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.

16 thoughts on “The RB Financial Stability Report

  1. I assume the target audience for this is the general public. Those likely to be perhaps the most interested in the report being the depositors whose unsecured deposits are at risk in respect of an OBR event. We can look to the rating agencies for an overall comparison, but the regulator’s additional comment would be really useful. Do you know whether the Bank constrained from reporting on institutions on an individual basis? For example, breaking down Figure 5.12 further by sector by bank would be useful. Same goes for Figure 2.7 by bank.

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    • I think the target is probably people like MPs and financial analysts/financial media. they assume the public will get the material “translated”. There are some legal restrictions on what individual bank data can be disclosed, and the Bank is reluctant to highlight indiv banks (since the focus here is supposed to be the system). But your point is part of the reason why I’ve argued that data supplied to the RB by banks should all immediately become public – the risks are faced by us as depositors, not by the RB officials.

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  2. Michael, would you mind explaining how the “efficiency of the financial system” is defined?

    As an engineer, I struggle to comprehend how it could possibly be ‘efficient’ from New Zealand’s point of view to have our biggest four banks Australian-owned, making combined annual profits of $4.5billion, almost all of which gets sent to Australia.

    Besides, would not a Sovereign Money banking and financial system, in which banks are mere financial intermediaries and never money creators as they are now, be a sounder and more efficient system, given that booms and busts would to all intents and purposes be eliminated and steady economic growth ensue?

    Does the RBNZ have a research program underway to evaluate Sovereign Money? If not, how about you ask your former colleagues, why not?

    Those interested in the topic of Sovereign Money may wish to read this very recent paper on the actions of Canada’s Central Bank in the years 1935-1975, when it routinely created money ex nihilo for both central and local government: http://www.levyinstitute.org/publications/is-monetary-financing-inflationary-a-case-study-of-the-canadian-economy-1935-75

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    • The short answer is that it is not defined (at least in the legislation). At the time it was put in the Act, 1989, the drafters clearly had in mind the desire to avoid as many direct controls as possible, and ensure a level playing field between competing lending institutions. In some ways, it is an odd provision – there isn’t anything similar in most other countries – but Parliament has kept on reaffirming it in additions and amendments to the legislation over the years.

      If NZers saved more then more of our companies (perhaps including banks) would be NZ owned and less profit would accrue to foreign shareholders. But the savings rate is largely a private choice, and I’d have thought should be respected as such. remember that the Aus banks have a great deal of capital invested in NZ, to earn those profits on.

      I’m sure the RB does not have a research programme on sovereign money.

      I will look forward to reading the paper. Of course, in NZ the RBNZ used to create money for producer boards (esp the Dairy Board) – details are in the old RB books.

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      • Superannuation contributions in Australia is compulsory with companies paying in upwards from 9%. As of 30 June 2015, Australians have over AUD$$2.02 trillion in superannuation assets.

        Higher interest rates do not lead to more savings in productive assets. Higher interest rates result in higher bank savings which in turn leads to higher lending for the bank to retain their margins.

        Our lack of savings is in the lack of our superannuation contributions and that is the reason why we do not own our own banks.

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      • As I think I’ve pointed out before, the gap between Australia’s national savings rate and NZ’s is, if anything, smaller now than it was when Aus first introduced compulsory private savings. there is reason to doubt that policy has done much more than change the form in which savings are held, and enrich lawyers, accountants, funds managers, trustees etc

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      • If I use myself as an example. When Kiwisaver company contribution went to 3% it was only then that I decided that I would take up the kiwisaver option otherwise I would have been better off paying off debt. Paying off debt does not equate to more savings. Within 2 years my kiwisaver fund is now in excess of $20,000 after fees. Now that $20,000 contributed by me and my employer can be invested by the superannuation fund manager into more productive assets which would not have been available if I was paying off debt. Therefore the logical conclusion that if we had more contributions in kiwisaver we would have owned our banks.

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      • The maths is relatively easy. 33% of NZ households are debt free, this means that 67% of NZ households have debt. Kiwis all know that it is better to pay debt off rather than to have cash in the bank because bank deposit interest rates are less than bank debt also interest on cash in the bank is compounded annually whereas bank interest on debt is compounded monthly.

        There are roughly around 1 million NZ households. Therefore there are 670k people paying debt off and not contributing to savings. There are about 1 million working people which means if they were on compulsory kiwisaver you would have 1 million people contributing towards savings plus their respective employers which potentially equates to an equivalent of 2.6 million contributing people(employer contribution is higher than employee contribution by 1%). Without kiwisaver you would have lost 670k people out of the equation. With kiwisaver, you have brought in the equivalent of 2.6 million people.

        Therefore simple maths would suggest a higher national savings from compulsory kiwisaver.

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      • But it isn’t a maths issue; it is a behavioural one (and a statistical one). Paying off debt does contribute to savings (all else equal), altho perhaps not in the forms/assets that you might prefer. But the deeper question is who do people respond to Kiwisaver. I’d be surprised if over the years I was working and Kiwisaver was in place I saved a single dollar more than I would have if, instead, the RB had just given me a pay rise of the same amount as the employer contribution to Kiwisaver (altho it is in a different assets – and a less attractive one, that I can’t use til I’m 65). Treasury research, by people like David Law, suggests that my experience is not uncommon.

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  3. Agree, difficult to know how to fully digest the new prudential measures and whether they will have ‘unintended consequences’ but given history is repeat with examples of concurrent bank credit growth and real estate price inflation being followed by some form of ‘crisis’, dampening the growth of bank credit dedicated to the housing market doesn’t seem a bad idea. I guess there is an upper limit to the amount of debt an economy, or sector within an economy, can sustain but what that ‘upper limit’ is remains difficult to pin down so a judgement is required. For now, I’ll give the RBNZ the benefit of the doubt!

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  4. Fair enough, except that

    (a) credit to income ratios aren’t surging upwards, or even reaching new highs (one of the key crisis indicators historically, and
    (b) I guess the provisions of the Act are there for the more sceptical!

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  5. Not sure why Wheeler would be concerned with investors representing 40% of borrowings. If you restrict a large buying group(first home buyers) to a LVR restriction, you would expect automatically the remaining buying groups would show dramatic increases as a percentage.

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