A tale of two regulators

Earlier this week two banking regulators gave speeches about housing.  Both  began the same way –  one noting that housing is a “hot topic of dinner conversation” and the other that it is “not unusual…for the topic of conversation over a meal – be it a dinner table with friends, or a barbeque in the backyard –  to turn to the subject of real estate”.

The first speech was by Grant Spencer, Deputy Governor (with responsibility for financial stability functions) of the Reserve Bank of New Zealand.  The second was by Wayne Byres, Chairman of the Australia Prudential Regulatory Authority (APRA).  The speeches are really like chalk and cheese –  very different and the differences largely reflect positively on APRA.

I’ve already touched on a few points from Spencer’s speech, mainly around the tension between the encouraging results of last year’s demanding stress tests and the Reserve Bank’s increasingly intrusive and expensive lending restrictions.  In that post, I also passed on an observation someone had made to me that Spencer’s speech had a very strong macroeconomist’s flavour to it, with little sense that he, or the Bank, had much feel for the credit standards being applied by the banks.  At one level, that isn’t surprising: Spencer (and most of his senior colleagues) has a background in macroeconomics.  But Grant Spencer has now been responsible for financial stability and regulatory functions for eight years, and spent the best part of a decade in fairly senior positions in the ANZ.

Byres, by contrast, appears to have been a bank supervisor/regulator for most of his career.  And it shows.   He knows that banks get into trouble when they make bad loans (and banking systems get into trouble when enough banks make enough bad loans).  At one level that is a truism, but it seems to drive Byres, at least on the evidence of this speech, is to focus on the quality of the loans banks are making, and the standards banks (management and Boards) are applying in advancing credit

Byres articulates APRA’s goal as “to preserve the resilience of the banking system”, rather similar to the Reserve Bank’s statutory goal to “promote the maintenance of a sound and efficient financial system”.  And that seems to be his focus: to ensure that banks have enough good quality capital to withstand shocks when they come, and focus on monitoring the quality of banks’ lending behaviour to help (a) ensure those capital buffers are large enough, and (b) reduce the risk of a large number of loans turning very bad.

Rightly, in my view, he does not seem to see it as APRA’s role to stabilise house prices, nationally or in any particular city/region.  Other stuff happens, and it is the responsibility of the banking supervisor/regulator to ensure that the banking system can cope if things go wrong.  Stress tests are one component of that –  and Byres gave a good speech on them late last year.

Here is Byres on what drives the housing market

Any discussion on housing market conditions these days typically starts – and sometimes ends – with housing prices. It’s clear that Australian housing prices are high. On common metrics such as pricesto-incomes or prices-to-rents Australian housing prices are at the higher end of the spectrum, measured either historically or internationally. There are many reasons proffered for why this is: a strongly growing population, geographic and regulatory constraints on supply, the impact of lower inflationary expectations and financial deregulation, and taxation arrangements all feature prominently in explanations of the level of Australian housing prices.

He doesn’t seem to see it as APRA’s role to praise (or damn) aspects of government policy, or to lecture others (based on no underlying research or analysis) on what needs to be done.  He just accepts that there are active debates on many of these issues and, whatever the cause, Australian house prices are high.  That might become an issue for a banking regulator, and to know that one needs to understand the quality of the loan books (individually, and across the system as a whole) and the capital banks have.

Contrast that with Grant Spencer’s speech, written as if the Reserve Bank were a pre-eminent source of wisdom on wider housing market issues, impatient that mere politicians have been slow to get with the Bank’s preferred programme.  Tax changes are “essential”, “much more rapid progress” is needed in improving housing supply, and so on.  And all the time, other areas of policy, which might be inconvenient to the current government (eg the role of new first home buyer subsidies, active immigration programmes) are passed over in silence.  The issue is not whether Spencer is correct in any of his individual observations –  on some I think he is right, and in others probably not –  but that he cites no evidence or research for his views, and that such advocacy on highly controversial political issues, is just not the role of a banking regulator (or a central bank).   “Tax” appears a lot more often in Spencer’s speech than phrases such as “lending standards”, “loan quality”, “origination standards” or the like  (as far I can see, those phrases don’t appear at all).

