Martien Lubberink questions whether the RBNZ has become too philosophical about bank capital

Martien Lubberink questions whether the RBNZ has become too philosophical about bank capital

By Martien Lubberink*

“You guys are little bit philosophical: the Netherlands and France are the only two countries in Europe that haven’t taken a position on capital requirements.” That was Emil from Nomura, who, in early 2012, queried me about the Dutch position on minimal capital requirements. The Swedish bank authorities had just announced that capital ratios should be at least 10% Common Equity over risk weighted assets (RWA). The Brits expressed a desire to follow suit, Germany had made up its mind. But France and the Netherlands were … philosophical.  

Obviously Nomura wanted to do business. Help banks issuing capital. And rightly so, banks will only issue capital when the supervisor offers clarity. Remember Elvis’ adage: a little less conversation, a little more action please. Prolonged inaction will harm financial stability.

There are reasons to believe that the Reserve Bank has become  philosophical on bank capital too. 

That speech

First is a recent speech of Reserve Bank Deputy Governor Geoff Bascand on financial stability. The speech did not draw a lot of media attention. However, the section on bank capital is disquieting. Discussing the pros and cons of bank capital, Bascand highlights the private interests of banks: “There is a debate as to how high that price [the price of higher capital requirements] really is. And we need to weigh those private costs against the social costs of a crisis.”

This is remarkable, because the Reserve Bank has always claimed to protect the financial system, not the private interests of banks. 

More importantly is this. Ten years after the GFC, Bascand’s speech shows that the Reserve Bank has still not taken a position on bank capital. The speech is littered with dovish philosophical capital claims. For example, it mentions: “The literature is therefore helpful in pointing to the direction that regulatory capital should travel, but not the destination.” Perhaps. But statements like these set the RBNZ apart from its Australian counterparts. APRA and RBA have no problems pointing out the destination of bank capital. It’s called ‘unquestionably strong’.

It’s not only words

Second is the recent outcome of the 2018 European Banking Authority (EBA) stress test. The EBA publishes all the relevant data, also on capital ratios. So, we can compare New Zealand bank capital ratios (using the Dashboard) with those of EU countries. 

Adjusting for size, the average common equity tier one (CET1) capital ratio of New Zealand banks is 11.43%, with the big banks barely meeting that average:  

Compare this to CET1 ratios of EU banks, which are 14.22% on average.[1]  Most European banks sport CET1 ratios higher than 11.43%:

The difference in CET1 ratios between Europe and New Zealand is 2.79% (14.22-11.43). Adjusting this by 2% to reflect conservative risk-weights, the average ratio is still 79 basis points below that of the European average. Also this study from the U.S. Federal Reserve shows that optimal bank capital levels range from just over 13% to over 26%. New Zealand dwells at the lower boundary of that range. 

Moreover, European banks have increased average CET1 capital by more than 700 basis points since June 2011. But New Zealand CET1 ratios have increased by only 115 basis points since 2013, when the RBNZ started measuring CET1 capital ratios.[2]  

Buffer, buffers, and a bit of Pillar 2

Just in case you wonder why the European ratios are so high; Europe implemented the full Basel III tool-box. This includes an array of buffers. There is a conservation buffer, a buffer for systematically important banks, a buffer that kicks in when lending grows too quickly. These buffers can augment CET1 ratios to about 13%. Then there are Pillar 2 requirements, which allow a supervisor to augment regulatory capital of individual banks. This to cover risks that are not covered by the main regulatory requirements. Some European banks are required to hold 10% additional Pillar 2 capital. It all stacks up! And it stacks up because of that comprehensive tool-box called Basel III.

You need a hammer

Third is the joint FMA and RBNZ report on conduct and culture. This also contains interesting dovish statements on capital. 

Just in case you wonder what bank capital has to do with conduct and culture, here’s an illustration. Banks need to hold capital for Operational Risk (as well as for credit risk and market risk). The text below, from the Credit Suisse annual report, shows how it works: 

Credit Suisse got itself into trouble by mis-selling RMBS before the global financial crisis. The U.S. Department of Justice found out and fined Credit Suisse. Then FINMA, the Swiss Market Supervisory Authority stepped in and made Credit Suisse change its way of measuring risks. This led to a CHF 9.0 bn increase of Risk Weighted Assets – and with it a CHF 1.125 bn increase in bank capital.

