Twenty questions

I wasn’t planning to write anything today, but in the Herald this morning there was an “interview” with Reserve Bank Governor Adrian Orr around the bank capital proposals. I put the word in quote marks, because it was more of a platform for the Governor to articulate his views and frustrations, than any searching or penetrating scrutiny.  I tweeted out a link which attracted a response from Newsroom’s Bernard Hickey

Twitter isn’t really conducive to a long list of possible questions (240 characters and all that) and I have more readers here than there, so I thought I’d jot down a few suggestions, a non-exhaustive list of possibilities, here.

  1.  Given that proposals of this sort were always going to be controversial, why didn’t you adopt a more robust process from the start (eg technical workshops, green papers etc before the Governor signed up formally to a specific option)?
  2. Especially so given that in this area you (single decisionmaker) can be seen as prosecutor, judge, and jury in your own case, without any rights of appeal?
  3. Why did you not publish all the relevant documents when the consultation paper itself was released, rather than drip-feeding them out over months?
  4. Why was there no proper cost-benefit analysis, with assumptions and senstivities clearly stated, published with the consultative document?
  5. Why have you not published (or prepared?) a robust comparative assessment of your proposals relative to the capital rules proposed/in place in Australia, enabling submitters to see clearly the similarities/differences?
  6. Why have you repeatedly attempted to slur all critics of your proposals as representing “vested interests”, rather than engaging with the substance of the arguments critics have made?
  7. Wouldn’t your position, and preferences, appear more robust to disinterested parties if they could see you engaging with, and specifically responding to, alternative perspectives?
  8. Are you willing to revisit the Bank’s previous decision on the inadmissibility of CoCos?  Given the relatively high level of CET1 capital, what grounds do you have not allowing (eg) CoCos issued to wholesale investors to meet any additional capital requirements the Bank considers warranted?
  9. Wouldn’t the ability to issue CoCos to meet any additional capital requirements be particularly valuable to the (capital-constraind) New Zealand banks?
  10. Why was there no discussion of OBR in the consultation document?  A credible OBR system appears to greatly reduce the need for any capital requirements (let alone very high ones), so does this absence suggest the Bank was walking back its support for OBR?
  11. Where is the evidence for the claim, made several times in the recent Bank FSR, of evidence that the costs of financial crises are much higher than previously realised?  Realised by who, and when? (Bearing in mind that current capital requirements post-date 2008/09.)
  12. You have taken to suggesting that the 2008/09 episode in New Zealand supports the need for further increases in bank capital.  GIven the very low level of loan losses and NPLs through that period –  a severe recession, after a dramatic run-up in credit to GDP – can you elaborate on your view?
  13. Why was there no discussion/analysis of the probable transitional effects in the consultative document?
  14. Why are you not proposing to impose the same higher capital requirements on NBDTs?  Won’t this further un-level the playing field?
  15. What sort of disintermediation from the balance sheets of the big 4 locally incorporated banks do you expect to see, bearing in mind that the requirements don’t apply to (a) other non-bank lenders in New Zealand, (b) banks operating here that are not locally incorporated, (c) foreign banks not operating here, but lending to major New Zealand borrowers, or (d) to the domestic securities market?
  16. How does this disintermediation square with the efficiency constraint that appear prominently in your Act (didn’t we experience lots of disintermediation in the 70s and early 80s?)
  17. Do you agree that any costs of the higher capital requirements are likely to fall most severely on borrowers (and depositors) with the fewest alternative options?  Under that heading, is it likely modestly-sized borrowers with idiosnycratic needs (including farmers) will be among the harder hit?  If not, why not?
  18. In your documents you do not seem to have engaged with the evidence that floating exchange rate countries that did not have a financial crisis in 2008/09 did not perform much differently than floating exchange rate countries that had a financial crisis?  Why not?  Doesn’t this suggest your “cost of crisis” assumptions are substantially overstated?
  19. How, if at all, do you distinguish between the economic costs of a misallocation of resources during a credit boom (which higher capital requirements are unlikely to stop) –  but which only crystallise (and become apparent) in the bust – and those arising from the banking crisis itself?   There is no sign that you attempted to draw this distinction in any of your documents?
  20. Why are you so reluctant to pay heed to repeated waves of Reserve Bank stress tests which suggest that very severe (appropriately so) adverse shocks would not severely impair the health of the New Zealand financial system, based on the lending standards adopted in the last decade or more?

