The Reserve Bank stands by its stress tests

Last Saturday I highlighted the Reserve Bank’s response, via Herald columnist Mary Holm, to a reader’s concern about the possible impact of a 50% fall in house prices.  A Bank spokeswoman, speaking prior to the release of the Financial Stability Report and of the Bank’s proposed restriction on banks lending to investor property borrowers in Auckland, had expressed confidence in the ability of the financial system to withstand such a shock.

While I was happy to highlight those comments, I had wondered (and had mentioned the possibility to a couple of people) if it was just a case of the left hand not knowing what the right hand was doing –  perhaps the Governor had not been aware of what someone in his PR department had been saying.   That doubt was reinforced after I was told that at the Finance and Expenditure Committee hearing on the FSR the Governor had refused to engage on, or respond directly to, a question about the stress tests.

However, in today’s Mary Holm column another Reserve Bank spokesman was commenting. He is quoted as saying:

“We repeat our comments from last week that the Reserve Bank was generally satisfied with how banks managed their way through the impacts of two adverse economic scenarios in the 2014 bank stress tests, which included a scenario similar to what your reader describes.

“We are comfortable that the New Zealand financial system is capable of withstanding a major adverse event, such as a collapse by up to 50 per cent of the Auckland housing market.”

That is good to know.  It is not just a statement about last year, when the stress tests were done, but about the risks banks have on their books now.

But it just reinforces the question as to what possible basis, under its Act, the Reserve Bank can have for proposing to ban banks from lending a singe cent to anyone, secured on an Auckland investment property, above 70 per cent of the value of that property.    The Bank is required to use its regulatory powers to promote the soundness and efficiency of the financial system.  Efficiency will inevitably be impaired by the proposed restriction, and the Reserve Bank has just told us today that the system can cope with a fall in house prices as large as has been seen anywhere.

The Reserve Bank told us its consultation document would be published later this month.  That now leaves only the coming week.  We should look forward, with considerable interest and some scepticism, to the case they will make.

3 thoughts on “The Reserve Bank stands by its stress tests

  1. Michael – is it necessarily true that the failure ( or lack thereof) of a bank stress test is the benchmark for assessing the worth and more specifically the legality ( in terms of consistency with the RBNZs act) of regulatory action? The relevant section of the Act says if I remember correctly that the Bank must use these powers for the purpose of enduring the soundness and efficiency of the financial system. While the stress test results are one potential indicator they are not a necessary condition to justify regulatory action. Indeed I suspect that very little prudential regulation might be justified if this were the case. Stress tests are indicators of what might happen given a number of important assumptions any of which may not be true in real life. Also stress tests almost always are calibrated to ensure banks pass them ( or else additional capital should be added by failed institutions). History shows that stress tests have a poor record at predicting financial crisis. I think many reasonable people would consider a large fall in Auckland house prices might challenge the stability of the financial system in NZ. It’s true that in some circumstances it might not but would you expect the Bank to bank on being that lucky? The spillovers to the rest of the country would potentially be great.

    The Banks actions in this area are in step with the generally successful international experience with regional LVR type measures. I think that this alone makes it difficult to argue the Bank is acting in an ultravires manner. The IMFs advice in this area is that macro prudential measures can be employed assuming key macro policy settings are also supportive. Your stance on monetary policy settings thus seem further supportive of the Bank’s stance. Although I am sure that the government could be doing more to help as you point out.

    Regards
    Kelly

    Like

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