This is the way to go. Capital is a great hammer tool to discipline banks. 

Abandoning that important tool?

The combined FMA and RBNZ conduct and culture report, however, does not mention regulatory capital. Which is remarkable, given that the Reserve Bank not so long ago required Westpac New Zealand to hold an additional 200 basis points of regulatory capital because of poor conduct.

Has the Reserve Bank abandoned a potent tool to discipline banks? 

To answer that questions, lets look at the policy initiatives on Operational Risk. I mean, perhaps the RBNZ contemplates the introduction of a new operational risk framework to deal with matters of conduct and culture. Unfortunately, here too it looks like the capital doves are gaining ground. For example, last year’s consultation reporton the Review of the Capital Adequacy Framework offered the following options:

The third option could potentially deal with culture and conduct.

Alas, looking at the response to the consultation, the RBNZ appears to favor the second option: All banks will calculate the RWA arising from operational risk in the same way, using the Basel Standardised Measurement Approach.

Again, this makes me wonder: has, under Adrian Orr, the RBNZ become too philosophical about bank capital?


[1]: These ratios are on a fully-loaded basis, which are conservatively low, because they apply the full Basel III  deductions from capital. 

[2]: I weighed the Common equity tier 1 ratios from the RBNZ statistics tables by total assets. 


*Martien Lubberink is an Associate Professor at the School of Accounting and Commercial Law at Victoria University. He previously worked for the central bank of the Netherlands where he contributed to the development of new regulatory capital standards and regulatory capital disclosure standards for banks worldwide including Europe (Basel III and CRD IV respectively). This article first appeared in Capital Issues and is reproduced with permission.

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Great article - Thanks interest.co.nz

(From the Hayne Royal Commission in Aussie, yesterday)

“…what needs to change here is a banking culture that took a decade to go bad, and will take at least that long to put right…. (NAB Chairman's) admission the NAB board's compliance risk rating has never been lower than red, but for one month, since he joined the board seven years ago….” It's really difficult for a board to be held accountable for ensuring anything…there were doubts as to whether it was "appropriate or even possible to prescribe a particular culture for financial services entities"….”

Bank capital is crucial in moderating bank behaviour, both on the balance sheet and in the corporate suite/branches.
A dovish approach to the topic by the RBNZ is not appropriate and allows future risks to our financial sector to evolve. Why? Because 'our' banks are Australian banks, and look how they behave(d) !

A good thought provoking article. Thx!.

While we're here it's also worth re-visiting Gareth Vaughan's 2017 article on the subject and to reflect on what has happened since in Australia and what is happening in their housing market. The fact that we have specific 'bail-in' legislation essentially means that depositors funds are, in the event of a crisis, simply bank capital.

https://www.interest.co.nz/opinion/88863/gareth-vaughan-suggests-apras-u...

NJ - I don't think many people understand that bank deposits can be used to save a bank, thats how I understand it anyway, above a certain threshold accounts can have a haircut ! Hope RP understands this with his TD's ?

Hi Shoreman
From memory, I'm pretty sure that RP's term deposits are not with an Australian bank though. The depositor 'bail in' legislation is something very few in NZ even seem to understand has been written into law by the previous administration. Which bank has the largest residential home loan book in NZ? I wonder if they had anyone working on the inside who knew someone in government who could help them get that through parliament?

Shoreman, your concern for my financial welfare is misguided. If I were exposed to a haircut worthy of my concern, it would be via Kiwisaver. By this stage, NZ property prices will have already sunk by 30% or more.

Earlier this year, I transferred my Kiwisaver funds to cash. This cash fund is simply term deposits spread over all major NZ trading banks. Some is also invested in BMW, Meridian and Toyota. Outside of this, I have a sum with Rabobank under a grandparented arrangement. The principle and all interest earned are guaranteed in full by the Netherlands parent bank.

Surely that Rabobank term deposit has to expire at some point?