Byres appears to know better.  He concentrates on banking; on what banks do, and on the regulatory role of APRA.  Doing banking regulation well is not always easy.  No doubt plenty of supervisors in the United States, Ireland and the United Kingdom thought they were doing a fine job in the years running up to 2008.  It turned out not to be so.  Lending standards will, of course, often look rather better before a crisis, or even a recession, than they do in the wake of such events.  But if we are going to have official prudential supervisors –  and for better or worse we do  – we need people with enough knowledge of the industry to ask the hard questions, and sceptically sift and weigh the evidence.  As Byers notes (if only we heard this line more often from our Reserve Bank).

“lower credit quality portfolios may not necessarily be worrisome if the strategy is a conscious one, the additional risk is appropriately priced and managed, and adequate capital is held.  That is really what much of our work has been designed to test”

And much of the rest of his speech is devoting to talking through what evidence there is on these points.  It is what one might expect from a bank supervisor.

He observes that there is no evidence in Australia that investor loans have been riskier than owner-occupier mortgage loans, while noting the need to be cautious about extrapolating that experience into a more stressful scenario.  Our Reserve Bank does not even seem to have gathered the data on the New Zealand experience, including in the last few years in which some regions have had material falls in nominal house prices.

Byers steps through data on third-party originated loans, interest-only loans, high LVR loans (interestingly, he focuses on loans with LVRs greater than 90 per cent, not (say) the above 70 per cent loans the Reserve Bank is about to control in Auckland), and loans approved outside standard loan parameters.  I’m not sure I saw anything specific about pricing.  But I came away from the speech with a sense of better understanding the market, but also with a sense of a supervisory agency that knew, and could talk judiciously, about what was going on.

The impression I took from Grant Spencer’s speech was rather different.  There was very little about indicators of risk arising from the behavioural choices of banks.  We’ve seen no evidence advanced that credit standards have been deteriorating (eg specifically in the Auckland investor property finance market), let alone that any such deterioration was not appropriately matched by pricing, and capital, that covers the risks.     There might be problems looming, but the Reserve Bank just does not set out the evidence, even though it has rushed in with a succession of heavy-handed policy interventions.  There is a sense of an institution flailing around, citing this statistic and that, but without a coherent and well-grounded analysis of the issues and risks to the banking system.

There are limitations to Byres’s brief speech.  He is no more inclined that the Reserve Bank to acknowledge that supervisors and regulators get things wrong.  And perhaps he is light on the sort of big- picture macro-oriented, internationally-informed analysis of systemic risks.  But when the Reserve Bank tries to offer this latter perspective it does not do it well.  As far as I’m aware no country has ever run into a systemic banking crisis when credit has been rising no faster the nominal GDP (and perhaps especially when nominal GDP itself has been growing slowly by historical standards). But you won’t learn that from any Reserve Bank document, even though that is the current New Zealand (and Australian) situation.  You also won’t get any sort of systematic analysis, or even a summary distillation of such analysis, on the similarities and differences between what has been going on in New Zealand in recent years and, on the one hand, what happened in the crisis countries, and on the other hand, what happened in countries that avoided crises.  Grant Spencer and Graeme Wheeler repeatedly invoke Ireland and the United States, but no serious observer thinks developments in New Zealand remotely parallel the specifics of those two (quite different) country experiences.

There has been a tendency in some quarters to lionise APRA –  I’ve been in meetings where it has been lauded as the world’s best bank supervisor.  I’m not in that camp.  Apart from anything else, the minimum risk weights the Reserve Bank has insisted on for housing loans have been more conservative than those required in Australia, and APRA is only now catching up.  And I’m also not convinced by arguments that we should out-source our bank supervision and regulation to APRA – ultimately much about bank supervision is about crisis management, and in crises managing national interests matters a lot.   But for the time being, APRA presents a much more credible and convincing face to the world, conveying a calm and balanced sense that they understand banking and banking risk, than does the regulatory/supervisory side of the Reserve Bank of New Zealand.  New Zealand deserves better than that.

Perhaps it is another dimension for the Reserve Bank Board to assess in its forthcoming Annual Report?

