RBNZ: “imperative” Australia’s banks lift capital levels

By Leith van Onselen

The Reserve Bank of New Zealand (RBNZ) has released its latest Financial Stability Report (FSR), which explained why banks need to hold more capital:

Domestically, debt levels are high in the household and dairy sectors, leaving borrowers and lenders exposed to unanticipated events. Similar challenges exist globally, given current high public and private debt levels, and stretched asset prices in many of New Zealand’s trading partners.

The capacity for some foreign governments and central banks to respond to unanticipated negative events is also limited by their current high government debt and low nominal interest rates. It is imperative to improve New Zealand’s financial system resilience while conditions are conducive.

Increasing financial institutions’ capital positions is central to ensuring that they can withstand severe shocks. We have proposed higher capital requirements for banks, and are currently reviewing public submissions on this proposal…

In December 2018, the Reserve Bank released a consultation paper that proposed to raise bank capital requirements so that banks have sufficient capital to withstand a 1-in-200 year event. The proposals reflect the critical role of banks in New Zealand’s financial system, particularly the largest banks whose failure would severely affect all New Zealanders…

Bank profits can help absorb credit losses during times of stress. New Zealand’s banking system has been highly profitable over the past decade compared with international peers (figure 4.3). But it is uncertain whether profits can be maintained when times are bad. If profits cannot be maintained, banks must rely on buffers of capital to absorb losses…

The Reserve Bank requires banks to maintain minimum levels of capital, relative to their risk exposures (mainly comprising credit risk), to ensure bank owners have enough ‘skin in the game’ and absorb losses before other investors, such as depositors.Banks can boost their resilience by maintaining large buffers of capital over their minimum capital requirements. All banks currently exceed their minimum requirements (see figure 4.4).

In December 2018 the Reserve Bank published proposals to increase the minimum level of regulatory capital, to ensure the banking system can better withstand financial and economic shocks. It proposed that the current Tier 1 capital requirement, of 8.5 percent of risk-weighted assets, be increased to 16 percent for ‘systemically important’ banks and 15 percent for all other banks (figure 4.5). It proposed that this should be achieved by increasing regulatory capital buffers over a five-year transition period.

The proposals would increase the conservativeness of New Zealand’s capital requirements relative to other advanced economies, which has fallen in the past decade. The proposals reflect evidence that the costs of bank failures are higher than previously understood and the Reserve Bank’s view on the appropriate risk appetite for banking crises. It was proposed that the capital framework should be set so that banks have sufficient capital to withstand a 1-in-200 year event. The Reserve Bank’s preliminary assessment was that while the proposals could lead to a slight increase in borrowing costs, this would be more than offset by the benefits of a safer banking system.

While the RBNZ is prudently lifting capital requirements for New Zealand’s big four Australian-owned banks, which comprise 90% of New Zealand’s mortgage lending, captured APRA is busy eroding lending standards by shredding its interest rate buffer just months after the Hayne Royal Commission lambasted Australia’s banks for shoddy lending, and just five months after APRA said is was permanent.

While the RBNZ acts prudentially, APRA is working hand in glove with the banking sector to pump out more mortgage debt to marginal borrowers.

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Unconventional Economist

Leith van Onselen is Chief Economist at the MB Fund and MB Super. Leith is an economist and has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.

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