A few submissions have so far seen the light of day. Those I’ve seen are:
- One from the Reserve Bank, together with a supporting Bulletin article on risk weights and bank lending,
- One (brief) from the New Zealand Initiative, [ and a fuller version I hadn’t stumbled on] and
- One from Auckland investment banker Andrew Body, a frequent contributor to debates on some of these issues.
The Reserve Bank’s contribution is mostly defensive in nature: if there are any issues, responsibility doesn’t rest with us or with our regulatory model. Which is, of course, pretty much what you would expect them to say, as an entrenched and powerful independent existing regulator, who no doubt believe that all the policy judgements they’ve made have been wise, in the best interests of New Zealanders etc. But just because it is them saying it doesn’t automatically mean they are wrong.
And in some areas no doubt they are right. As they note, having four big banks isn’t at all unusual. And some scepticism of state-enabled “maverick disruptors”, especially in the form of an unimpressive modest retail bank, is likely to be well-warranted. They also fairly note that patterns of finance have changed over time, something particularly evident in rural lending (where Rabobank is now the second biggest lender) and in corporate lending (where even on the data they have access to – and big corporates can tap international markets directly – overseas banks other than the big 4 apparently now have 30 per cent of the market).
And I (have always tended to) share their view that (approved regulatory) relative risk weights, used in calculating capital requirements matter a lot less than is often made out. In principle they should make no systematic difference at all since the aim of relative risk weights is more or less to reflect true differences in the underlying riskiness of different types of credit (eg a residential mortgage, with a 40 per cent LVR, is likely to be much much less risky, individually and as part of a portfolio, than an unsecured loan to a B-rated corporate). In practice, things aren’t that simple, including because the dividing lines between different types of lending and associated risk aren’t always clear or straightforward, and which side of a rather arbitrary line something falls can matter. And since no one – regulator or regulated – knows with any great certainty how (relatively) risky different types of loans are (mercifully, very bad crises don’t come along very often, and so data are scarce and open to contextual interpretation – regulators can get things wrong, and impose risk weights on particular types of lending that are quite at odds with the views of the lenders themselves. And any mapping for particular Reserve Bank imposed risk weights to either the pricing or availability of individual loan products is likely to be fuzzy and indirect at best.
Most importantly, relative risk weights simply do not explain why bank balance sheets are chock-full of residential mortgages. Rather, the artificial scarcity of houses and land, imposed over decades by central and local government, has led to hugely expensive houses, which each incoming generation needs to finance. Bank balance sheets would be much smaller if regulatory reform successfully delivered enduring low prices of houses and urban land.
All that said, one shouldn’t be too keen to come to the defence of the Reserve Bank as regulator. This is an agency with very limited specialist expertise at the top (see, notably, the Bank’s Board which now wields the policymaking power), has a culture of being aggressively dismissive, produces no serious research or analysis on financial regulation or stability (even though these functions now comprise the largest chunk of the Bank’s staff) and so on. What speeches there are lack any real depth or insight.
As I noted at the start, the New Zealand Initiative’s submission is brief. There are, broadly speaking, two aspects to it. The first is about efficiency considerations – a dimension unfortunately now lost from the legislation
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Of course, any bureaucracy can produce a cost-benefit analysis of sorts of justify its own choices. I didn’t find the case for the 2019 decisions compelling, but a review now – especially if the reviewers were appointed by the RB or those sympathetic to it – isn’t really the answer (and under current legislation the Minister of Finance can’t direct the Bank in this area). My own view remains that (a) key people matter, and b) key policymaking decisions (as distinct from implementation on individual instruments and institutions) should be moved back to the Minister of Finance, who has both some real accountability (governments get tossed out, and question in Parliament routinely) and better incentives to balance the competing imperatives around any regulatory structure. It is very unusual to delegate major regulatory choices to an unelected agency (the more so, one with little demonstrated depth, expertise, and commanding little respect).
The New Zealand Initiative doesn’t go that far. They propose instead
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I’ve written previously in favour of splitting around a NZPRA, which would have advantages for both those functions and for the Reserve Bank’s monetary policy and related functions. As they note, a suitably-qualified FPC might be a halfway house, although I’m not sure that the MPC – as staffed, and (not) scrutinised and held to account for the mistakes of recent years – is a great advert.
(I’m less convinced of the merits of taking the Governor off the Board. The FMA is primarily an implementation agency without much of a public face. The Reserve Bank, or major policymaking committees, are a different matter…….and for what it is worth it would be quite anomalous internationally not to have the Governor on the central bank board.)
The main prompt for doing this post was Andrew Body’s submission, which he was kind enough to send me. I don’t agree with everything in his submission – we’d disagree I think mainly on the risk weights issue (see above) – but the bulk of the submission captures a number of areas where the current Reserve Bank is ill-equipped for its job, and not doing that job well. His submission is an easy read. Here are a few extracts.
