Martien Lubberink says the RBNZ's bank capital proposals offer more of the same and the regulator ought to look to Europe for an alternative approach

Martien Lubberink says the RBNZ's bank capital proposals offer more of the same and the regulator ought to look to Europe for an alternative approach

By Martien Lubberink*

The current prudential regulation renders the New Zealand financial system vulnerable to the impact of significant shocks.

The Reserve Bank of New Zealand relies on self-discipline and market discipline. Compared to other supervisors, the New Zealand Reserve Bank takes a rudimentary, almost Spartanic approach to bank supervision. Pillar 1 dominates, there is no Pillar 2 to speak of.

Because of a fear of moral hazard, supervision was not meant to be intrusive. There is no deposit insurance system. Thus far, this has had no adverse impact on the financial system. I guess we have been lucky. However, the current approach to supervision is out of date and unsustainable in its current form.

In some way, New Zealand banking can be compared to cycling in the Netherlands. Since the 1970’s the Netherlands has created a very safe cycling infrastructure. As a result, cycling in Holland has been very safe. If you have visited Amsterdam, you must have noticed that there is hardly any traffic enforcement. Dutch cycling also relies on self-discipline and on monitoring (other cyclists, cars, pedestrians).

However, this system is now starting to show cracks. The number of bicycle casualties is on the rise, for two reasons. First is the ageing population: vision loss and hearing loss do affect older adults, impairing their ability to monitor traffic. Second is technological advancements: battery-powered bicycles have become increasingly popular. Combined, these two factors make cycling in the Netherlands today more lethal than driving cars, which was never the case.

The New Zealand approach to prudential supervision, shaped by a reliance on self-discipline and market discipline, has become an anachronism. The GFC demonstrated the limits of market discipline and depositor monitoring. The post-GFC era shows the limits of self-discipline: poor conduct is a growing problem. In light of these developments, the RBNZ approach to prudential supervision increasingly reflects a set it and forget it attitude. Like cycling in the Netherlands, the New Zealand financial system, once deemed very safe (see Calomiris and Haber (2014)*, has become vulnerable.

Breaches of capital requirements will become visible quickly. The prize-winning Financial Strength Dashboard allows the New Zealand public to identify weak banks and act accordingly. Prompted by social media, retail investors fearing the Open Bank Resolution haircut will move money abroad, to well-managed and resilient European, Far East, or North American banks. Money that was deemed to be sticky in the past has become hot.

Meanwhile, new risks are emerging. They affect the resilience of the New Zealand financial system. Operational risk has become much more important: examples are cyber security risk, the risks associated with money laundering, and other conduct risk, such as Libor related scandals, as well as scandals that led to the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry. A recent article in the Financial Times showed that banks’ risks managers are most concerned about cyber security risk, and that the attention for operational risk had increased by seven percentage points over the last year. Quoting Paul Sharma: “There is definitely more of a focus on conduct rather than capital.”

No simple solutions in banking

Andrew Haldane some years ago championed the virtues of the Leverage Ratio. He claimed that the Leverage Ratio would be a ‘simple ratio’, thus rendering it superior to the risk-based ratio. However, Haldane failed to acknowledge the era of accounting scandals. About 10 years before his speech, companies like Enron and WorldCom demonstrated that the simplicity of accounting is deceptive. Enron kept information off-balance sheet, which rendered the reported values of assets and leverage unreliable.

In other words, the idea that there exists a simple measure of solvency is misleading. The same applies to the different ways of calculating Risk Weighted Assets. Metrobank, the UK contender bank, which lost a whopping 75% of its market value because it did not get banking regulations right, demonstrates that the Standardised Approach is not a panacea for small banks that are encouraged to compete against established rivals. Likewise, the idea of a “wall of equity” suffers from the same problem.

Deutsche Bank in February 2016 demonstrated that investors will get very nervous once a bank approaches a breach of its capital requirements. It is not obvious that requirements of 4%, 8%, or 18% will calm investors once they anticipate a breach.

The Nordic banks have recently demonstrated that high levels of capital will not prevent a bank from getting into trouble. Dankse Bank, plagued by money laundering problems that wiped out half of its market value, may have suffered from a supervisor who applied a set it and forget it approach.

