Credit conditions

Back in mid-2009, just as the first glimmers of recovery  from the severe recession were emerging, the Reserve Bank launched a credit conditions survey (of lending institutions).  It was a sensible enough initiative but, to be honest, I never paid much attention to it.  We knew conditions had got very tight during the recession and (at least in my remaining time at the Bank) the data weren’t that interesting –  of course credit conditions were easier than they’d been in the midst of that financial scare, and when there were changes shown they were for pretty obvious reasons (eg access to housing credit was reported as tightening when the Governor imposed LVR restrictions).   Also, the number of institutions covered was quite small, and one had to worry that results could be affected by who happened to fill out the form in a particular institution on a particular occasion (plus, when reporting to your prudential regulator incentives aren’t entirely straightforward).

There is a series of questions about:

  • observed loan demand (by class of loan),
  • expected loan demand,
  • observed credit availability,
  • expected credit availability, and (since early last year)
  • a series of factors potentially affecting the availability of credit.

That makes for lots of series.  I’m less interested in the demand side, which is largely going to reflect stuff we see captured in other data (eg housing turnover, business surveys etc).  But demand for new business loans does seem to have fallen away somewhat in recent years.

But what about the supply side?

Here is observed credit availability over the last six months (the survey is six monthly) for the four business sectors (there was no particular change in availability to households).

credit 1

And here is what respondents expect (presumably from a position of knowledge, responsible for something around overall credit within their own institution).

credit 2.png

Yes, there is some idiosyncratic variability in the response at times, but in the ten year history of the series we’ve seen nothing like the tightening in expected conditions observed in the last few quarters, now across all the business classes (there is little movement on the mortgage and personal household lending categories).

It isn’t easy to know quite how much weight to put on these responses –  for a start, with only one incomplete cycle of observations, we have little idea of “normal” variability as economic conditions turn down.  But as the recent downturn is larger than the post-2009 upturn (coming off a pretty savage tightening in conditions) it doesn’t have the look of something that should be quickly glossed over.   It looks to represent a potentially quite material tightening in monetary and financial conditions.

The other question they have about actual credit availability might also tend to confirm that unease.  Respondents are asked about how credit availability is now compared to the past three years (I guess to smooth through idiosyncratic influences on the past six months).  Here are the responses for the business sector loans (household was directly and materially affected by the waxing and waning of LVR restrictions, a policy intervention).

credit 3.png

Again interesting that there had been little movement re SMEs, but for the other three business categories the scores are getting back towards levels we saw just after the last recession.

Early last year the Reserve Bank did a welcome extension to the survey and started asking respondents about the influence of various specific factors that could reasonably influence credit availability.  Here are answers.

credit 4

Cost of funds hasn’t been an issue in changing credit availability (nor would you really expect it to be –  should affect price rather than availability), and neither has competitive pressure, but look at those four striking negative yellow bars.    Risk appetite among the lenders, risk capacity, and (distinctively) regulatory changes have all worked to (apparently materially) tightened credit conditions.

Sadly, here we reach the limits of the survey. It would be fascinating to be able to disentangle quite what is going on.  There is a quite plausible story that all three of the other negative yellow bars are primarily a reflection of the fourth, regulatory change (presumably the Governor’s capital whims).  Perhaps it isn’t so, and there are independent reassessments of risk and willingness to bear risk going on in head offices, whether here or in Australia, but whatever the precise combination of factors it is pretty likely that regulation is already weighing fairly heavily on credit availability in New Zealand. (I only qualify that claim a little because banks perhaps have an incentive to play up the issue, knowing that the Governor is about to make his final capital decisions, but I doubt that is more than a marginal factor here, given the small number of respondents and the ability of the Bank to query each).

You may recall the consultation document the Bank published almost a year ago on the Governor’s proposals to greatly increase capital requirements for locally-incorporated lenders.  You may not recall the discusssion of these sorts of effects, let alone the apparent differential sectoral effects.  That isn’t the fault of your memory.  There just was no discussion of those issues in the document.  Which seemed odd at the time, and even more extraordinary now.  It will be interesting to see how the Governor responds to these data in his two scheduled press conferences in the next few weeks (MPS and FSR).

While these data are clearly of some relevance to the bank capital debate, my main interest in them was in the more immediate issues around the appropriate stance of monetary policy and the setting of the OCR.   There appears to have been quite a sharp change in market sentiment/pricing and the views of some market economists this week on the chances of the Bank cutting the OCR on 13 November (the reasons for that change still aren’t fully clear, and one is left wondering if the Bank has been signalling –  by accident or design –  some change in its own view).

My interest is much less in what the Bank will do in the short-term, but in what they should do (which should, of course, make my commentary of interest to the Bank, given the Assistant Governor’s speech the other day, but…..).  “Will” and “should” eventually tend to converge, but it can take some considerable time for them to do so.

But if we grant that this credit conditions data is material the MPC did not have when they did their August forecasts, or made their slightly panicked last minute decision on a 50 basis point cut, and did not even have at the last OCR review, it really should be  colouring the projections they finalise next week (even if the variable might not feature in their formal models).  Add in own-activity business survey data that has shown no signs of rebounding since August, inflation expectations that have either fallen further (surveys) or remained very low (inflation bond breakevens), and a core inflation rate that remains consistently materially below the (focal) midpoint of the inflation target, the case for not cutting the OCR in November seems weak at best.  There isn’t another review opportunity until February, the world situation (if not one of sentiment spiralling downwards) seems no stronger substantively, and for a committee that was sufficiently rattled to do a 50 point cut only three months ago –  and not to have seen anything much improve since then –  to do nothing now would only further muddy the communications waters, leaving people even less clear about how the MPC thinks, or that there is a consistent and disciplined process at work, secreted away from the public/market spotlight.

