
How Effective Will These Bank Capital Changes be in the Event of a Major Global Financial Crisis?
However, 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. (These silent bank runs were what led to the various US bank bail outs in the US and UK in the last financial crisis.
But an increase in capital does not protect you from such a situation.
Editors Note: This article was first published 19 December 2018. Updated 8 April 2019 to include new material released from the RBNZ. Updated again 1 July 2019 to include news of submissions by the public on capital changes.