Martien Lubberink says in bank regulation, some problems never heal. And the current vacuum of credible RBNZ leadership creates opportunities for poor regulation. Not helping, Nicola Willis pursues a fallacy

By Martien Lubberink*

Apparently, Adrian Orr left the Reserve Bank suddenly because he felt increasingly cornered by demands from the banking sector to lower capital ratio requirements. His decision to protect the financial system against a hypothetical 1-in-200-year shock—rather than the 1-in-100-year event originally advised by his colleagues—has come back to haunt the outgoing Governor. In bank regulation, some problems never heal.

At its core, this is a story about reputation and credibility.

In October 2018, I met with the RBNZ team responsible for the capital review, led by Ian Woolford and Susan Guthrie. It was an unusual meeting—about ten staff members gathered in a café in Wellington’s CBD, I felt flattered and ambushed at the same time. Despite a room full of RBNZ policy boffins, Ian led the questioning. He wanted my perspective on capital requirements. I told him that, while a regulator can demand as much capital as it likes, those requirements must be credible.

The team apparently grasped the first part, but not the second. The RBNZ went on to propose capital requirements so high that they had to be significantly watered down a year later. I described this climbdown as offering an “olive tree“, not an olive branch—a move that undermined the credibility of the original proposal and, by extension, Adrian Orr himself. It was his project, his defining policy, and apparently, the hill he chose to die on.

Orr knew in 2018-2019 what he was doing: requiring excessively high capital ratios based on a 1-in-200-year event, knowing that without this extreme scenario, the proposal would not result in materially higher capital requirements. It was an open secret—widely understood but never formally acknowledged.

The fallout from these decisions is now evident, both domestically and in the broader regulatory landscape.

Damaged reputation, damaged goods

Fast forward to 2025, and the global regulatory landscape has shifted. Major regulators—including the Federal Reserve, the European Central Bank, and the Bank of England—are delaying, softening, or outright reconsidering the finalisation of Basel III. The UK has introduced a competition mandate into its prudential framework, signalling a broader shift in regulatory priorities.

In this global context, it is very difficult to keep pushing our banks for capital requirements that are based on the pipe dream of a Governor whose decisions were seen as reckless.

As economist Robert MacCulloch pointed out on Newstalk ZB, Orr’s decision to flood the economy with stimulus in 2020 gave the world the false impression that New Zealand’s financial system was fragile—when, in reality, it was rock solid. Orr’s later pivot toward engineering a recession only cemented his reputation for erratic policymaking. And then there’s the $32,000 taxpayer-funded trip to Washington, taken while simultaneously overseeing a monetary policy that puts people out of work. Orr’s unexplained departure is the final act in a tenure marked by missteps. The result is a Reserve Bank with a damaged reputation.

This loss of credibility is now playing into the hands of those pushing for looser regulation.

Short-term gains and longer-term pain

The current vacuum of credible leadership creates opportunities for poor regulation. Like vultures circling a carcass, the big banks and their allies are seizing the moment to push for lower capital requirements. Not helping matters are the bush researchers Simon Jensen and Andrew Body, who selectively cherry-pick evidence to argue that the Reserve Bank’s capital requirements are inadequate.

Meanwhile, Finance Minister Nicola Willis is gathering advice on overriding the capital requirements, convinced that relaxing them will somehow turn the economy around. Yet, global regulators and academics have repeatedly warned against this fallacy:

• BCBS Chair Erik Thedéen in October 2024: “It may be tempting for some to argue that regulations should be watered down and that supervision should be less intrusive, in order to promote lending to specific sectors or to “unlock” economic growth. But, as with other areas of economic policymaking, any perceived short-term gains are usually more than offset by longer-term pain. Shaving off a few basis points of capital will not unlock a wave of new lending, but it will weaken your resilience. More generally, being well capitalised is a competitive advantage for banks and their shareholders, as it ensures that they can continue to grow and invest in profitable projects across the financial cycle.”
• ECB’s Elizabeth McCaul, October 2024: “it is a fundamental misconception to frame safety and competitiveness as opposing forces. A stable and secure financial system forms the bedrock of long-term competitiveness.”
• Paul Conway just recently: “I don’t think that tweaking risk weights here and there is going to be anywhere near the game changer that’s required to lift productivity and to lift capital intensity in the New Zealand economy”
• Outgoing Fed Governor Barr, February this year: “When we don’t follow through on our commitments, for whatever reason, concerns about a level playing field rise in other jurisdictions, in an international “race to the bottom” on standards. This harms us all and makes U.S. banks less competitive.”
• Berger and Bouwman, 2013: “capital helps small banks to increase their probability of survival and market share at all times.”
• Leonardo Gambacorta and Hyun Song Shin: “In a cross-country bank-level study, we find that a 1 percentage point increase in the equity-to-total assets ratio is associated with a four basis point reduction in the cost of debt financing and with a 0.6 percentage point increase in annual loan growth.

And yet, figures like Body, Jensen, and some New Zealand media persist in arguing otherwise.*

Next Steps for Nicola Willis

In this context, our Minister of Finance should think carefully before stepping into the Reserve Bank’s domain. Politically, it is poor optics—interfering with a supposedly independent institution does little to restore the Reserve Bank’s damaged reputation. If anything, it risks further eroding credibility by making monetary policy appear subject to political whims.

More importantly, the push to lower capital requirements is based on an important misunderstanding. While the rules technically apply to all banks, in practice, they primarily apply to the big four. Smaller banks, including Kiwibank, already hold significant excess capital to satisfy rating agencies. For example, the Big 4 banks hold Tier 1 capital 0.53% above the requirement, while smaller banks hold 2.17% in excess**—primarily to satisfy their owners and rating agencies like Standard & Poor’s.

This puts Willis in an awkward position. She does not want to be seen as helping the big Australian banks, yet overriding the RBNZ’s policy would do just that. Instead of boosting competition or strengthening the economy, the primary beneficiaries of such a move would be the largest Australian-owned banks—the very institutions that political rhetoric often targets.

A smarter approach would be to request a full evaluation of post-GFC regulations by the Reserve Bank. Such a broad review—assessing the effectiveness of all prudential regulations introduced over the past 15 years—could re-anchor capital requirements to a different systemic shock threshold. This would allow for a well-reasoned adjustment while preserving credibility and financial stability.

If Willis proceeds with overriding the Reserve Bank, she risks being held accountable for any future financial instability or bank failure.

With Orr’s departure, Willis has an opportunity to recalibrate financial regulation responsibly—without risking the credibility of the Reserve Bank or her own position.

^{*An example of the latter is Rebecca Howard, who in Businessdesk calls the requirements restrictive: “That, given the clamour from banks around restrictive capital requirements, may rule him out.”}

^{** These are Rabobank, Kiwibank, SBS, TSB, Heartland, and Co-op.}

This analysis was first published here and us used with permission.