This Wednesday brings the release of the latest Reserve Bank Financial Stability Report. With pre-release lock-ups having (appropriately) been discontinued, the Governor’s press conference will, for the first time, occur an hour or two after the release. That will mean that journalists will have had a chance to talk to analysts and industry representatives before questioning the Governor. In principle, that should make for some more searching questioning and scrutiny.
Presumably the document will focus on the two main areas of credit exposure in the New Zealand financial system: dairy, and housing.
It isn’t that long since the Bank released the write-up of the dairy stress test it did with the major rural lending banks last year. I thought that write-up was a bit too optimistic – in particular, it was based on a stress test assuming a fall in dairy farm prices much less than the fall in Auckland house prices that they had assumed in their earlier housing shock stress test – but I don’t see any reason to change my view that the dairy book does not represent a systemic threat to the soundness of the New Zealand banking system. It would be good to see a discussion this time based on some less positive scenarios, (and hopefully without the Governor taking on the mantle of a politician in trying to offer guidance to – or exert moral suasion on – banks as to how they should deal with farmer clients).
But most interest is likely to centre on the Bank’s discussion of the housing market, any resulting risks it sees to the health of the financial system, and whether the Bank is planning to devise yet more direct regulatory controls on banks’ housing lending activities.
On the policy front, the best thing they could do would be to simply abolish the various LVR restrictions puts in place over the last three years. Those restrictions were ad hoc, ill-grounded, intrusive, and unnecessary. If the Reserve Bank has concerns about the ability of the banks to withstand severe adverse shocks – and if they do, those concerns have not been laid out in public backed by robust analysis – it is free to propose, and consult on, requirements for banks to fund a larger share of their assets from capital rather than deposits. Capital requirements are less costly, less intrusive, and require considerably less knowledge by offficials.
Of course, the Reserve Bank won’t be lifting the restrictions, and the real interest seems to be whether the tentacles of this one-man branch of the administrative state will extend even further into the business operations of private companies (and their customers). Will LVR limits be further refined, and extended? And will the Bank decide to try (consulting on) limits on the debt to income ratios of borrowers?
Consistent clear communication has not been the Governor’s strong point, so in a sense it is anyone’s guess. The Reserve Bank does have a non-binding Memorandum of Understanding with the Minister of Finance on (so-called) macro-prudential policy. In that document, the Bank undertakes that
The Bank will consult with the Minister and the Treasury from the point where macro-prudential intervention is under active consideration, and will inform the Minister and the Treasury prior to making any decision on deployment of a macro-prudential policy instrument.
We have heard noises from the Prime Minister about possible land taxes, but nothing about new banking regulatory controls. And, although the document is non-binding, limits on debt to income ratios are not, at present, included in the MOU’s list of possible instruments “considered useful in the New Zealand context”. That said, debt to income limits were preferred by The Treasury to the Auckland investor LVR restrictions imposed last year.
If the Reserve Bank is going to propose yet more new controls, one can only hope that the rationale, and supporting analysis, will be done to much higher and more demanding standard than what was offered in 2013 when LVR limits were first imposed, or last year when the investor restrictions were introduced, and the regional differentiation of LVR limits was imposed. One of the things I pointed out then was how little research the Reserve Bank seemed to be doing, or publishing, in support of its new enthusiasm for direct controls on the banking system. That doesn’t seem to have changed.
There has not, for example, been a single Discussion Paper, Analytical Note, or Bulletin in the last 18 months on the efficiency of the financial system and the way regulatory imposts affect efficiency, or any cross-country research evidence on what marks out financial systems that have had domestic financial crises from those which have not. No more has been heard recently of the loose comparisons they attempted to draw last year between New Zealand and the experience in Ireland and the United States, but instead of replacing those comparisons with more in-depth research and analysis there has just been silence. Given (a) the scale and nature of the Bank’s regulatory interventions and inclinations, (b) the potential size of the risks, and (c) the significant research resources they have been funded for, that silence doesn’t seem very satisfactory.
It would, for example, still be good to know whether the Bank has been able to identify any examples of countries with banking systems which have come under severe stress from housing lending when
(a) there is little of no direct government intervention in housing finance,
(b) when debt to income ratios have been little changed from those over the previous decade, and
(c) in a floating exchange rate country.
As the Bank has noted previously, vanilla housing loans have rarely, if ever, been at the heart of a systemic financial crisis. For all the worries about Ireland, for example, the problems there were mostly those of speculative building (commercial property in particular, but also residential), and a monetary system that meant interest rates were set for German and French conditions, not those in Ireland itself.