Are you going to buy stocks at the bottom of the next crash with all that dry powder?

Q: with deposits being bailed in to protect the bank from a future failure.

whats the point of a deposit guarantee?
for once the bank has failed, after bail in, equity all gone

at/past the point of failure of failure
the original deposit had been transformed into equity already.

whats to gtee?

Within the OECD, its only NZ and Israel that don't offer a deposit guarantee. This is soon to change here; https://www.interest.co.nz/category/tag/deposit-insurance

If it all hits the fan, it would be unwise to be found as the odd one out. Once rumours mount of bank stress, deposits will be transferred to safer shores.

Hi RP

I only discovered the other day that UK also has 'bail in' of deposits if required to save the banks. Passed through house in December 2014. The difference however is that the first £85K of savings per institution (parent bank) is covered by a depositor guarantee. Here, not so good, I can't believe the oldies haven't been skipping down to the Beehive with their hip replacements, to stand firm picketing for months on this. This is again the fault of the media for not kicking up enough of a fuss about the risks that this places on this system. It's hardly going to illicit good behaviour from the banks either!

" illicit good behaviour" is an oxymoron. But post-Haynes, perhaps not a Freudian slip? Eliciting, perhaps, or, because it's Da Bankz, Soliciting?

Well spotted Waymad.. I must have been thinking about illicit behaviour! 'Soliciting good behaviour' is another oxymoron is it not, few professions charge such extortionate amounts for every 5 minutes of client time! I am of course talking about solicitors rather than other professions where soliciting occurs!

Is the intent to mislead by not starting the Y axis of both of those graphs from 0?

And not including Westpac?

You mean that Aussie bank who admitted in 2017 that 50% of their Australian loan book was on interest only terms?

I left out Westpac, because it would show this bank is doing well on capital. But the Westpac ratio is 200 bp higher because of that fine - which I explain in the last part of the story.

How is this misleading?

Most NZers don't appreciate how important the bank capital adequacy ratios are or the impact on our day to day lives. The RBNZ's use of aspects of the Basel rules indirectly determines who are financial winners and who are losers in NZ.
Currently the winners are home owners YAHOO (sarcasm) and the losers are farmers and business owners and their employees and suppliers.

...and I remember grappling with the Basle Accord when it didn't even have a number!
You'd think after 30 odd years it would be standard practice by now.

Are Martien's numbers real? There is just so much smoke and mirrors in these bank ratios. If it's a mortgage it only needs 25% of the capital. So does 10% capital ration mean that actually there is only really 2.5% equity backing the loan book? Greenspan recently recommended 20% to 25% equity with no adjustment for anything.

It's all very well having a sophisticated model, all very efficient and all that. Trouble is evolution doesn't favour the super efficient specialist for too long. These models only deal with ordinary, normal times, not times of great change and stress. Martien doesn't mention the Italian banking system has 17% non performing loans which seems just a bit relevant. EU finance is just too political to believe any official figure.

My take on NZ not having a bank guarantee scheme was to make sure the government's hands weren't tied, so they can bail people out or not, as they see fit, but they are not any easy mark to be gamed like last time.

The numbers are sources from public data, therefore please be my guest and redo the numbers.

The graph deliberately shows countries like Sweden, Norway, and Denmark which are countries comparable to NZ and sport ratios that are about twice as high as NZ banks.

Roger - from memory Tier 1 equity ( what the average person would call owners contribution plus retained earnings is 4% ) Residential loans are calculated at 50% risk so equity required $2 per $100 lent on mortgage dependent on length of loan and home owner versus invester as borrower. In addition banks can use an additional 4% of what they call contingent debt and preferential shares as Tier 2 equity which they can onlend at the same ratio $100 per $2 of what is not even their own money but can be written off by bank management under certain conditions.

Apart from low levels of capital, the level of provisioning for loan losses is woeful. When the RE correction does come, despite assurances that the banks have been adequately stress tested the losses will be enormous. With such high concentrations in overpriced real estate assets these buffers will be found wanting.

What is the point of a central bank if it does not provide lending of last resort?. Losses of banks under the RBNZ's regulatory control should be the RBNZ's responsibility. OBR is a means for the RBNZ to dodge its fundamental responsibility.

