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

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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It's no surprise that there was an increased competition element to changes in the bank capital rules, though not central to it. Also, one can't openly admit to intending that when introducing these changes without being accused of holding "anti-business" values.

Unsurprisingly, smaller banks have been vocal regarding their more-than-welcoming tone on the new capital requirements from the time the proposal was first floated last year.

I’m not completely sold on Orr, but good on him for taking the time out to have a one on one with you.

No change to the smoke and mirrors system, aka the risk weighting system, then? So a bank can still lend 3 or 4 times as much to house buyers as it can to businesses? Isn't our biggest systemic risk in household debt? Isn't this the heart of NZ's capital importing, house price inflating, high immigration, shareholder diluting and unsustainable ponzi business model?

Am I alone in thinking that NZ has two business models that are unbalanced? The dominant one being international financial inflows into an advanced economy causing higher debt or higher unemployment. (see Michael Pettis for details). This is made worse by political sycophancy and immigration and results in higher house prices for all. The subordinate business model is based on export of goods and services, but this is kept in survival mode by the excess capital inflows of the dominant business. Am I missing something?

Absolutely you aren't missing something. All growth and innovation is gone, economies now just playing monetary tricks to pump up debt levels to support zombie economies.

I have said it before - recession is healthy as it strips away the unproductive and refocuses capital into productive industries. The current life support system is all down to a fear of recession, everyone is scared and with highly interlinked economic systems if one economy sneezes the entire house of cards could collapse.

An economy where hedge fund managers can simply ring up central banks and ask for more cash at negative interest rates to pump up their assets which then gets called "growth", is not one that makes any sense. Yet it is what we have.

Blobbles writes: "hedge fund managers can simply ring up central banks and ask for more cash at negative interest rates"

Don't get me started on hedge funds and their managers, it gives me colic. ;)

The influence of Wall Street hedge funds is slowly creeping into rural America.
Tucker Investigates: What is destroying rural America?

https://youtu.be/IdwH066g5lQ

FYI, if the market price of the shares of the company was in the 60's (the share price that Paul Singer sold at), then this would unlikely have happened, and the community of Sidney would have continued unchanged, and there would have been no mass layoffs. At that share price, the hedge fund would not have bought shares in the company. Instead, due to the low market price of the shares, the hedge fund purchased shares in the retailer (and main employer of the town)

Also shows you how an entire community can get decimated when the main employer is laying off employees.

Roger,

Quite right. The risk-weighting system was as useless as papier-mache dam during the GFC in the GFC and to mix metaphors, will be shown up as a paper tiger in the next crisis. Mervyn King covered this in his post GFC book, Alchemy.

Could someone ask Mr Orr if the massive derivatives exposure of our Aussie owned Banks was taken into account when the new capital requirements were calculated? Do the Aussie parent banks hold all the risk here?

KPMG calculated the exposure in 2018 to be $37 trillion dollars.

https://www.macrobusiness.com.au/2018/06/australia-sitting-ticking-deriv...

There are so many such skeletons waiting to pounce, as they did during GFC 2008. Counter party risk, any one ?

It would be informative if the central bank regulators insisted the banks divulge capital reduction offsets available to them because of the derivative book for each risk weighted asset under the internal ratings based (IRB) model

"But, but, but, that would be real transparency, Minister. Can't have that now, I mean people might panic. House prices might go down. Regulation isn't about actual transparency, you see, it's about the comfortable illusion of transparency and order. So people feel someone is in charge, that all's well, that government and banks know what they are doing. That experts know what's going on. That sort of thing, not real transparency, no one wants that. Far too frightening."

I think NZ has a great Governor in Mr Orr, intelligent, knowledgable, independent and brave.

... yes , Adrian is orrsome ... but ... there are unintended consequences .... and his plans will cost the big Aussie banks ... and who will they ping to pay for those additional compliances .... themselves and their shareholders ? ..... ah ha deeeeee ha !

Look in the mirror , friend... and I'll look in mine ... thems the dumb schmucks who're gonna stump up the moola ....

Imagine paying for the privilege of a robust banking system huh? How else do you propose we do this? Legislate a cap foreign bank profits?

.. they're Aussie owned and domiciled ... why ought we pay them anything ... they pull $ 5 billion in profits out of our country every year ...

Not actually majority Australian owned....most of the shareholding of ANZ, CBA, NAB and Westpac is held by parties offshore from Australia. So us and the Aussies are kind of in the same boat here.

''boosting Competition''
We hear that every year but the reality is that they are all the same.
TSB is voted the best bank for customer satisfaction every year and yet i suspect very few swap over.
You hear about people turned down for loans from 1 bank turning to another bank,but the simple truth is there is a reason why they were turned down.

Have you ever Voted for one of these awards? I haven't? You know why?
If they are like the Canstar Awards, they are bought and paid for advertisements.
Maybe "Consumer New Zealand Awards" are different - but I doubt it!

Is there any information on the year to year step up required in capital during the 7 years period ?
If so, the banks have no right to straightaway raise the rates by 20 or more basis points, right ?

Also, stricter RWA (on house lending) and cap on profit repatriation, especially as our banking is dominated by overseas interests should be seriously considered to strengthen the banking here.