(Bearing in mind that there is still some material local data to be released before 13 November) the risks around a further OCR cut in November at present look quite asymmetric.  As we drift closer to the next recession, and to the limits of conventional monetary policy, the very best thing that could possibly happen would be positive surprises on core inflation, spilling over into somewhat higher inflation expectations.  People are no longer convinced inflation will settle at 2 per cent or above. It would be better, for almost everyone (certainly for the management of the next downturn) if they were.   When credit conditions appear to be tightening quite materially –  and that even before the final decisions are announced –  getting that sort of outcome will be made harder than necessary if the Bank ends up setting on its hands, confusing messaging, all for what?  So that the Governor can get some perverse psychic satisfaction from surprising people again?   Unpredictability is not a desirable feature of public policy.

 

Productivity (lack of it) and other things

When I was writing some comments last week on Reserve Bank Deputy Governor Geoff Bascand’s speech in Australia I was playing round with some comparative data and stumbled on this chart.

nzau 1

Over the entire period (since 1991) real GDP per capita has grown at exactly the same rate in Australia and New Zealand.   And I haven’t even cherrypicked the starting point: my chart starts when the SNZ quarterly GDP per capita series starts.

Of course, even in 1991 we were materially less well off than Australians, but should we take some comfort from having kept pace over now almost 30 years?  I’d say not.

Here’s why.   Look at the employment rates in the two countries

nzau2

You might be among those who think the more employment the better but (a) working is a cost (an input) to the employee and (b) wouldn’t it have been much preferable, even if you think higher employment rates are some great thing, for it to have resulted in more growth in average per capita income than in the country where employment rates didn’t increase as much?   Australia’s unemployment rate is a bit higher than ours, and that is a mark against them, but it is only a small part of the difference in the employment rates.

And here is a chart that is perhaps even more stark.

NZau3

Across the whole population, the average Australian is now working 5 per cent more hours than in 1991, while the average New Zealander is working 22 per cent more hours.

And yet the bottom line, growth in average real output per capita, is the same.

The difference is productivity – or, more specifically, in our case the lack of anywhere near enough productivity growth.

I’ve got other things on today, so that is it for original content.  But earlier this morning I was rereading my submission to the Reserve Bank consultation on the Governor’s plans to require large increases in bank capital.   There wasn’t anything in it I would now resile from.  I also skimmed through former colleague, and expert in bank capital modelling, Ian Harrison’s papers (here and here) and I doubt he would resile from anything in there.

But what remains striking is how little engagement there has been from the Governor on his proposals.    He has only given four on-the-record speeches this year, not one of which has involved a serious sustained attempt to make his case, let alone engage with alternative perspectives.  The only attempts I’ve seen to respond to alternative perspectives seem to simply involve suggesting that anyone who disagrees with him is somehow bought and paid for, and therefore their views aren’t worthy of serious notice or scrutiny.

At one level, it shouldn’t be surprising, given Orr’s personality and intolerance of challenge or disagreement –  and the fact that, formally at least, he doesn’t have to convince anyone but himself (since he is prosecutor, judge, and jury in his own case, and there are no rights of appeal). But as matter of good governance, in a democratic society, it reflects very poorly on him, on his handpicked senior managers, and on the Bank’s Board and Minister of Finance who are paid to hold the Governor to account but in fact act as if there role is to simply get out of the way and let the Governor get on with it, poor as the process and substance have been, poor as Governor’s conduct increasingly seems to have been.

And so I’ll leave you with some of the unanswered points from my submission

An unbiased observer, looking at the New Zealand economy and financial system, would struggle to find a case for higher minimum capital ratios.   Among the factors such an observer might consider would be:

• The fact that the New Zealand financial system has not experienced a systemic financial crisis for more than hundred years (and to the extent it approximated one in the late 1980s, that was in the idiosyncratic circumstances of an extensive and fast financial liberalisation which left neither market participants nor regulators particularly well-equipped),

• Our major banks – the only ones that might pose any serious economywide risks – come from a country with very much the same historical record as New Zealand,

• Despite very rapid credit growth in the years prior to 2008 (increases in the credit to GDP ratios among the larger in the advanced world, spread across housing, farm, and other business/property lending), and a severe recession in 2008/09 and afterwards, the banking system emerged with low loan losses,

• Since then, banks have not only increased their actual capital ratios (and been required to calculate farm risk-weighted assets more stringently) but have also substantially improved their funding and liquidity positions (under some mix of regulatory and market pressure).

• Over the decade, bank credit growth (relative to GDP) has been pretty subdued and there has been little or no evidence (in, for example, Reserve Bank FSRs) of any serious degradation of lending standards.

• The balance sheets of the large banks remain relatively simple, and there has been no sign (per FSRs) of the sort of financial innovation that might raise significant doubts about the adequacy of existing models.