The Reserve Bank Act sets out the bare minimum of what Financial Stability Reports must contain
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
Typically FSRs have not done the basics well. The Reserve Bank might prefer that “efficiency” did not feature so much in the various bits of legislation it is responsible for, but Parliament has chosen otherwise. And yet the reporting on the efficiency implications of regulatory policy has typically been quite weak – and there has been no research the Bank has done to draw on or refer to. In one sense, it may not have mattered much when the Bank’s policy approach was fairly non-intrusive. But the current Governor clearly believes he is better able to determine the structure of banks’ loan portfolios than they are. However, he has offered no analysis of the efficiency implications of his choices, or even a discussion of how best to think about the issue.
It is now almost three years since the first LVR limits were announced. Surely we should also be expecting to see some good empirical analysis of what impact those restrictions have had? And not just on the things the Governor cares about – house prices and financial stability – but the side-effects and distributional implications that got so little attention in the regulatory impact assessment the Bank prepared when it imposed the policy. The investor finance restrictions are newer, so it will be hard to provide much concrete analysis of the impact just yet, but the Act requires them to make the effort. Of course, it isn’t enough simply to say ‘house prices are materially higher than they were when the regulatory restrictions were imposed’ but citizens might reasonably ask what useful impact these intrusive new controls – imposed on the whim of one unelected individual – have had? And how, for example, does the Bank think banks themselves have responded? Since the banks are profit-maximizing entities, and the Reserve Bank has constrained one line of business, where have banks sought profits instead? And can we be confident that even if the level of risk in the directly-constrained books has been reduced slightly, that the restrictions have made any difference to the overall riskiness of the banks, and the system?
There may well be good answers to these questions, but so far there has been little sign of the Reserve Bank providing the analysis that would enable us to be comfortable. And recall that providing the material necessary to allow readers to assess the Bank’s regulatory activities is not an optional extra, but a statutory requirement.
Of course, to make the point is also to recognize how weak the system actually is for promoting effective accountability:
- The Governor personally decides on all the regulatory measures, and is also personally responsible for the contents of the FSR. It isn’t plausible to expect that FSRs will ever contain anything suggesting doubts about choices a Governor has made, and it is unlikely that they will ever contain a balanced and comprehensive set of material allowing readers to draw their own conclusions. The Act describes the FSR as an accountability document. In fact, it is better seen as a marketing document.
- The Bank’s Board has some responsibility for scrutinizing the Governor, including around FSRs. But the Board has limited resources, is too close to management, and has a track record of seeing its role as being to provide cover for the Governor, and to assist the Bank in its outreach activities (see last year’s Annual Report). The Minister’s recent letter of expectations, which explicitly asked the Board about the balance between soundness and efficiency may help a little, but it is going to be difficult for the Board to ever adopt anything other than a pro-management perspective.
- Parliament’s Finance and Expenditure Committee has limited resources for scrutiny.
There is never going to be perfect scrutiny or accountability, and being a small country brings inevitable resource constraints. But there are some possible institutional improvements. For example, a separation of the role of chief executive of the institution from that of policy decision-making would be a step in the right direction. And I’ve argued previously that there is a case for something like a Macroeconomic Policy Council, a small body that would have responsibility for undertaking or commissioning independent reports on aspects of the conduct of fiscal analysis and policy, monetary analysis and policy, and financial regulatory policy. Operating at arms-length from the Reserve Bank and Treasury, such a body would contribute to a better quality debate on policy issues in these areas, and help provide the assurance to citizens, and MPs, that the quality of policy, and of supporting policy analysis and advice, was running consistent up to the sort of standard we should expect. Our current system puts too much legislative weight on self-assessments (in the case of the Bank, both for MPSs and FSRs). They typically don’t happen to any great extent at present, and it is probably unrealistic to think that institutional incentives will ever allow them to happen in a way that offers much genuine insight on policy choices and analysis, and certainly not when the results might be awkward for the institution and individuals publishing the self-assessment. If we are serious about scrutinizing powerful unelected individuals wielding huge discretionary powers, which we should be, that really needs to change.
By the way, it is worth remembering when the FSR comes out that the Reserve Bank has no statutory responsibility for the housing market. It has just two main roles:
- maintaining a stable general level of prices, and
- using its various regulatory powers to promote the soundness and efficiency of the financial system.
Dysfunctional housing markets are a matter for elected national and local government politicians.