And that was a list straight from the top of my head, without even pausing to check my submission on the proposals.  It wouldn’t be hard to come up with at least another twenty questions that journalists seriously interested in holding the Governor to account might reasonably ask.

21 thoughts on “Twenty questions

  1. Here are my two questions for Mr Orr, not from the top of my head, but after considerable serious thought:

    1. Given that
    a. according to the Reserve Bank Act 1989, part of the RBNZ’s mandate is to improve the efficiency
    of the banking and monetary system, and
    b. nowhere in the Reserve Bank Act 1989 is there any definition of what “efficiency” means in this
    context, nor how to measure it,
    how do we know how well you – or indeed any of your predecessors – have been performing your duties?

    2. Please tell me whether you agree or disagree that the RBNZ should be conducting some serious research
    to establish which of two banking and monetary systems – the present one or a Sovereign Money one –
    would better “promote the prosperity and wellbeing of New Zealanders and contribute to a sustainable and
    productive economy”, as the RBNZ’s mandate requires it to do.


    • Michael, it was somewhat disconcerting to me that my formatting completely disintegrated when I posted my comment. Worse, it seems that there is no provision for me to edit my comment immediately after posting it.

      Fortunately, for patient readers my meaning is crystal clear!


      • The present banking system works pretty well for global trade. The question now is whether the RBNZ should be interfering with increased capital proposals for our big Australian banks that rely heavily on savers deposits to fund their lending revenue activities.


  2. To which you could add, why have you chosen an “independent” reviewer of your proposal who wrote a paper pretty much saying the same as what you propose. That does not seem to be a way of bringing independent scrutiny to your conclusion on bank capital requirements.

    Liked by 1 person

  3. Hi Michael,
    thank you for your considered and not “vested” views here 😉 I would venture to say that as with most other people who disagree with the capital proposals, your vested interest is the well being of New Zealand. Both you and Ian Harrison deserve a medal for the considerable amount of time and effort that you have put into assessing the RBNZ proposals (Others who also deserve mention are Geof Mortlock and Martien Lubberink – who as an academic followed through on his legal obligation to express his opinion about the capital proposals as presented by RBNZ).

    My first question is also a game of spot the difference.

    RBNZ provided an aide memoire (amongst the many documents RBNZ released) to the Minister of Finance stating that while the capital review itself is not expected to be a surprise, that the extent of the proposal is expected to be a surprise.

    In an interview with’s Gareth Vaughan (in Jan or Feb), the governor, when asked if he was surprised that the banks are surprised, stated something along the lines “I am not surprised, I am disappointed, this has been a 2 year process…”
    (happy to go back and transcribe the actual wording of the interview)

    As the minister was advised to expect the industry to be surprised about the extent of the proposals, why was the governor disappointed? The two comments were not the same and give quite a different meaning.

    Question 2
    Although not an appropriate proxy in the first place, why did RBNZ choose not use data prior to 1990 when using the relationship of annual house price change and annual gdp change as a proxy for correlation in it’s single exposure modelling? There is a house price index that goes back to 1962 (semi annual instead of quarterly data points prior to 1990). Stats NZ have GDP data that can be downloaded from their website going back to the 1970s. When extending the sample period, the correlation reduces. (The Westpac submission highlights the issue of the chosen range of correlation – the choice of correlation impacted the outcome of the modelling much more than the choice of PD and LGD).

    RBNZ is respected and trusted by most New Zealanders, who rely on RBNZ to make reasoned decisions on behalf of all New Zealanders. I don’t understand what has changed to make New Zealand’s banking system so much more risky now, that would necessitate the proposals.

    I hope that RBNZ does not take the same approach to reviewing capital requirements of the insurance industry (ominous comments coming from the FSR release). If they do, I believe that there will be a serious risk of market failure, particularly for apartment owners in Wellington. Who wants to be on a body corporate board right now?

    Liked by 2 people

    • Thank for your lofty comments, however, I am not sure if I am under a legal obligation to submit my comments.

      I did so because I am worried that the proposals will not contribute to a safer financial system. It is too much a credit risk proposal, which turns the clock back to 2004. It is 2019 approaching 2020.

      A comprehensive proposal on capital should include: resolution and recovery, operational risks and should revisit interactions with liquidity risk, market risk, governance, stress testing, asset quality, IFRS9. It should also look into solo versus consolidated supervision. The proposal is therefore largely incomplete.