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It is often forgotten just how much of an impost was imposed on banks the local incorporation and outsourcing requirements.
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What I’m less sure of is how much of this is idiosyncratic to New Zealand, and how much is a general tendency of regulators and the regulated. The stylised wisdom when I was at the Reserve Bank was that banks were typically under orders from Australia to be very reluctant to upset or call out the regulator (there or here). Of course, when your regulator – as Graeme Wheeler did here – takes offence at anodyne critical comments from a bank economist, and calls in the heavy artillery to get the economist silenced, it sends a message. Banks have a lot at stake, and the Reserve Bank has a lot of power, which can be wielded for good or ill.
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Before turning to governance
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Much of that makes a lot of sense. But, of course, there is no sign that the Minister of Finance has any interest whatever in a better Reserve Bank, whether in its monetary policy or regulatory functions. She just reappointed the chair, has left Board vacancies unfilled, and included nothing about a reorientation in her Letter of Expectation. Instead, she seems to have been toying with arbitrary new taxes on banks.
Standing back from all three submissions, a few things struck me. The first (and most important) is that neither the Reserve Bank in its defence or the critical submitters mentioned the APRA regulatory requirements and how they affect things in New Zealand (neither did the FEC’s terms of reference). That should be really quite surprising as most of the grumbling is about the four big Australian banks, all of which are part of Australian-based consolidated banking groups, regulated as such by APRA (eg capital requirements that apply to group exposures as a whole). There is no doubt that more onerous regulatory requirements can materially affect the New Zealand subsidiaries, but in any area in which the RBNZ’s requirements were less burdensome than APRA’s it might make or little or no difference here, as the group would still be constrained by group-wide regulation. I’ve never been quite sure how it all works out in practice – how banks do their pricing and risk allocation etc having regard to these distinct regulatory regimes – but it is surprising not to see it mentioned once. At an aggregate level, I’m inclined to the view that the Reserve Bank never made a compelling case for the extent of the 2019 increases in New Zealand capital requirements (and that the heavy focus on high capital is somewhat misplaced, relative to the much-harder-to-measure/observe changes in credit standards), but markedly lower requirements might well become non-binding.
I’ve long been a bit puzzled as to why more non deposit-taking entities don’t lend directly into the New Zealand market (at least if, as we are often invited to believe, there are excess profits on offer here). I recall being heavily involved in some work almost 20 years ago now on possible alternative approaches to monetary policy implementation, and one thing we focused on a lot then was the possibility of entities lending mortgages (say) directly into New Zealand from abroad. Disintermediation was also in focus when the first LVR restrictions were put in place. But none of it ever seem to have come to much. I was exchanging notes with a banking lawyer recently and asking why, say, Macquarie – an aggressive new entrant to the Australian mortgage market – couldn’t just lending into New Zealand as “Cheap Mortgage Loans Limited” (so wouldn’t need to be a New Zealand bank), but the person I was engaging with noted that people who had considered such options were scared that the Reserve Bank would act to stop them (and apparently there are designation powers in the new deposit-takers legislation). You have to wonder why it would: no New Zealand depositors’ funds would be at risk, and new competition would be injected to the system. I note it mainly because it isn’t entirely compelling that everything sensible has been done by the Reserve Bank to reduce unnecessary barriers to entry. Better “Cheap Mortgage Loans Limited” than a juiced-up Kiwibank, in which taxpayers’ money is directly at stake.
I have no expectation that the FEC inquiry will produce anything useful. It isn’t set up to. The submission time was short – who could commission serious or fresh analysis in that time? – and the committee has few resources, no specialist support, and its members don’t appear overly strongly qualified, except to pursue narrow political agendas (some of which might be sensible, but most won’t). And thus how equipped are they going to be to evaluate competing claims in the submissions they receive? It isn’t like a court case in which expert witnesses are grilled by counsel for both sides, and arguments, evidence, and implications tested. A proper workshop, with major submissions presented as papers with discussants and audience questions might have offered the prospect of shedding some serious light. But the political process is all too often interested more in heat than light.
UPDATE: Martien Lubberink (VUW) draws my attention to his submission here. A one sentence summary might be that we should be at least somewhat grateful for what we have – a stable, predominantly foreign-owned, system – and wary of the siren calls to any sort of quick fixes to apparent problems. Thus far, it is hard to disagree (although I have a few specific areas in which I might reach different views than he does).
Michael Reddell spent most of his career at the Reserve Bank of New Zealand, where he was heavily involved with monetary policy formulation, and in financial markets and financial regulatory policy, serving for a time as Head of Financial Markets. Michael blogs at Croaking Cassandra - where this article was sourced.
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