• In terms of the wider policy environment, government fiscal policy remains very strong, we continue to have a freely-floating exchange rate, and there has been neither legislation nor judicial rulings that will have materially impaired the ability of banks to realise collateral.

• And the Open Bank Resolution option for bank resolution has been more firmly established in the official toolkit (note that if OBR were fully credible then, in the absence of deposit insurance, there would be little case for regulatory minimum capital requirements at all).

• And repeated stress tests –  over a period when the regulator had no incentive to skew the tests to show favourable results –  suggested that even if exposed to extremely severe adverse macro shocks, and associated large price adjustments for houses, farms, and commercial property, not only would no bank fail, but no bank would even drop below current minimum capital requirements.

• Consistent with this experience – also observed in Australia, the home jurisdiction of the parents of our major banks – the major banks operating here continue to have strong credit ratings (consistent with a very low probability of default), and the ratings of the parent banks are even higher.

• There has been no change in the ownership structure of our major banks, or in the implied willingness of the Australian authorities to support the (systemically significant) parents of the New Zealand banks were they ever to get into difficulty.

Add into the mix indications that New Zealand banks CET1 ratios, if calculated on a properly comparable basis, would already be among the highest in the advanced world –  in a macro environment with more scope for stabilisation (floating exchange rate, strong fiscal position, little unhedged foreign currency lending) than in many advanced countries –  and there would be a fairly strong prima facie case for leaving things much as they are.

But the Reserve Bank’s consultative document – and associated material, including speeches and interviews – engages substantively with almost none of this context.

And

It is grossly unsatisfactory that throughout months of consultation the Bank has made no effort to illustrate how its proposals for minimum CET1 ratios and the associated floors around the calculation of risk-weighted assets, compare with those planned by APRA for the Australian banks.

Such an exercise should have been relatively straightforward, especially if the Reserve Bank had done what most New Zealanders might reasonably have expected, and worked closely together with APRA in formulating its proposals.  Of course, New Zealand is a sovereign nation and the Reserve Bank (regrettably) has final decision-making powers in New Zealand but:

• APRA has a considerably deeper pool of expertise, including at the top of the organisation, than the Reserve Bank of New Zealand,

• The nature of the risks in the two economies and markets is quite similar (including similar legal institutions, and similar housing markets),

• If anything there is a case for thinking that APRA minima would be ceilings below which New Zealand requirements for our large banks should be set (since we have the benefit of strong parent banks, and well-regarded supervisor of those banks, whereas the parents  – and parents’ supervisors – themselves are on their own, and we have also chosen to have the OBR as a frontline resolution option),

• For the institutions that might pose potential systemic issues in New Zealand, any substantial increase in capital requirements can reasonably be seen as an attempt to grab group capital for New Zealand.  Why not work these things out together?

The onus should, surely, be on the Reserve Bank of New Zealand to demonstrate – make the case in detail – why the New Zealand subsidiaries of Australian banks should be subject to more onerous capital requirements than the parents, and banking groups as a whole, are subject to.  But not once has the Reserve Bank attempted to make that case.

I ended

New Zealanders deserve better than they have had in the poor process and weak substance that together made up this consultation.

To which one can only add that the repeated reports  –  some of things in public, others less so –  of the way the Governor has handled himself, his own conduct, through this episode are deeply disquieting.  There is little sign of the sort of character and temperament we should expect from a senior public servant exercise so much barely-trammelled power.  The Minister of Finance may declare that he has full confidence in the Governor.  The public should not, and if the Minister continues to sit on the sidelines doing nothing but expressing full confidence that should probably raise more questions about the Minister himself.

Meanwhile, one wonders what our new Australian Secretary to the Treasury makes of her first encounters with national policymaking and advice.

The Governor’s “independent experts”

Several months after going public with his plan for really large increases in capital requirements for locally-incorporated banks, and apparently feeling under a bit of pressure, the Governor of the Reserve Bank selected some foreign academics –  anyone local, he claimed, had been bought and paid for – to each write a report on aspects of the multi-year bank capital review.  I wrote here about the appointments, the terms of references the three selected people were working to, and what we might reasonably expect from them.

Their role was tightly-drawn, wasn’t primarily focused on the current (most contentious consultation), and they were only supposed to talk to anyone outside the Bank with the advance approval of the Reserve Bank.  Their focus was supposed to be on the Bank’s documents, not on (for example) the submissions the Bank had received in response.   And while there was talk of looking at the New Zealand specific context, none of the invited academics had any particular knowledge or, or background in, New Zealand.

This is what I wrote about what we might expect

I’m not impugning the integrity of the independent experts.   But they have been chosen by the Governor, having regard to their backgrounds, dispositions, and past research –  a different group, with different backgrounds etc, would reach different conclusions – and the Governor is well-known for not encouraging or welcoming debate, challenge or dissent.  Quite probably the experts, each working individually, will identify a few things the Bank could have done better, but it will all be very abstract, ungrounded in the specifics of New Zealand, and the value of their reports is seriously undermined in advanced because of who made the appointment, and the point in the process where the appointment was made.  This is the sort of panel that, at very least, should have been appointed a year ago.  Better still, it would not have been appointed by the Governor.