Not one comment above about the Government (effectively the RBNZ represents the Government in this case) acting to protect private business's. Everyone is getting buried in the detail. What would we think if the owner of the local diary went to the Government and asked them to protect them from the possibility of collapse?

I hear the response now - because banks are different! Ask yourselves why they are different and how this came about, and then ask if it is RIGHT, as in moral,and ethical.

Banks are above all private business's and somehow we have reached a place where the conventional wisdom is that taxpayer funds and regulations should be in place to protect them from collapse. Didn't we learn anything from history?

why is it the banks that are being protected and not the public?

Murray... The reason the Banking system is protected, is because it is critical. Its pretty much the veins/arteries/heart/lifeblood...etc , of our economic system. All of us use it everyday to transact.
The banking system really is a Public/private Symbiosis...

I dont think "bailout" is the right word to use..
If a Bank becomes insolvent it will be taken over by the govt/RBNZ.
Shareholders of the Bank would lose everything ( as happens in all bankruptcies )
If a Bank becomes insolvent Depositors are at risk of losing much of their money, as they are way down the list of of creditors priority.
The OBR is actually an attempt by the RBNZ to limit depositors loses .
If the Govt/RBNZ had to takeover an insolvent Bank, they would enact the OBR.
Some depositors money would become Capital , the Govt/RBNZ would also recapitalize the Bank and then it would be business as usual as the Bank slowly healed its balance sheet.
As owners of the Bank, the Govt might actually make money as the Bank became profitable.

A good question is why should taxpayers bail out creditors ( depositors) if a Bank fails..?
The OBR is an attempt to both protect depositors and also have thenm suffer the consequences of being unsecured creditors in a failed business.. ( After all, NZ does not have deposit insurance ).

If what I say is kinda correct, then the RBNZ might be more concerned about the quality of a banks "loan book" than the amount of Capital adequacy it has..??

Thats the way I see it..

"The reason the Banking system is protected, is because it is critical. Its pretty much the veins/arteries/heart/lifeblood...etc , of our economic system."

That, in and of itself, I would suggest is one of the biggest issues we face. If it is so critical, why is money creation in the hands of private corporations? So, we might need a banking system, we don't need banks.

Roelof ask yourself why any ONE bank is so critical to the economy that regulation and legislation is designed to protect the bank, a private company, over the rights of the general public? In reality they are just another business, not different really than the diary I mentioned. The problem is our Governments have allowed them to get too big, too powerful and are now afraid to act on behalf of the people they are supposed to represent. If they are so critical to the economy, why are they not Government owned? They have manouvered themselves into a position where they can manipulate the economy, something that for any other company is ILLEGAL!

You describe the OBR and the words you use still make it look like legalised theft. You ask "why should taxpayers bail out creditors ( depositors) if a Bank fails..?" which is what i ask. Why should a bank be able to steal my money when they cannot run their own business properly? God knows they make much more money from my depositis than they pay me in interest, but still they can take my money while their own is protected?! As an ordinary Kiwi, all the banks largely look the same to me. Much of the information coming out of Australia about banks risky behaviour is largely invisible to the man on the street (me) and thus the assumption of competition is just BS. What i want when i use a bank, (and today's systems and processes demand I do) is that my money on deposit with them is MINE, not theirs, and they are accountable to ME for how they use it and treat it. I want the banks to be as acountable to me as any other business i deal with is.

the lack of bankers going to prison for their behaviour during the GFC is the single biggest failure in the GFC. The second failure is that the Government (US) bailed the banks not the ordinary mums and dads who had deposits with them.

"Didn't we learn anything from history?"

Of course we did, that we don't learn from history. The Federal Reserve was only ever created to further the interests of private banks.

Central/Reserve banks/governments believe that protecting the banks does protect the public.

Morals/ethics? Look around. They would be a hindrance to maximising "wealth" creation. Mankind has slowly eroded any sense of morals/ethics over the last few thousand years, if any actually existed in the first place. Or, our only ethic is as much money/wealth as possible no matter the cost.