The Reserve Bank’s Financial Stability Report was released earlier this morning. The headline, of course, was the easing in the loan to value restrictions on mortgage lending, although perhaps what should get more attention was the Governor’s suggestion that the avowedly “temporary” restrictions” will be in place for at least “the next few years”. There was no good case for them – putting a bureaucrat between willing borrowers and willing lenders – in the first place, and there is no good case for having them in place now. Other than, of course, the interest that isn’t the public interest at all – more discretionary power for an unelected unaccountable public official.
(Given the Bank’s repeated unease about dairy debt, it has also never been clear to me why LVR limits were appropriate for people buying houses but not for people buying farms. I used to raise the point while I was still at the Bank, and have never heard a satisfactory or persuasive response.)
Two other small things in the press release warrant just brief mention for now:
The first was this
Our preliminary view is that higher capital requirements are necessary, so that the banking system can be sufficiently resilient whilst remaining efficient. We will release a final consultation paper on bank capital requirements in December.
Time will tell how persuasive their case is, but given the robustness of the banking system in the face of previous demanding stress tests, the marginal benefits (in terms of crisis probability reduction) for an additional dollar of required capital must now be pretty small.
And the second was this
Aside from CBL, the insurance sector as a whole is meeting its minimum capital requirements. However, capital strength has declined and a number of insurers are operating with small buffers. The insurance industry must ensure it has sufficient capital to maintain solvency in all business conditions.
That is quite a shot across the bows of the sector, but it is worth remembering that when the solvency standards were set up the Reserve Bank consciously chose not to require insurers to hold sufficient capital to remain solvent in all circumstances. I vividly recall the day I asked, at the internal Financial System Oversight Committee, whether the solvency standards were demanding enough that they would have prevented the AMI collapse, and was told no.
But two other things caught my eye in the full document.
The first was that the Bank no longer seems to be claiming that LVR controls – coming between borrowers and lenders for five years now – have done anything to improve the soundness of the financial system (while they have inevitably impaired the efficiency of the system). Those are the statutory goals the Bank is required to use its powers towards, and yet in the document today we find this (in the cartoon summary at the front):
The restrictions have reduced the number of borrowers who would be forced to sell their houses or significantly reduce spending if they ran into financial problems.
But, even if true, that is not the same – at all – as improving the soundness of the financial system. It is about “nanny knows best” customer protection, which is no part of the Bank’s mandate. You can’t be forced to sell your house if the Bank’s action prevented you from getting into one in the first place.
And here is the claim from the body of the document
The Reserve Bank’s LVR restrictions have leaned against the build-up in risks from high household debt by increasing the amount of equity borrowers have in their homes. The restrictions have seen the proportion of outstanding mortgage debt to households with loans larger than 80 percent of the value of their houses fall from over 20 percent in 2013 to under 7 percent. This extra equity provides households with more room to avoid cutting consumption or defaulting on their loans if economic conditions deteriorate or if interest rates rise.
Nannying again, not (apparently) focused on the soundness of the financial system. As a reminder, the two diverge because (a) even if LVR controls modestly reduced housing lending risks, we never get a good sense of what other risks banks have taken on to maintain profits, and (b) because less risky lending means banks need to hold less capital. Capital relative to (properly assessed) risk-weighted assets is the key issue when it comes to solvency.
From the text there is no way of telling whether the Bank’s focus has really changed or just the marketing. But marketing – from a powerful public agency – should be aligned with, and disciplined by, mandate.
And then there is climate change. In the Governor’s press release there was this
In the medium-term, an industry response to a variety of climate change-related challenges appears likely, requiring investment.
Which is pretty cryptic, perhaps even empty.
But in the full document there is a two page spread on “The impact of climate change on New Zealand’s financial system”. There is lots of text, and very little substance. It smacks of the Governor bidding for relevance – signalling to his buddies on the (political and business) left – and involvement in the wider whole of government programme, and perhaps worse, it looks like a bid for more budgetary resources (a case we know the Bank has been making) or amended legislation to do things like
The Reserve Bank is developing its own climate change strategy. The strategy focuses on ensuring that climate risks are appropriately incorporated within the Reserve Bank’s mandate. The Reserve Bank also stands ready to collaborate with industry and government to help position New Zealand for the challenges ahead.
This for a body with two city offices, and a balance sheet full mostly of exposures to New Zealand government debt and overseas government debt.
The text burbles on about possible risks, but it all adds up to very little. There are numerous risks banks and borrowers face every decade, every century. Relative prices change, trade protection changes, external markets change, exchange rates change, technology changes, economies cycle, land use law changes. Oh, and the climate changes.
If one looks at the structure of New Zealand bank (or insurer balance sheets) it just isn’t credible that climate change poses a significant risk to the soundness of the New Zealand financial system (that pesky law again). Some individuals are likely to face losses from actual and prospective sea-level rises, but banks (and insurers) typically have diversified national portfolios. People can’t have mortgage debt without insurance, and so the insurers are likely to be constraining people first. Much the same surely goes for the rural sector? Sure, adding agriculture into the ETS at the sort of carbon price some zealots have called for would be pretty detrimental to the economics of a dairy debt portfolio, but then freeing up the urban land market probably wouldn’t be great for residential mortgage portfolios, and we don’t see double-page spreads from the Reserve Bank on that issue, or the Governor trying to play himself into some more central role in that area. It smacks of politics – signalling the Governor’s green credentials – more than anything legitimately tied to financial system soundness.
But then we probably should not be surprised. The Governor sells himself as head of a tree god (fortunately there was none of that stuff in today’s document), and gives speeches on climate change, but eight months into his term still hasn’t managed to give a speech on either of his main areas of statutory responsibility (monetary policy or financial supervision/regulation/stability).