The three reports were released a few weeks ago and the visitors pretty much delivered for the Bank –  as, no doubt, having carefully selected them, the Bank was pretty sure they would.   There were, as I suggested, a few apt suggestions and questions but very little sustained engagement with the deeper issues, with the New Zealand context, or with the process.   The experts appear to have been let out to talk to a few (commercial bank) people outside the Reserve Bank but –  as per their terms of reference – there is no sign of systematic engagement with the range of expert submissions or submitters.  One declared himself comfortable that the Bank had answers to all the points raised by submitters, which may have been comforting for him but –  and this report was written months ago –  not so much for New Zealanders who’ve had no engagement from the Bank.

A Bank summary of the three report is here.  The Bank has claimed full-throated endorsement from the experts they selected.  Personally, I was a bit surprised how limited the reports were: offering more support (from people already strongly disposed to think more capital “a good thing”) than illumination.

I’m going to step through the reports one by one but I’m only going to talk about their comments on the current consultation on the minimum level of bank capital (for some –  and reasonably enough given the terms of reference –  that makes up only a fairly small portion of the report).

The first of three was by James Cummings, now of Macquarie University and formerly a researcher at APRA.    His report was quite long, but there wasn’t much insight offered relevant to the current consultation. There is a lot of reportage. For example, he simply channels –  without examining – the Reserve Bank’s claim about the greater vulnerability of New Zealand.  And despite being (a) Australian, and (b) previously from APRA he offers no thoughts on how robust the case might be for minimum core capital ratios here being material higher than those in Australia.  Then again, neither has the Reserve Bank.  There is no discussion about the trans-Tasman nature of the big four banks and the possible implications for the design of a sensible capital regime.  He mentions the Bank’s stress tests but – again simply, and briefly, channelling the Bank – to downplay them.

Cummings makes what appears to be a reasonable point that the Bank may have over-estimated the cost of equity in the Australasian banking sector (I presume that is one of the points the Bank will be having a look at).  But that is really about all the value he adds on the current consultation.  He is clearly highly sympathetic to the idea of the Australian banks listing their New Zealand subsidiaries locally and reducing their 100 per cent ownership of the subsidiaries. That will have been music to the ears of Messrs Orr and Bascand –  Orr in particular appears to have been pursuing that outcome as some sort of “New Zealand nationalist” goal, quite unrelated to his statutory mandate.  Cummings is correct that issuing equity locally could get round the fact that the imputation regime, although operating domestically in both New Zealand and Australia, doesn’t operate trans-Tasman.  But he doesn’t engage at all with the likely costs to selling down ownership and local listing (if they were non-existent, for example, the tax argument might already have led to partial local floats of the subsidiaries).  Those costs might well include a less strong ability to rely on the parent in the event of a crisis.  You’ll recall that really serious crises are supposed to be the focus of the capital review.

The second report is by David Miles of Imperial College, London (who spent a term on the Bank of England’s Monetary Policy Committee).  Miles has published some past research (unsurprisingly, given his selection) pretty sympathetic to higher capital ratios.  His (shorter) report is almost entirely focused on the current consultation.

He appears keen to be supportive of the Bank, and he begins his report by pushing back against the claim –  made by various critics –  that the Governor’s 1 in 200 year risk appetite stake in the ground was really just plucked out of the air.    And yet the Bank itself released a paper –  dated a mere six weeks before the release of the Bank’s proposals –  written by one of their internal experts, which adds the 1 in 200 year risk appetite possibility  (ie a 0.5 per cent annual probability of crisis) almost as an afterthought.

guthrie.png

Presumably the Governor latched onto 1 in 200 and they were off.  Much of the subsequent supporting analysis and modelling was only done, and released, after the Governor had already nailed his colours to the mast and published his radical plans.

Miles is actually somewhat sceptical about several of the assumptions the Bank has made in its modelling, and Ian Harrison – expert submitter on the modelling etc who neither Miles nor the others show any sign of having engaged with –  plausibly argues that Miles show signs of not fully understanding the modelling framework and thus being less critical than he should be.   One of the parameters (R, around correlations) was based on a particularly shoddy piece of “analysis” –  Miles, being more diplomatic, observes simply “but this evidence is quite weak and not a firm basis to be confident that a higher value of R [than used conventionally] is justified.”.

By background, Miles is a macroeconomist and you might therefore have supposed that he would something insightful to offer around the scale (in GDP terms) of the sort of severe crisis the Governor’s plans are designed to avoid.  The Bank uses quite a high number – 63 per cent of GDP –  in turn based on remarkably little analysis (several sentences in this paper).  Miles reckons this is quite possibly a “serious underestimate” and “seems optimistic”.   His argument for this appear to rest on nothing more (you can check –  page 14 of his paper) than a thought experiment in which he posits the possibility that the entire extent to which UK GDP now is below the pre-2008 trend is a) all due to a financial crisis, and (b) permanent then the cost of crisis might be 330 per cent of GDP.    As indeed it might, but Miles provides no discussion for why we should interpret even UK GDP that way, no mechanism for how these huge effects (more costly than World War Two?) might arise, no distinction between GDP lost because of poor lending and borrowing in the boom (costs which crystallise later) and those actually related to the banking crisis itself, and no engagement with (for example) comparisons between the output paths of countries which had financial crises with those that did not.  I’ve argued – it was in my submission –  that something more like 10-20 per cent of GDP might well be more reasonable.

