Governor Adrian Orr tells interest.co.nz the RBNZ's capital increases should make the banking sector more competitive

By Gareth Vaughan

Governor Adrian Orr says whilst boosting the competitive banking landscape wasn't a core reason behind the Reserve Bank's increases to bank capital requirements, it's a "positive externality."

The final decisions in the Reserve Bank's broadest ever review of bank regulatory capital requirements were announced on Thursday, alongside cost-benefit analysis from the central bank and prudential regulator.

The changes include reining in the use of the so-called internal models, or advanced models, approach by the big four Australian-owned banks. In a video interview Orr told interest.co.nz the Reserve Bank has "always been quite close" to stopping the internal models approach from being used in New Zealand. However allowing its use by ANZ, ASB, BNZ and Westpac is part of NZ's "global citizenship."

Reining in the use of internal models by the big four banks and allowing smaller banks to use new types of capital would benefit competition, Orr suggested.

"It has been interesting because the competition question is not at all inside of the framework of what we went about. It's about the probability of default, the velocity of default and the skin in the game to make sure they're lending. But a positive externality of all this work is that it does make the field more competitive. You've got more access to different funding instruments for the smaller banks, you've got less of the competitive advantage for the advanced modelling versus the standard [modelling used by banks other than the big four]. That [internal models] was never meant to be a competitive tool. It was meant to be a risk allocation tool, but we've found banks using it for quite a different purpose. So that's again a great opportunity for banks to be able to compete," Orr says.

He notes that the final decisions in the Reserve Bank's capital review adapt international standards to suit the NZ environment.

"These capital models largely come from the Bank for International Settlements in Switzerland. The very first thing they say is 'these are models for on average, take this and then adapt it to your country or your financial system.' People forget to hear that second bit. 'So take this tool set and use this tool set for your country' and that's what we've done," says Orr.

"So every country's got its own unique particular combination of level of capital [and] nature of capital for their own unique financial system. And for us we have gone from first principle starting from the Basel criteria 'what do we need to have different or better for our situation?' So the outcome's exactly that. We've got all of the right Basel flavour with unique New Zealand calibration in there."

"And most of that calibration come through there in that final level of capital. But we haven't done anything to the risk weighted frameworks for example .And I have to say we've had a lot of confusion, in part deliberate out there, around what will it mean for some parts versus other parts of the economy. Nothing we've done today changes the risk weightings of it, it's simply about the level of capital," Orr adds.

Asked whether the Reserve Bank had been close to doing away with the internal models approach Orr says; "I think we've always been quite close to that. But part of that global citizenship [is] we have to listen and be prepared to hear the banks who are advanced modellers who happen to be the four Australian banks. But it's a licence they have to continue to earn to keep and that licence is about showing the capability of being able to do this modelling and then the deliberation and actually running these models."

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