5 thoughts on “A tale of two regulators

  1. Michael, you wrote “But if we are going to have official prudential supervisors – and for better or worse we do – we need people with enough knowledge of the industry to ask the hard questions, and sceptically sift and weigh the evidence.”
    In the light of that, here’s a hard question: What evidence is there that the current debt-money system we have had for three hundred years or so is better for ‘we the people’ (as opposed to the bankers) than a sovereign money system, in which ALL money is created ex nihilo, free of debt and free of interest, by a government agency (it could be the RBNZ) at a rate to just keep CPI inflation to a medium-term average of zero, (or whatever low rate the government deemed to be desirable) and gifted to the government for spending according to its democratic mandate, with a corresponding reduction in government revenue from other sources (hopefully, taxation)?

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  2. Interesting question, and I will try to get to a substantive answer, but it may take some time.

    For now, I would just note that monetary policy and prudential supervision are two quite different functions. In many countries- Australia is one – they aren’t even done in the same institution. There are overlaps, as there are between monetary and fiscal policy, but I think the issues you are posing are mostly about monetary policy and monetary institutions.

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  3. “As far as I’m aware no country has ever run into a systemic banking crisis when credit has been rising no faster the nominal GDP (and perhaps especially when nominal GDP itself has been growing slowly by historical standards)”. Music to my ears Michael. My concern is not so much about the day to day choices but how the structure of our institutional arrangements slowly strengthens or weakens our society.

    In my more cynical moments it seems to me that New Zealand became the Perfect Rentier Economy under the well meaning but misguided management of Bollard and Cullen. It seems to me this is probably due to the slow stagnation brought about by the adoption of MMP, which abolished the ability of a new government to sweep away the excessive stupidity of it’s predecessor. Thus, after a brief period of rapid change New Zealand became ossified and the banking sector was able to cement it’s dominance (they are clever chaps after all).

    In short, the pendulum was prevented from swinging and so institutional arrangements have become hostage to The Household Debt and the staus quo. Thus the role of the RBNZ has become the Office of Administration of Interest Payments at the highest rate the debt serfs can afford, forced to modulate interest rates in the best interests of the debt farm management. In this way the finance “industry” prospers and its percent of GDP is maximised and maintained.

    Is my charicaturisation incorrect or merely overstated?

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    • I’m not fan of MMP, but I’m sceptical that it has made that much difference. After all, we would plenty of very incremental govts in the 50s and 60s with FPP: I think the issue now is more one that no one at the senior levels of either main party actually thinks there is a case for major change. In the late 80s a case could be mounted – an atmosphere of crisis – and even there it was some strong-minded finance ministers rather the crusading leaders who really made a difference, for good or ill.

      I don’t really buy the “serving the finance sector’s interests” line – at least not at a conscious level. After all, LVR controls aren’t exactly welcome to banks – who will have to find other places to lend to meet their ROI targets

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      • Yes, just to clarify, I like to try looking at things from a radically different point of view if I can find one. The idea is to suspend disbelief for a while as usually there is something to see. Conspiracy theories are usually right in that there is a problem, but hopelessly simplistic and misguided in identifying it. When it comes to action I favour slow and steady as you don’t know where the potholes are. Thought experiments are safer.

        So, as regards the Rentier economy, it’s not necessarily a bad thing in an agrarian economy. It seems to me that it is appropriate for manufacturers to be near customers, therefore it seems appropriate for New Zealand to a producer of more basic ingredients from agriculture or mining.

        As regards “serving the finance sector’s interests”, yes, but I was trying to be provocative, not offensive. It is the inadvertent result of the choices we have made. I think the finance sector is essential but it has got far too big and far too important. My tentative suggestion is to gradually eliminate interest as a tax deductible expense over a 15 year time scale and compensate by reducing company taxation. Interest is a capital structure decision not an operating expense, and company taxation is double taxing to some extent. Bill English’s attack on depreciation is a clumsy approximation to reducing the eligibility of interest as a deductable expense.

        Why do I think this? Well, I found manufacturing in NZ much harder than I expected and being a landlord much more rewarding, for reasons that I think are embedded deep in the institutional framework somewhere.

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