Lastly, regarding the writing down or writing off of CoCo capital, the RBNZ prefers a high trigger. However, the idea that a high CoCo trigger will contribute to financial stability may suffer from the same keep it simple, set it and forget it mindset.

The 4th Capital Review Paper: more of the same

Against this backdrop of an increasingly vulnerable banking system, emerging risks, supervisory complacency, and the longing for the simple world of yesteryear, the RBNZ presents a proposal that can be best characterised as more of the same.

Briefly summarised the main elements of the 4th Capital Review Paper are:

  • Tier 1 capital requirements at 15% of Risk Weighted Assets (RWAs),

  • a 1% surcharge for systemically important banks,

  • a structure of regulatory capital where Common Equity Tier 1 (CET1) dominates,

  • a more prominent role for a conservation buffer, which comprises solely of CET1,

  • a significantly diminished role for non-equity capital,

  • a more prominent role of the Standardised approach of calculating risk weights, and

  • a significantly diminished role for the Internal Ratings Based approach of calculating risk weights.

More: Total capital ratios for New Zealand banks will be 17% overall, and 18% for systemically important banks, up from 10.5%. The main capital component driving this increase is the conservation buffer, which adds 5% to the current buffer of 2.5%. The D-SIB (Domestic Systemically Important Bank) and Countercyclical Buffer contribute 2.5% to the increase in capital.

The same: As under the current rules, these are all Pillar 1 requirements, meant to cover credit risk, market risk, and operational risk.

However, the RBNZ proposal fails to acknowledge the vulnerabilities of the current system: i) better-informed and more savvy retail investors and depositors; ii) the growing importance of operational risks, iii) the complexities of banking and the naive belief in simple solutions. Instead of acknowledging operational risk and liquidity risk, the Reserve Bank focuses on a risk that is largely under control: credit risk.

More of the same is hardly an improvement, it leaves the current financial system vulnerable to the impact of significant shocks. The governance of own funds regulation at the Reserve Bank is such that a next official may dial the ratio requirements down to levels that are comparable to other countries. I doubt if such a move will contribute to safety and stability, hence my submission.

My comments [submission on the RBNZ capital proposals] therefore will focus on the structure of capital. The RBNZ should let go of the idea of the “wall of equity” and accept layers instead. Layers in the form of, for example, contingent convertible capital. But also “layered” degrees of capital disclosures, thus following the example of Europe’s Pillar 2 framework, which is now split into two parts, of which the “guidance” part allows the supervisor to do its job: supervise. This instead of the current approach which seems to be inspired by Madame de Pompadour’s famous adage: Après nous, le déluge.


* Calomiris, C. W. and S. H. Haber (2014). Fragile by Design: The Political Origins of Banking Crises and Scarce Credit. 41 William Street Princeton, New Jersey 08540 USA: Princeton University Press.

*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). 

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European regulation. European tax rates. Can’t have your cake and eat it prof. If we go down your route, and I’m not saying what you are raising is wrong will of necessity require a quadrupling in the size of the regulatory impost and who will pay for that. The banks or the taxpayers. Both will squeal.

The Rbnz approach is a practical response of s host regulator to a home regulator that has depositor preference and no incentive to protect the hostdepositors. Hold more capital locally ensures that the home regulator which does follow the European approach will make sure that the local banks have dealt to all the risks and issues you raise, just to ensure that the host bank is not damaged.

A clever response to an extraterritorial problem. Only other thing that really needs proper beefing up is ICAAP. Sits hand in glove with the capital regime. Not enough attention is paid to it by the banks or the public.

I’m more concerned with the ultimate cost and who loses if NZ continues with their hands off approach
GFC2 is coming and yet NZers Savings are still uninsured !
You had JK The now head of ANZ -NZ heading a NZ bank that has just been reprimanded by the RBNZ
You indeed live in The shaky isles for depositors Savings as well as earthquakes

While not discrediting your perspective Martien, are you not holding on to the perpetual growth myth that banks have clung to since the gold standard was dropped? Capital requirements are a way to limit banks abilities to enable virtually unlimited credit creation, and effectively create money. that is at least one of the fundamental reasons the world is in so much strife today. The power of the banks needs to be dialled back, very strongly, how else would you achieve this?

