The Reserve Bank is an unusual entity. It has a board that is not a board, and a governor who is also a chief executive.
The governor has immense power, including sole responsibility to determine the capital requirements for all registered banks by controlling their “conditions of registration.” Because the governor’s regulatory powers are vested directly in him by the Reserve Bank of New Zealand Act, he is not accountable to the bank’s board for how he exercises those powers.
As the Initiative explained in our April 2018 report, Who Guards the Guards? Regulatory Governance in New Zealand, the unprecedented concentration of power in the governor’s hands would not matter if the bank’s regulatory performance were consistently exemplary. However, our research found the Reserve Bank commands neither the respect nor the confidence of the financial institutions it is tasked with regulating. The chart below from our report provides a snapshot of how poorly the Reserve Bank is regarded compared with its co-regulator, the Financial Markets Authority (FMA), which has a well-respected governance board.
Of course, our report was published before the appointment of new Reserve Bank governor Adrian Orr. He promised to bring a fresh approach. And he started well, contacting the chief executives and chairs of New Zealand’s major financial institutions about the criticisms in our report.
But since then, shortcomings in the bank’s decision-making processes are back in the spotlight.
The latest ruckus started with the Reserve Bank releasing proposals on December 14, 2018, to increase bank capital ratios to levels that are unprecedented elsewhere in the developed world. The proposals would almost double the required amount of high-quality capital that banks will have to hold. The Reserve Bank estimates the new capital requirements are equivalent to about 70% of the banking sector’s expected profits over the proposed five-year transition period.
The proposals are the culmination of a Reserve Bank study extending back to March 2017. Yet, despite the nearly two-year gestation period, banks were given just over three months to respond to them (including the Christmas holiday period).
In a tacit acknowledgement that the original submission period was unreasonable, late last month the bank extended the deadline for submissions to May 3, 2019. At the same time, it reissued its consultation document to incorporate a number of corrections and clarifications.
The proposals have sparked considerable debate. To date the criticisms centre on four key themes.
‘Flying colours’ pass
The first is that New Zealand’s banking sector has been subject to regular, rigorous stress-testing by the Reserve Bank. And it has come through with “flying colours.” The last stress test took place in 2017. It involved scenarios including a 35% fall in house prices, a 40% fall in commercial and rural property prices, and 11% peak in unemployment and a Fonterra pay-out average $4.90 per kgMS. The outcome was that no bank made losses and no bank fell below the central bank’s minimum capital requirements. Of course, our banks also came through the real-life stress test of the global financial crisis in comparatively rude health.
The second is the unprecedented nature of the proposals. Fitch, the international rating agency, described the Reserve Bank’s proposals as “radical” and “well beyond the international norm.” Indeed, the proposals set a risk appetite to reduce the frequency of a bank failure to once every 200 years – a figure unsupported by any analysis from the Reserve Bank.
The third focuses on the implications for borrowers. The Reserve Bank itself asserts the impact on borrowing costs “would be minimal.” However, market commentary suggests the proposals would either cause a significant increase in borrowing costs (that is, mortgage rates) or a contraction in the availability of credit. UBS, an investment bank, suggests the proposals could see borrowing costs for New Zealanders increase by 86 to 122 basis points. In any case, the Reserve Bank’s consultation document contains no coherent attempt to model the costs and benefits of its proposals.
Chip on shoulder?
The fourth centres on the governor himself. Several commentators have queried whether the governor has a chip on his shoulder about the Australian-owned banks in New Zealand. Whether true or not, the governor is heavily invested in the proposals. Last month, he took the remarkable step of writing to BusinessDesk’s Jenny Ruth to rebut her opinion-piece questioning whether the bank’s proposed capital requirements involved “gold-plating.” This hardly suggests the governor is maintaining an open mind during the consultation period.
Even if the Reserve Bank’s proposals are justified, the furore surrounding their release highlights the shortcomings in the Reserve Bank’s governance. It is hardly healthy for commentators to express concerns that proposals as important as these might be the product of a single individual’s idiosyncrasies.
If, like the FMA, the Reserve Bank had a conventional board with ultimate responsibility for regulatory decision-making, market participants could have confidence that all proposals were being tested by independent experts with the experience to evaluate them.
Fortunately, the Reserve Bank’s governance is the subject of Phase 2 of the Minister of Finance’s review of the Reserve Bank of New Zealand Act. Submissions closed last Friday. The Initiative has recommended the Reserve Bank receive an FMA makeover. The current ruction suggests this can’t happen soon enough.
Mr Partridge is chairman of the New Zealand Initiative.