The Reserve Bank’s Financial Stability Review is out tomorrow.  The last such document came out in late November, when we got a lot on the non-issue (from a New Zealand banking system systemic risk perspective) of climate change and almost nothing on bank capital.   There was a double-page spread on the former –  which the Governor has next to no responsibility for –  and on the latter only this

A consultation paper on the minimum capital ratios is due to be released in December. Our preliminary view is that higher capital requirements are necessary, so that the banking system can be sufficiently resilient whilst remaining efficient. The Reserve Bank’s aim is to announce final decisions on all key components of the capital framework in the second quarter of 2019.

The actual announcement of a huge proposed increase in minimum capital ratios was a mere two weeks away –  decisions must already have been made –  and there was not even a hint of the magnitude of what the Governor was about to hit the economy with.  And do note that strong sense of pre-determination: they thought they could announce proposals on the eve of Christmas and have everything finalised by June.  Their latest plan, announced last week, is for a final decision in November.   Even then, there is a strong hint of pre-determination, with comments as recent as the last day or two stating that “we will lift capital levels”, even if they now seem to want to sound more open about the extent.

I don’t suppose the Governor will be saying much tomorrow about the substance of the bank capital proposals.  Submissions have now closed, and it would be unwise for him to weigh in further now, at least if he hopes to be able to defend himself against charges that the consultation wasn’t for real.     But I hope there are serious questions –  both at the Governor’s press conference, and from the Finance and Expenditure Committee –  about the process.    It has been poor from the beginning, built on a weak and inappropriate governance framework, and if the latest announcement is a little more encouraging there are still significant unanswered questions.

Under the terms of the Reserve Bank Act, the Governor can unilaterally vary conditions of registration for banks.  That includes their minimum capital requirements.  This isn’t a conventional regulatory model: no ministers are involved, no decisionmaking board is involved, Parliament’s regulations review committee can’t disallow such rules.   And, of course, the Governor is not elected, is not even appointed by people who are elected, and neither he nor those who appoint him face any serious or effective accountability.  The only thing he has to do is to make sure that he jumps through the process hoops around “consultation”, and even then it is a very weak test given the deference courts tend to pay to agencies, and the extreme reluctance of banks to ever openly challenge their regulator in court (the Bank has lots of other discretion it can wield to disadvantage awkward banks).  It is a bad case of the adminstrative state run rampant, neither accountable nor particularly expert.

The Governor himself can’t change the statute he operates under (although the government does have underway at present a review of the Reserve Bank Act).  But a good Governor can recognise the limitations of that legislation, and choose to operate in ways that minimise the risks and disadvantages of a framework put in place decades ago, when the designers did not envisage the Bank exercising major regulatory discretion.  As it is, the Governor is effectively prosecutor, judge, and jury in his own case, and there are no rights of appeal.  Anyone with the slightest sense of history and human nature would recognise certain risks in such a model.   Checks and balances not.

The Reserve Bank’s overall capital review has been running for several years, dating back to Graeme Wheeler’s time.   There has never been strong grounds for urgency around the review, capital requirements having been lifted last only a few years ago.  Of course, regulated entities (banks, in this case) want certainty, but I’m pretty sure even they want robustly developed and scrutinised rules.

How much better if, having got their internal staff work to a certain point, the Reserve Bank had engaged in some proper, open-minded, consultation before the Governor ever signed on to a particular proposal.   Perhaps there could have been a series of Analytical Notes, Bulletin articles, and other background papers, reviewing relevant literature, reviewing the New Zealand experience, comparing and contrasting New Zealand’s situation with those in other countries (including identifying how and in what ways specific countries were relevant comparators, and rigorously reviewing arguments and evidence around possible medium-term transitional effects.  It might have all come together in something like, in older parlance, a Green Paper: not formal proposals, but a canvassing of issues, possibilities, risks, costs, benefits and so on.  A series of workshops and/or conferences could have been held over several months, open to interested parties (including invited local and international experts), to help test the Bank’s preliminary thinking. scrutinise the evidence etc etc, and all without the eventual decisionmaker having committed himself.  Such a process wouldn’t simply have been about picking holes, but might have highlighted new evidence (for or against) the Bank wasn’t aware of, or identified a list of important further questions needing more analysis or research.

It could have been a genuinely constructive process –  the path to better policy, as well as to a better reputation for the Bank (recall that stakeholder survey from a year or so ago).  At very least, it would have helped alert senior management (the Governor particularly) to the potential weaknesses in the Bank’s own analysis, major areas of concerned that commenters might raise if the matter went to formal consultation, and thus should have helped his own preliminary decisionmaking process.

And having done all that over a period of several months, the Governor might then have taken a preliminary view and moved to the next phase of consultation, but have done so with all his ducks in a line:

• all the relevant papers would be released at the same time (not continue to be written over several months) including the pro-active release of background internal material,
• there would be a proper rigorous cost-benefit analysis, with appropriate key sensitivities and asssumptions clearly highlighted,
• there would be a regulatory impact assessment, not just done by those championing the reform, but independently reviewed and scrutinised,
• and recognising that, unlike when a minister initiates legislative proposals (which have to get through Cabinet, select committee, and Parliament), the Governor is the sole decisionmaker on his own proposal, it would have been appropriate for the Governor to have announced the appointment –  at the start of the process –  of a small independent panel of credible experts to assist him in his later deliberations.  The Governor can’t delegate his statutory decisionmaking powers to expert advisers, but he can commit to have serious regard to the analysis and advice of such a panel, and to publish their advice before his own final decision was taken.

But we’ve had none of this.  Instead, the Governor charged ahead on what was evidently little more than a whim and a personal preference, and has been rushing to try to backfill his case ever since.  Having run into what appears to have been unexpectedly strong resistance to his plans –  and not just from the directly affected banks themselves, but from plenty of people with no vested interests –  we are now finally promised a proper cost-benefit analysis, and some “external experts”, but it is now so late in the piece that whatever and whoever they come up with is going to be greeted with a considerable measure of scepticism.  Anyone can produce a cost-benefit analysis to meet his or her boss’s preferences, and there will inevitably be a sense that whatever is finally produced –  how many more months away? –  it was generated to support the boss rather than to illuminate the issues.  And who are they going to find to serve as “external experts” this late in the piece, when most of those who think about the issues domestically have already either expressed their views and been involved as consultants in preparing submissions by others.  There can be a role for overseas experts, but knowledge of the New Zealand system and New Zealand experience should not be irrelevant.  And quite what is the selection process the Governor is going to use at this late stage –  the suspicion will inevitably be that he will be aiming for people just credible enough to look serious, but emollient enough not to want to make difficulties.

In a better world, having got this far, the Bank would now commit to publishing the cost-benefit analysis, the regulatory impact assessment, and the advice of the (as yet unknown) external experts and then reopening the consultation process for a short period (say 4-6 weeks), and only after any new submissions had been received, analysed, and seriously considered would the Governor make his final decision.   These are very big issues, with potentially major economic consequences, and no urgency (no doubt the Bank will tomorrow repeat its longrunning assurance that the financial system is sound).  We need to see much better policy processes used than have been on display so far –  all the more so when a single non-expert unelected official is making the proposals and the final decisions, and when his final decisions cannot be appealed.