You might also have supposed that the macroeconomist among the experts might also thought about discount rates.    As we typically have the highest real long-term interest rates among advanced countries, the appropriate long-term discount rate here should also be higher (making taking insurance against even a costly future crisis rather less valuable than it might be in some other countries).  Even the Reserve Bank noted that point (even if it changed nothing in their analysis) but not the Bank’s macroeconomic expert adviser.

Miles’s offering is pretty abstract and doesn’t engage with the specifics of New Zealand (or the trans-Tasman nature of our large banks) much at all (although he does note the difficulty the Governor’s proposal may pose for our capital-constrained local banks).  Given his background, that isn’t really surprising –  and is more a reflection on the Bank than on him.

But a couple of his concluding remarks are worth highlighting.   He is quite dismissive of the issue that I and others have raised as to whether there is a robust case for setting New Zealand core capital requirements so much higher than those in Australia or than in most other advanced countries.    There is, in his view, no information value whatever in such judgements by other authorities, when set against a “careful” Reserve Bank of New Zealand analysis.  That analysis really should pose questions not for New Zealand citizens etc but for other countries, who perhaps just haven’t done enough of the Bank’s sort of analysis.  He makes a fair point that we don’t want the same speed limits on all roads –  it depends on the risk –  but offers not a scintilla of reason to suppose that macroeconomic risks, and exposure to severe shocks, is more severe in New Zealand than elsewhere.

And then there is his final, distinctly two-handed, defence of the Bank’s stance.  As far as I’ve seen, his final –  perhaps delicately worded –  swipe at the New Zealand regime has had no coverage.  Here is what he has to say.

The RBNZ has adopted a principle of being conservative as regards bank capital to offset possible risks from its light-handed approach to supervision. That is a choice and one partly based on the view that having very large resources devoted to intrusive oversight of banks is not the most efficient road to go down. That is a conclusion that engineers and safety experts often apply when dealing with the design of structures. There is a choice between building bridges many times stronger than you expect them to need to be OR you having large teams of inspectors who pay frequent visits to examine all bridges and monitor flows of traffic over them.  It is clear that nearly all countries follow the first strategy.

That may be a useful guide for bank supervision.

Ouch.  On the Reserve Bank’s own numbers, the Governor’s capital proposals involve an annual loss of GDP of $750 million.  You could buy a really large (by New Zealand standards) number of new bank supervisors and regulators for even a 10th of that amount.  I’m sceptical there even is much of that sort of trade-off in New Zealand, at least for the big 4 banks, given that they are, in effect, subject to APRA’s own more hands-on supervision.  But 30 more supervisors might be cheap compared to the costs and distortions of the Governor’s current proposal –  even allowing for the old maxim, about the devil making work for idle hands.

It was striking that neither Miles nor Cummings devoted any space at all to the sectoral and distributional effects of what the Governor is proposing –  and thus did not point out that the Bank’s consultation papers have not done so either.     Thus, no mention of the fact that the rules would apply to locally-incorporated banks, but not to (a) other banks, (b) non-banks, whether deposit-takers or otherwise, or (c) to market-based funding mechanisms (eg securitisations or bond finance directly).    Or, thus, that the burden of the policy will fall very unevenly –  those with easy access to alternative sources of finance will face no material impact at all, and those without could be hit quite severely (whether in terms of cost, credit standards, or competition among credit providers).

The third of the experts, Ross Levine, a US academic –  with no particular background in policymaking or bank regulation, but with an impressive publications record across a range of areas –  does touch on alternative sources of finance.  Indeed, it is one of the main themes of what is really an essay on incentives, risk-taking and so.  It is quite a thoughtful essay  – with some suggestions of issues the Bank might have discussed but didn’t – but it isn’t really clear what bearing it has on the merits of the Governor’s proposals or the quality of the analysis and argumentation supporting them.

Levine’s deep conviction is that banks are heavily subsidised, prone to recklessness, and that anything that reins them in, reducing their relative importance, is prima facie a good thing.    Those aren’t his exact words, but a paraphrase they seem to capture his view pretty well.   Well, fine, but some evidence would be nice, perhaps especially when you are dealing with (a) a pretty vanilla banking system, (b) in a country largely free of a track record of serious systemic financial crises, and (c) where the country’s vanilla banking system is owned by banks based in, supervised in, another country with a similarly strong track record of financial stability.   Remarkably, despite the focus on issues around incentives, Levine does not discuss at all how his thinking about the issues facing New Zealand might be affected by the fact that the big 4 banks are themselves owned by other (foreign) banks, subject to group capital requirements.  He suggests the Bank should assess some of these issues –  and it is a fair enough criticism that it hasn’t –  but offers no perspectives of his own. If the New Zealand subs remain wholly owned by the parents, for example, it is unlikely that any New Zealand capital requirement policies will affect the incentives on managers of the New Zealand operations, who operate largely as part of wider banking groups.

Because Levine is keen on a reduced reliance on banks, he thinks the Reserve Bank should have put more weight on how non-banks might respond.   He is keen that they should do so but it isn’t clear if he is aware that (a) the last (small) financial crisis in New Zealand was among non-banks or (b) that non-banks are subject to a lighter (materially so if the Orr proposal proceeds) regulatory regime than banks. Nor, it seems, has he given much thought to the implications of potential bank lenders not covered by the proposed new requirements.

