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.
croaking cassandra 
But, for example, I see some evidence in wider circulation, that lending standards have deteriorated, e.g.,
http://www.interest.co.nz/opinion/72818/big-banks-have-nearly-25-their-mortgage-books-paying-interest-only-gareth-vaughan-asks
And that debt is rising rapidly, e.g.,
http://www.interest.co.nz/news/77632/stats-nz-reports-nz-current-account-deficit-rose-nz463-mln-june-quarter-annual-deficit
It’s just that RBNZ isn’t talking about that in particular – which I agree with you – seems extremely odd..
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Thanks. The interest-only numbers are interesting. Of course, it would be even more interesting if they’d dug out a time series (incl what the share looked like in 2007). Presumably a lot of interest-only loans are to investors, who actively prefer not to repay principal, since interest is tax-deductible. That might be a different sort of risk than IO loans to owner-occupiers, taking IO because it is the only way they can afford the loan.
But, then, these are the sorts of things the RB should be covering in the FSR.
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When you think about the OBR tool – perhaps it isn’t in the best interests of overall financial stability to provide the kind of information that allows depositors to scrutinise/compare (and hence more appropriately manage their risk). That said, however, if we really did know which bank(s) were ‘safer’ than others – one would assume then that the more ‘exposed’ lending institutions would be forced to raise their interest rates on deposits accordingly. And that’s the market as it should function anyway.
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It is having something like the OBR as intended-policy that makes maximal disclosure highly desirable. If govt policy were bailouts, or even deposit insurance, ordinary depositors shouldn’t care much, and the govt would have to care a great deal (as bearer of residual risk). But policy is to aim to use OBR, so the risk is with us, not them.
Of course, it is hard to take entirely seriously the idea of OBR being used for the failure of a major bank (there is a huge number of voters with each bank), at least while the NZ govt’s own finances are in reasonable shape.
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Good point about lending standards – I wonder why the Bank doesn’t survey them as various other central banks do? I look at the ECB one from time to time…
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They do have one (or did), altho it is probably too aggregated to really shed much light on whether problems are likely to develop (from memory it didn’t distinguish among residential mortgages types).
In fact, it is shown here
http://www.rbnz.govt.nz/financial_stability/macro-prudential_indicators/chartpack-Oct-2015.pdf (page 2)
And, of course, the other issue is that since it was only started in the depths of the recession in 2009, there isn’t a “normal times” reading to benchmark it against.
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On the OBR, when it was initially introduced, I read the explanatory RBNZ paper. I sent a question via email to the RB (perhaps you answered it!) on whether or not deposits in Bonus Bonds were subject to the OBR. The answer came back worded a bit odd .. I sort of interpreted it as a cautious or implied (but not that explicit) ‘yes’. I’m still not convinced :-).
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I certainly didn’t answer it. I’d assumed Bonus Bonds would not be covered, because I had understood the assets were held in a separate unit trust (rather than on the balance sheet of the ANZ). But perhaps I’m wrong,
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Yes, and I read the trust deed (although it’s a couple of years back now – and perhaps they have changed it?) before asking the question. The question is even more relevant now that interest rates on savings have fallen even further – yet OBR risks are (IMO) increasing.
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(I’m not a financial adviser but) I can’t see how Bonus Bonds could be caught in OBR. They aren’t a direct liability of the ANZ, the funds are invested in a separate trust, and in any case any credit losses on trust’s own assets could be managed (within limits) by reducing the rate of return (prize pool). Perhaps if the RB suggested Bonus Bonds would be caught by OBR they meant that any bank securities held by the Bonus Bond Trust could themselves be subject to OBR if the bank that issued those securities failed. That would make sense.
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It is policies like
1. paying out record dividends to shareholders year on year which make the banks vulnerable to shocks as profits are not retained
2. low documentation loans that allow for indiscriminate lending
I am starting to warm to Wheeler when he indicates that it is important that the RB does not have stress tests that encourage banks to seize up the economy if they stop lending altogether. Credit must also be made available in recessions and the banks have a habit of freezing lending altogether which deepens a recession.
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But bank capital ratios (including retained earnings) are high by international and (recent decades) historical standards.
The nature of recessions is that everyone becomes more cautious, borrowers and lenders alike. After all ,there was no material impairment of bank assets during the 08/09 recession in NZ and yet bank lending standards were tightened, and pressure put on some borrowers to reduce their exposures etc. It is going to happen next time there is a recession too, and there is little or nothing that Wheeler can do to stop that – or should do, since these are private businesses. Policies like the LVR restrictions won’t – on the Bank’s own numbers – make very much difference if something very nasty happens, and the sorts of restrictions that might make a big difference would require a level of knowledge/certainty about the future that is not given to anyone (including central banks), and would in any case impinge deeply on what it means to be a free society.