      Liked by 1 person

      • I very much support your point regarding resolution and recovery which of course requires the RBNZ to review its stance on OBR and bail-in. There is a strong case to be made that bail-in will be a much more effective market discipline measure than more common equity. The RBNZ takes it as self evident that more common equity increases “skin in the game” and hence results in better risk discipline. The skin in the game idea works if the bank has nothing to lose but that is not a fair description of how banks are capitalised today. I suspect the opposite is true. Increasing common equity at this point will either drive risk out of the regulated area or result in banks being under pressure to take more risk. This increased risk does not have to be credit related, it can equally be all of the harder to measure non-financial risks that you list.


      • If my financial advisor would have ‘skin in the game’ then I would run away from him as fast as possible. Skin in the game will lead to more risk taking, it’s a no-brainer.


  4. My questions would be:

    1) Before changing the capital framework what analysis has been done to justify a change in that framework in the first place? Post GFC we noticed a surge in operational risk incidents (conduct, Libor- rigging, money laundering). Post GFC we also see that spreads of bank securities are not universally reverting to pre-GFC levels – which may indicate that bank failures are not automatically translated into a bail-out AND that bail-in is still a risky proposition. In other words, bank failures will probably still be disorderly – which will likely lead to an elevated risk of runs.

    Shouldn’t any major change in prudential supervision therefore focus on Oprisk and the interactions between capital, liquidity, and resolution and recovery?

    2) Why has been chosen for an approach that has the smack of Basel II? Even in the absence of Dr Doom and the occasional flocks of black swans we learned from the GFC that “once in a n years” statements were void of realism. Why then use such VaR-ish models?

    3) Why didn’t the RB just set an aspirational goal: “We want to be unquestionably strong too!” Had the RB done that, then we would have been saved the discussions on assumptions supporting the 15 or 18 percent requirements. The RB could have picked the top quartile or top decile, and it would be very easy to defend.

    4) Why did the RB rely so heavily on economists and economic papers, knowing that i) academic papers reflect a typical selection of knowledge: only papers with results are published in the public domain. Policy makers may not be aware of this selection bias. ii) prudential supervision combines knowledge of history, politics, law, finance, accounting, and … economics. But economics offers only limited knowledge – some variations and adaptations of Modigliani and Miller, and that is pretty much it. Academic papers are not necessarily safe when handled by untrained economists and policy makers.

    5) Why didn’t the RB involve, from the outset, capital specialists from investment banks and peer regulators, or even the academic who contributed to capital rules at the EBA, the Basel Committee, still is in contact with capital specialists around the world, and who works just three minutes walking distance from the Terrace?


  5. Michael.
    One observation regarding question 12
    “You have taken to suggesting that the 2008/09 episode in New Zealand supports the need for further increases in bank capital.  GIven the very low level of loan losses and NPLs through that period –  a severe recession, after a dramatic run-up in credit to GDP – can you elaborate on your view?”

    I suspect that the RBNZ might respond that the lesson they took was not the size of the loan loss but the fact that the banking system needed to be guaranteed. There are responses to this of course that are alluded to in your other questions. That then leads to a useful discussion of the role of deposit insurance and of deposit preference and the role of OBR. I have views on this that may not align with yours or the RBNZ but that discussion is I think a key part of the overall capital adequacy discussion.


    • Thanks. Yes, there may be good answers to several of the questions, altho as I noted in Friday’s post I don’t think the guarantees argument is a strong one (tho could be more relevant to debates about liquidity/funding structures).

      I’m in favour of deposit insurance, and deeply sceptical that OBR would ever be used without it. From memory, you and I differ on depositor preference.

      Liked by 1 person

      • Yes. I see deposit preference as complementing deposit insurance and moving the solvency risk of the bank to stakeholders who are better positioned to absorb it and provide market discipline. I am much influenced by Gary Gorton’s papers on the need for deposits to be information insensitive. I am also deeply sceptical that OBR would ever be used for the obvious reasons. That said it makes no sense that the RBNZ can believe in OBR but oppose bail-in.


      • P.s. I was not offering an opinion on the substance of their concern. Simply an observation that may be what their issue. If so the size of losses does not change the fact that the guarantee was brought in and they were unhappy with that outcome given their position on deposit insurance.


      • Yes, I recognise that. In the specific circumstances we found ourselves in that weekend I suspect we’d have had the guarantee even with 16% min capital ratios.


      • I don’t disagree with that. I think the retail deposit guarantee should have been in place anyway. The wholesale guarantee was an unfortunate requirement responding in part to the fact that other governments had already put similar guarantees in place. The capital held by local banks was irrelevant in those circumstances.


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