His conviction is that banks are heavily subsidised and thus that capital requirements are generally too low. But he shows no sign of having engaged with, for example, indications regarding the sort of capital ratios found to work (for shareholders and creditors) in financial intermediaries where there is no credible prospect of a government bailout.  I touched on this in a post earlier in the year: as yet, we have no deposit insurance, and yet TSB, Heartland, and SBS each operate with actual risk-weighted total capital ratios of around 14 per cent. while the Governor wants to insist on 16 per cent minimum core capital ratios for the big 4 banks.  But I guess that sort of perspective would muddy the rhetorical story.

Levine doesn’t get into at all the issues around the actual economic cost of crises, the marginal reductions in those costs from the last few percentage points of capital requirements, discount rates or the myriad of other relevant angles. In fairness, he claims not to be taking a strong view on whether what the Governor is proposing is too high or too low, but his priors pervade his paper –  priors the Bank knew very well when they hired him.

The reviewers reports are generally pretty positive on the Reserve Bank analytical staff involved in the technical aspects of this project.  That is good, but not particularly surprising or new.  The issues here are more about senior management –  the Governor in particular –  and reluctance to engage more broadly or on a wide range of angles and perspectives.  The Governor has recently been attempting to deflect criticism of him by suggesting it is all about his staff –  “you are all beating up on my wonderful staff”  –  when no one is criticising them much if at all.  Staff have to deliver for senior management, and the Bank’s technical staff seem to have done the best they could to provide support for the Governor’s whims and priors.    It is the Governor and senior management colleagues who refuse to engage, refuse to look wider, and fail to provide any sort of robust defence of a proposal to impose much higher core capital requirements here than in most other places and, in particular than in Australia.

As I said at the start, for handpicked reviewers, chosen at a time when the Governor had already put his stake in the ground, the reports were much what one should have expected.   The Bank seems to have taken the reports as reassuring support –  but that is why they hired these particular people, known for particular predispositions –  but I suggest you don’t.  Many of the bigger picture questions simply haven’t been engaged with, adequately or at all.

And, somewhat to my surprise, I didn’t see any mention at all of the paper that came out three months ago, from a working group of major central banks, looking at issues around appropriate minimum capital requirements, working within the academic framework these reviewers are comfortable with.   I discussed that paper here and  highlighted this chart and these issues

On my reading, this is the bottom line chart in the BCBS paper.

bcbs chart.png

They report the net marginal economic benefit (slightly lower GDP each year, offset against savings from a less serious crisis decades hence) from higher bank capital ratios, drawn from a series of studies.    On these models there were really big gains in lifting capital ratios, up to around to around 9-10 per cent.  If there are gains at all –  and they don’t report margins of error around these estimates –  they are looking extremely small beyond about 13 per cent.    Perhaps that doesn’t sound too far from the 16 per cent number the Reserve Bank is proposing for the big banks but (among other limitations, many made inevitable by data limitations):

  • this modelling is done on actual capital ratios, not regulatory minima (a 16 per cent minimum ratio is likely to see banks aim for something between 17 and 18 per cent actual ratio), and
  • none of this modelling takes account of differences in accounting and regulatory treatment across countries: conventional wisdom, (backed by estimates done by PWC) suggest that effective capital ratios in New Zealand (and Australia) would be far higher if things were measured the same way they were done in various other advanced countries, and
  • none of it takes account of the regulatory floor in how risk-weighted assets are calculated.  As the Bank is quite open about, a significant part of what is proposing is that in calculating risk-weighted assets, the big banks will have a floor of 90 per cent of what the standardised rules would generate (the more normal floor is, as I understand it, about 72 per cent).  A 17.5 per cent headline actual capital ratio would, on RB proposed rules, be akin to something like 20 per cent in the sort of framework the BCBS authors are looking at.

Nothing in this paper suggests any reason for confidence that effective capital ratios of, say, 20 per cent of risk-weighted assets would be generating net economic benefits, even on the (overly pessimistic) macro assumptions the authors are using.  But that is what the Reserve Bank claims to believe.  The onus, surely, is on them to show us, and to engage on their assumptions and analysis – in open dialogue – well before decisions are made.

There were other problems in this paper – for example, to my reading of the experiences of other countries they use too-high estimates of the cost of crises –  but those will do to be going on with.  Neither the Bank nor their independent reviewers have engaged with the challenges this paper –  not by some lone academic or iconoclast, but from within the hallowed halls of central bankers and supervisors –  poses to the Governor’s plans.

 

 

New Zealand and Australia

Yesterday’s post unpicked some of Reserve Bank Deputy Governor Geoff Bascand’s speech in Sydney earlier this week.  As I noted, the goal of the speech seemed to be to leave readers with a sense that there really were good grounds for New Zealand to impose materially more onerous core capital ratios on locally-incorporated banks (recall that none of these requirements apply to any other lenders, banks or otherwise) than those imposed in Australia.   The gist of the case was, we were told

Our conservatism, relative to Australia, in our bank capital proposals reflects the higher macroeconomic volatility that we have endured, as I pointed out earlier.

Even over the nearly 30 years Bascand asked us to focus on, this wasn’t a very convincing argument.