Nice to recall Haldane, who advocated for simplicity and transparency. I appreciate the article and the points it raises regarding two other forms of risk in addition to credit risk. I'm not so confident that we should be comforted, however, by the assertion that credit risk is "ok" and will not be a problem in the future.

I also take issue with the OP's rejection of "simplicity" (and transparency) as a core principle for effective bank regulation. Simplicity brings many benefits to a banking system, parts of which at least should function more like a simple and consistently-performing utility (like power, water and natural gas) providing intermediation between depositors and borrowers. The example of Enron's off-balance sheet items does not indicate a flaw with the principle of "simplicity" in bank regulation that Haldane advocated. It reveals a flaw with accounting standards or, perhaps, with the enforcement of accounting standards by regulators.

I disagree that bank regulation requires "layers" (weighted averaging over different forms of capital on the bank's balance sheet). The in-house proprietary risk modeling currently used by the Australian commercial banks (which allow them to play around with internally used risk weights that can paint virtually any kind of picture to regulators and depositors that the bank wants to project) is not fit for purpose. There is obfuscation underlying that complexity. Pleading for complexity is pleading for maintaining the gross asymmetry of information by which there's no way for depositors to get up-to-date real-time views of the bank's balance sheet and risk exposure.

The claim that depositors are "savvy" may be ok (although doubtful in my view). I would like them to be more savvy. But no matter how savvy they are, the current regulatory framework for commercial banks gives depositors almost none of the relevant information required for "depositor monitoring" to function as a competitive force incentivizng banks to effectively manage their risk. Please justify and provide evidence that "depositor monitoring" plays any meaningful role in NZ.

Quarterly reports are about the best info that depositors can find about banks. They enjoy multiple exorbitant privileges. One of those is the privilege to obfuscate and show very little to depositors and regulators about the detailed contents of their balance sheets.

A better alternative might be to offer gold for sale and storage in bank branches. This is how Germans keep their banks honest, at least that is the thrust of this article:
The large percentage of Germans storing their gold in bank safe-deposit boxes may look surprising but can probably be explained by the fact that in Germany many banks sell gold bars and gold coins directly to their customers, and its quite normal to walk into a bank in Germany to buy gold. So German banks that offer precious metals also offer safe deposit boxes, all in the one and same location.

I have no idea if this article is accurate, but it provides a viable method where each individual can choose his preference for storage of funds. Either with the bank as an unsecured creditor earning interest at an after tax rate less than inflation; or in lumps of metal in a box with their name on it. Should keep the banks and the government honest. Presumably that's why we don't have it.

Interesting to read, not that I understand all of it. I get that there needs to be something of value to underwrite banks creation of credit. I thought that was property. So did they. It's only when the prices go down does that principal not work. It's the balance sheet stuff, or, from what I read above, what's not on the balance sheet, that concerns me.
Struth, I've only just figured out how balance sheets work & now they're telling me the important stuff is off b/sheet???? And it looks like everyone from the gubmint on down is doing it. F.... ..e. More to learn tomorrow!
PS: Although the standard of the RBNZ requirements discussion is rising & that's good right?

Mooie artikel hoor Martien, jouw vergelijking van de Nieuw-Zeelandse bank zaken met het Nederlandse fietsen vond ik uiterst leuk.
Ik bekijk dingen vanuit een andere perspectief. Namelijk, om mensen verstand van zaken te leren kennen, mogen dingen soms gewoon naar de kloten gaan. Maakt mij niet uit als het een duure manier is om verbetering te vinden, als verbetering maar plaats vindt.

Well this is NZ after all. Why follow proven methodology from abroad when in the name of kiwi number 8 wire mentality you can invent your own inferior system! The Dutch are an orderly society, they are experiencing rising cycle injury rates because of the high levels of immigration affecting their Country. The new arrivals won't ride bikes they like to drive cars (badly) and are causing accidents as a consequence.