Some FSR omissions

Sometimes you read a document, particularly one that has interesting material in it, and react (positively and negatively) to what is in front of you.  It is harder to spot what isn’t there.

After my earlier post I went out, and as I walked the streets it struck me that I didn’t think I had seen any mention of credit standards in the Financial Stability Review.  I got home and checked.  Searching the whole document, none of these terms appeared:

“credit standards”

“lending standards”

“credit policies”

“lending polices”

In fairness, there was a brief mention of the difference between how much banks would lend thirty years ago ( in the 1980s when banks were really only just moving into housing lending) and now, but I don’t think that really fills the bill.

At one level that wasn’t too surprising –  I’ve highlighted previously how their Head of Financial Stability (and Deputy Governor) had managed to give a whole speech on housing and housing finance risks without mentioning bank lending standards.  But it was pretty disappointing nonetheless.  Bad loans collapse banks and financial systems.  Sometimes macroeconomic circumstances turn out quite differently than anyone could have expected and even what were objectively pretty good classes of loans can get into trouble.  But, mostly, the really bad losses arise from a climate in which lending standards have been pushed progressively lower and laxer.   Very aggressive lending on Irish property development springs to mind, and the policy-driven deterioration in US mortgage standards.

But if it is the sort of omission we have come to expect from the Reserve Bank, that doesn’t make it any more acceptable.  Surely we should expect our bank supervisors to have a good feel for trends in bank lending standards, and to be able to adduce evidence to support their view?  APRA manages to, so why not our Reserve Bank.  So far, they have given us no evidence of, say, a sustained deterioration, beyond the point of prudence, in the lending standards of our banks over, say, the last decade, or even just the last couple of years (the latter being the period in which they have adopted much more aggressive regulatory interventions).

Incidentally, I also checked and found that the phrases “credit to GDP” and “credit to GDP gap” did not appear –  even though I’m not aware of any systemic financial crisis which has not been preceded by a recent substantial increase in credit to GDP (increases 10 t0 15 years ago don’t count).  It was also a little surprising that the terms “exchange rate”, “real exchange rate” or “TWI” don’t seem to appear either, even though the thing that usually goes hand in hand with a sharp run-up in credit to GDP, in foreshadowing heightened risk of crisis, is a material appreciation in the real exchange rate.    In the period 2002 to 2007 we had both –  and the banks had much smaller (liquidity and capital) buffers –  and yet the banks still came through unscathed.

If the Bank can’t point to detailed prudential evidence (deteriorating lending standards) or adverse trends in the big macro indicators (rapidly rising debt etc), it is really difficult to be confident that their recent regulatory actions are necessary, and well-warranted bearing in the mind the costs to individuals and businesses, in promoting the soundness and the efficiency of New Zealand’s financial system.

The RB Financial Stability Report

This won’t be a long post.  Today’s Financial Stability Report was pretty uneventful relative to May’s .

The body of the report had some interesting material, both on dairy exposures and housing lending.

But I had a number of concerns.

My most important was that the Financial Stability Report was, again, in breach of the Act. The Reserve Bank can write as much interesting analysis as it likes, and good analysis is always welcome, but they must comply with the Act.  Section 165A says as follows:

A financial stability report must—

  • (a) report on the soundness and efficiency of the financial system and other matters associated with the Bank’s statutory prudential purposes; and
  • (b) contain the information necessary to allow an assessment to be made of the activities undertaken by the Bank to achieve its statutory prudential purposes under this Act and any other enactment.

Much the same words are in section 162AA as well.  And this document simply does not comply.  It hardly comments on the efficiency of the financial system at all, at a time when the Bank is imposing ever more-extensive and complex controls on the activities of banks.

These are the four references to “efficiency”:

  • The first, on page 52, is simply one item in a list in an Abstract, summarising the chapter
  • The second , page 54, is purely descriptive, and deals only with payment systems (“the Reserve Bank has an objective of efficiency”)
  • The third, on page 56, refers to a goal as part of the “regulatory stocktake”, to improve the efficiency of regulation of banks
  • And the fourth, on page 58, is also purely descriptive (“ The Reserve Bank acknowledges that appropriately robust outsourcing arrangements can improve a bank’s efficiency”)

Not one of these refers to the efficiency of the financial system, and none offers any analytical perspectives.  But the Act is quite clear.  I hope some MP chooses to ask the Bank about it when they appear at FEC, and that the Bank’s Board –  legally charged with holding the Governor to account –  poses the question, and perhaps chooses to highlight the omission when they next write an Annual Report.  As it is, the accountability model is not working.  The Governor is imposing more and more controls, taking us further from an environment of regulatory competitive neutrality (across institutions, across types of loans, across places of loans and so), and he simply does not provide the material that would enable us to assess the Bank’s activities against the statutory responsibility to promote the soundness and the efficiency of the financial system.