As I pondered further the claim that New Zealand was exposed to materially more macroeconomic volality than Australia –  and the differences have to be “material” to support the material differences in proposed core capital requirements –  and conscious of the huge and wrenching Australian crisis of the 1890s, I’d just decided to look at a rather longer run of data when a reader, an academic economist, sent me an email making exactly the same point, and conveniently drawing my attention to this chart (from the Phil Briggs NZIER compilation of charts and text in New Zealand economic history).

briggs.png

It uses smoothed data because the estimates for the earlier decades, for both countries, are incredibly noisy.

But, if anything, over that 150 years, the Australian experience was more volatile than that of New Zealand.    Their financial crisis was much more severe than ours in the 1890s, and their experience of the Great Depression (including in the financial sector) is generally regarded as having been worse than ours, as examples.

You’ll recall that the Governor has chosen to attempt to calibrate his capital requirements so that, in principle, New Zealand experiences a financial (banking) crisis no more than once in 200 years.  We don’t have 200 years (of data, or experience) for New Zealand –  although the Australian data start from 1820 –  but if you want to mount arguments that we are (and will be) exposed to materially higher macro volatility than another country, it surely is only reasonable to look at as long a history of those two countries as one can reasonably get.  Unless, that is, one is using statistics/history for support –  for the boss’s whims –  rather than for illumination.

One can always discount history –  this, that or the other thing will always have been different, even if human nature isn’t –  but to mount a major policy case on a carefully chosen subset of history seems more akin to propaganda than to good policy process.

Or here is another chart.  Bascand included in his speech a chart on New Zealand GDP since 1965.   Here are the unemployment rates for the two countries since 1966 –  the official Australia data starts then and our series was backdated (from when the HLFS started in 1986) by Simon Chapple.  Not 200 years of data, but more than 50.

U rates long-term

Do those look like two economies prone to materially differing degrees of macroeconomic volaility?  If anything, Australia might have been a bit more volatile (over this particular period).  Peak unemployment rates in Australia in the Great Depression also appear to have been higher than those in New Zealand.

But I don’t want to mount an argument that Australia is more exposed to macroeconomic volatility than New Zealand is.   If anything, rather the contrary.  Over long periods, New Zealand and Australia have been two of the more similar countries on earth.  The modern countries emerged at much the same time, for almost all their histories they’ve had much the same exchange rate regimes, they’ve had strongly overlapping banking systems, they’ve been heavily dependent on foreign capital (especially in the development phase), they liberalised again at much the same time, they both run public debt sky high at much the same times, they both turned fairly inwards for a time, they’ve had pretty similar migration policies, they’ve mostly had very similar terms of trade cycles, and they’ve both had the rule of law (and similar legal systems) and democratic government throughout their modern histories.  They’ve been tolerably well-governed, tolerably successful in economic terms (Australia more than us in recent decades), with a high degree of financial stability in both countries for now well over 100 years –  with the sole exception of the brief period of shared craziness immediately after the 1980s liberalisation when no one (regulators, lenders or borrowers) really knew quite what they were doing.

2025 TOT

So if Adrian Orr and Geoff Bascand really want to mount a case for putting much more onerous capital requirements on in New Zealand than in Australia, it is simply absurd and untenable to  mount it on the basis of some intrinsic greater level of economic risk in New Zealand than in Australia.  It hasn’t been so in history, and they’ve not even sought to advance an argument for why it might be so in future.

Perhaps the Australians really have it wrong and superior wisdom rests with Messrs Orr and Bascand.  But, frankly, it seems unlikely.  Not only are the key Australian officials much more experienced in these matters than ours, and they have the additional worry that there is no prospect of parental support for their banks, but it is the New Zealand proposals which appear to put us out of line with (above) international benchmarks, despite the impressive long-term track record of financial stability here, the floating exchange rate regime, and a now well-established history of keeping governments out of credit allocation.

More generally, in banking systems that have so much in common, in economies with so much in common, surely we should have looked to our authorities to have worked closely with the Australians to have developed as common a regime as possible, recognising (inter alia) that if and when anything really goes wrong with any of the big 4 the problems will be trans-Tasman in nature and are likely to be resolved –  and be best resolved –  at a trans-Tasman political level.    I’m not suggesting Australian officials and politicians have our best interests at heart.  Both sides need to look after their own national interests, but those interests can be protected –  probably better protected –  by working closely together, on as common a framework as possibly, consistent with maintaining/pursuing an unquestionably strong banking and financial system.

As for New Zealand citizens and voters, we really should be demanding much higher standards from our top central bankers, who seem unable or unwilling to answer simple questions and challenges about what the Governor is proposing, or to do so in ways that are straightforward and reasonably defensible  That really should worry Grant Robertson, who is responsible for these men and for the institution.

The Deputy Governor goes to Sydney

Reserve Bank Deputy Governor (responsible for the financial stability portfolio) Geoff Bascand gave a speech in Sydney earlier this week.  The title was “Supporting sustainable economic growth through financial stability policy”, but it was really an effort to shore-up support for his boss’s radical bank capital proposals, and in particular to attempt to leave readers and listeners with some sense that there were robust grounds for having minimum core capital ratios materially higher (in headline terms, and in effect given differences in how rules are applied) in New Zealand than in Australia and that in the current climate there was lots of financial system risk.

