How much capital is enough?

17 May 2019

4. Kirk HopeThe Reserve Bank, an important institution responsible for much of our financial stability, wants changes to New Zealand’s banking rules.

It’s proposing that banks in New Zealand be required to hold more capital, to strengthen them and reduce the risk of failure.

The last time New Zealand faced a risk of bank failure was a decade ago during the Global Financial Crisis.

No failure occurred and New Zealand came through the crisis in reasonably good shape, however it is quite appropriate for the Reserve Bank to now review the rules to minimise future risk.

The Reserve Bank is proposing that banks should hold 20 to 60 percent more capital.  This would mean New Zealand would overtake Norway in having the highest bank capital requirements in the developed world.

The proposal would mean New Zealand’s main four banks having to obtain around $15 - $20 billion from offshore investors, a significant amount (by comparison the total capitalisation of the New Zealand sharemarket is only around $150 billion).

How would this requirement affect banks – and us, the banks’ customers?

There is a concern that banks might lend less, to reduce the need for capital enhancement.

Or they might pass on the additional cost to borrowers, making lending more expensive.

These outcomes would fall heavily on some groups in society.

Young lower income people could find it harder to get a house mortgage.

Small businesses often use housing mortgage finance to fund business activities since it’s less costly than business finance.  Restrictions in housing mortgage finance could constrain the ability of many small business ventures to get off the ground.

Farm debt, high by international standards, could be more difficult to secure.

Household debt, also high by international standards, could also be harder to secure.

Marginal customers might find greater bank restrictions on loans.

A study by Swiss investment bank UBS estimates that New Zealanders could end up paying between NZ$1.9 billion and $2.7 billion more on their home loans each year.

Given these potential outcomes, BusinessNZ is not convinced that the proposal to increase banks’ capital requirements should proceed.

Of course, the Reserve Bank has tools at its disposal to help soften the impact of more expensive borrowing.  It is possible the Reserve Bank could lower the Official Cash Rate (OCR) – and thereby lower interest rates - to compensate for the increase.  However, this would not necessarily soften the impact of restrictions on lending in specific sectors: first home buyers, small businesses, farms and others.

Reducing the OCR to compensate for greater capital requirements on banks would be like selling the family silver for a substantially discounted price.

Is the Reserve Bank proposing an extreme solution to the risk of bank failure?

Reducing risk always comes at a cost, and it’s important to ensure that the costs involved don’t outweigh the risks.

New Zealand’s risk of bank failure, given the quality of our regulatory systems, would be comparatively low, while the costs to the economy of the proposed requirements could be high.

BusinessNZ recommends that the Reserve Bank should undertake a comprehensive cost/benefit analysis of the proposals before any further steps are taken.

 

Kirk Hope | Chief Executive | BusinessNZ | www.businessnz.org.nz

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