Somewhat related to this point around efficiency, the Bank continues to assert that its LVR controls are reducing risk in the financial system.  But I don’t think I’ve seen analysis from them, either when the first controls were introduced, or with the latest extension,  looking at how banks will choose to maximise profits for their shareholders if they are prevented from undertaking some classes of lending.  There may be perfectly satisfactory and reassuring answer, but if banks are not able to undertake their preferred types of lending (which must be the case, or controls would not be binding) surely we should expect them to seek out other opportunities, which might –  or might not –  be just as risky as those the Reserve Bank is restricting?  The concerning dimension is not just the absence of the analysis, but the fear that the silence might suggest the Governor has not even thought about the issue.

What else struck me?

The Bank’s continued obsession with “investors”.  When pushed, the Governor will say that the Auckland housing situation is mainly a supply issue, but if supply remains severely restricted by regulation, and demand increases (eg with an acceleration in population growth) quite what would he expect, but some increase in people purchasing in expectation that tomorrow’s price will be higher than today’s?   And in a city where the combination of policy failures has pushed the home ownership rate down so far, what is surprising or troubling (from a financial stability perspective) about around 40 per cent of mortgage loans being for rental property purchasers?    They haven’t addressed these issues, which again makes it hard to assess their activities.

I was also struck by the mire the Bank has made for itself.  The Reserve Bank is  primarily a macroeconomic policy agency, and even in its financial stability role it has a systemic statutory focus.  And yet we have the Governor and Deputy Governor being quizzed about housing developments in Hamilton and Tauranga (4 and 3 per cent of the country respectively) and the Governor responding in some detail about the nature of the demand in those two markets (although with no apparent sense of any model of equilibrium prices).  Fortunately, they did say it was “too early” to be considering Hamilton or Tauranga specific measures.  I hope it always is.  The Bank, and those holding it to account, should be prompted to reassess and pullback from trying to run system-wide financial stability policy TLA by TLA.    More and more they turn themselves into people doing inherently political stuff, with no political mandate, and soon no doubt (if it hasn’t happened already) they will be being lobbied by councils and other entities in Hamilton, Tauranga and who knows where.

It was good to see journalists asking about the Bank’s stress tests.  The Governor and Deputy Governor now openly acknowledge that the banks, and the financial system, would be just fine if the system faced a shock of the size (very severe) the stress tests were done on.  That really should be largely the end of the matter for them.    Instead, they go on about how in a downturn banks might rein in their lending.  Indeed, and it is surely up to them –  the owners of private businesses –  to make choices about whether, and to what, extent it is economic to lend, and (hence) whether to raise new external capital.  We have monetary policy to deal with any associated economic downturns that lead to inflation undershooting the target.

Perhaps it is just me, but I continue to be struck by how little thoughtful cross-country or historical comparative analysis is provided in the FSRs (or in other associated documents, such as the Bulletin).  No two situations are ever fully alike, across time or across countries, but those comparisons are often the most helpful benchmarks we have.  And if the Reserve Bank can illustrate for us which comparators it regards as useful, and which not, and lay out the reasons for those judgements, it can help enable us to better assess how the Bank is handling its responsibilities in this area.  One difficulty for people doing the assessment is that almost all the factual and analytical material in this document could have allowed the Bank to have reached quite different conclusions  (eg high capital standards, strong liquidity buffers, moderate credit growth, all suggest that despite the rapid growth in Auckland house prices, the financial system is robust and efficient, and no further regulatory measures have been needed over the last couple of years).  We know what the Governor thinks, but how are we to know –  or at least have greater confidence –  whether he is right, or whether the alternative story would have been better?    The Bank needs to be doing, and publishing, more research in this area.

Oh, and finally, in the press conference it was hard not to conclude that the Deputy Governor looked rather more gubernatorial  and on top of his material than the Governor did. And it no doubt helped that Grant actually looked at the camera and the questioners.