(and, as I often point out to people, the US – which went through a wrenching crisis in 2008/09 – has actually been doing no worse (and on several counts better) than NZ in the years since, even though we didn’t have anything like the same degree of disruption to the financial intermediation process.
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With trillions of dollars in QE you would expect the US to have done a lot better than NZ with a hawkish RB intent on drowning any signs of green shoots trigger happy with interest rate rises.
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you are more optimistic than I am about the impact of QE ( most people in the field probably now wouldn’t claim that much for it), but there are parallels: the US was hamstrung to some extent by the zero lower bound (couldn’t ease further if they wanted to) and the NZ economy was hamstrung by an RB that consistently misread the economy and didn’t cut interest rates even tho they had plenty of room to do so.
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I have no doubts that QE has been particularly effective for the US. It was the US last desperate option in a currency war that has been raging now for at least the last 30 years with the chinese yuan pegged to the USD which allowed the chinese to rise as a new super economy and a new super power with predominantly US corporate investment funds. It was US corporate greed that allowed the effective wealth transfer from West to East and the muted response by the US senate from US job losses influenced by US corporate profits.
The wealth transfer cycle was quite straight forward.
1. Invite US investments into China lured by tax free economic zones with chinese partners
2. Use the US investments to build infrastructure and transfer technology and produce cheap goods
3. Sell these cheap goods manufactured by in china back to the USA and transfer profits to China
4. Use the profits to buy US treasury bonds in order to maintain the peg effectively lending the US cheap funds to buy more chinese products
5. Rinse and repeat cycle until you create a chinese super power.
If the US did not get into massive QE, the chinese Yuan would still be pegged to the USD and the chinese would still be aiming for 9% growth manufacturing and selling chinese products into the US. With QE, it is far too expensive for the chinese to maintain the peg allowing US products and US manufacturing and US jobs to improve. Without QE the US would be have been erased as a super power.
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Policies like the LVR restrictions do put pressure on banks to reprice cash deposits and debt instruments downwards in order to maintain their lending profit margins.
The NZRB whether knowingly or unwittingly has an upward interest rate bias that works in favour of the banks. It is this upward bias that allows banks to price in higher margins in a falling interest rate environment.
It is when interest rates rise that banks have a pricing margin problem. LVR restrictions are useful because it prevents the indiscriminate lending practices that inevitably arises as interest rates rises.
If the RB continues the practice of LVR restrictions when it does move the OCR upwards we would likely see banks dropping deposit interest rates to maintain margins.
The RB needs to understand that moving the OCR upwards carries more risk to bank stability and the economy than moving the OCR downwards therefore an upward movement should be much much slower to allow adjustments by the economy and by the banks. The Allan Bollard fiasco brought on with rapid interest rate rises and also followed by Wheeler nutcase 4 rapid interest rate rises recently crashed the greenshoots of our recent growing economy. Upwards should be slow and downwards should be faster. We have the reverse bias instead, fast upwards and slow downwards.
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Banks might be private businesses but obviously they are a cornerstone of financial stability which has implications beyond shareholders. Think the RBNZ – along with other ‘credible’ central banks across the world – are undertaking these macro prudential policies in the hope that when the next recession hits, the catalyst isn’t ‘the system’ itself. That doesn’t seem a bad approach to take even if the polices are somewhat experimental. To pinch a quote from The Bank of England Open Forum overnight: “credit is a public good like water [and] like water, you can drown in it”
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There are many aspects of that we could debate, but my proposition is that governments have more often been the problem (and certainly were in Ireland and the US) than “markets” or the “financial system”, and that the reversion to a dense thicket of controls is a (not doubt well-intentioned) power-grab by regulators who have not sufficiently made the case that they have the knowledge to be able to deploy them in society’s best interests.
Central banks would probably be better off putting their energies into dealing with the near-zero nominal interest rate constraint, the presence of which was the probably the biggest single demand-side factor holding back a faster rebound in the years since 2008.
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Agree, there were many actors that contributed to the financial crisis (politicians certainly played their part) and, to be honest, I’m still trying to educate myself about how and why the market mechanism for bank credit fails from time to time (and why it fails so spectacularly!)
But it does seem new regulations / incentives are required to ensure the allocation of credit is more equitable (or diversified?), that the supply of credit is less pro cyclical and, more broadly, financing is better balanced between debt and equity across all sectors of the economy??
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