Despite all the talk of consultation and review, I think it is now safe to assume the Governor won’t be backing down to any material extent.    The decision is due to be announced in “the first week of December” and since it is now mid-October the Governor must be very close to taking a final decision –  given that they still have to produce a Regulatory Impact Statement and a cost-benefit analysis to buttress whatever choice he makes, and (done reasonably) they take time.  Geoff wouldn’t have been sent off to sell the merits of the proposal in public, in Australia, if there were any prospect of any material turning.

The speech opened with a bit of a championing of inflation targeting.  It was a bit once over lightly (and Figure 2 leaves quite a bit to be desired) but it wasn’t really his main point.    Then we got a strange claim that

Usually our price stability and financial stability policies are complementary. However, the low interest rate world we live in complicates achieving both of our objectives, encouraging a build-up of leverage in the financial system. The persistent decline in long-term and short-term interest rates has supported very high levels of private sector leverage.

He made no effort to justify his claim around monetary policy at all (and recall that at the last MPS the Governor said interest rate mechanisms were working just fine), but the claim around leverage is pretty strange.  He says “a build-up of leverage in the financial system”, and yet the speech includes a chart illustrating the increase in the ratio of tier 1 capital to tangible assets over the last decade (that’s a reduction in leverage).  Then he talks about “very high levels of private sector leverage”.  And yet the chart under that paragraph shows that credit to households and businesses (including agriculture), as a share of GDP, is no higher now than it was in 2007 –  levels that did not lead to any particular economywide or systemic problems in New Zealand.  As for “leverage” –  debt to assets –  since asset prices (especially housing) have generally risen faster than GDP, economywide leverage must also have fallen.

For a senior official, with an economics background, responsible for financial stability to show little or no sign of having thought about why equilibrium interest rates now appear to be so low is…..well, quite a gap.  He seems confident that monetary conditions are ‘expansionary” but there looks to be little –  in credit growth, in asset price inflation, in wider consumer price inflation, in GDP growth rates relative to potential –  to support that proposition.

Then he moves onto his attempt to tell a story of heightened (financial stability?) risks.

We recognise that the risks globally are high, and New Zealand is particularly vulnerable to external events. Our economy is quite small – less than a fifth of the size of the Australian economy, and just like Australia, New Zealand is heavily reliant on commodity exports and is very open to financial capital flows. Commodity price movements in world markets determine the value of our key exports, as well as the price we pay for our imports, particularly those that are fuel-related. Monetary policy moves by foreign central banks may generate unfavourable fluctuations in our exchange rates.

Remarkably, that appears to be the only reference to exchange rates in the entire speech –  about how unhelpful they can be.  There is no sense that, in response to significant external shocks, both New Zealand and Australia have typically found exchange rate adjustment a helpful buffer.  I’ll come back to that point.

Then there is more of an attempt to convey a “New Zealand is more vulnerable” story, illustrated by reference to this chart.

bascand oct 1

It was a strange way to mount an argument – even if one thought the past two shocks (Asia crisis and “GFC”) were predictive of the future –  especially as he goes on to acknowledge that Australia’s term of trade (and thus incomes) have been pretty volatile.  Debt is nominal, and here is how growth in nominal GDP have compared in the two countries over much the same period.

bascand oct 2

Neither the frequency of fluctuations nor the amplitude of them look much different between New Zealand and Australia over this period.

Continuing his attempt to play-up differences we hear about nature

In addition to the disruptions in the global economic environment, the New Zealand economy is occasionally affected by weather-related shocks, such as droughts, that constrain the agricultural sector. In the past, we have also suffered severe damage to our infrastructure due to earthquakes.

Well, fine I suppose but (a) they have pretty savage droughts in Australia too, (b) droughts rarely pose any sort of systemic threat to the financial system, (c) Australia is materially more at risk (in economic terms) from climate change, and (c) the earthquakes story is mostly an issue about insurance (including supervision thereof) not banking, and about fiscal policy.  Perhaps there is a case for New Zealand to have lower public debt than Australia – although since his boss is champing at the bit for our government to spend and borrow more, I suspect that wasn’t the argument he was trying to make.

Then there is an attempt to play up housing exposures (apparently unaware that household debt ratios are higher in Australia than in New Zealand) and dairy exposures (but, remarkably, with no mention of the exchange rate as buffer), ending with this summary

That’s why maintaining financial stability in this highly vulnerable environment is challenging.

You might suppose that this “highly vulnerable environment” claim might have been backed by, say, stress test results.  But I guess they might have –  as previous ones have –  got in the way of Reserve Bank storytelling.   There is little or no credible basis for trying to claim that the New Zealand financial system is unusually or highly vulnerable.  Here, after all, is the Deputy Governor’s own chart.

bascand oct 3.png

Considerably more core capital than the banks had in the 00s, and we all know how modest the loan losses were in the subsequent, quite severe, recession, even coming after five years of rapid broad-based credit both (without even the moderating and guiding benefit –  so the Bank tells us – of Reserve Bank LVR restriction).

And then Bascand moves on more directly to making the case for the Governor’s planned swingeing increases in capital requirements for locally incorporated banks here.

Much of it is just a rehearsal of the same weak arguments we’ve heard all year.  There is the “very high” cost of crises, without any attempt to distinguish crisis effects from the misallocation resources in the preceding boom.  There attempts to minimise the (national GDP) cost of the insurance –  on Bascand’s own numbers from a previous speech perhaps $750 million per annum-  an argument which only works on implausibly large estimates of the costs of crises averted.

But there were new weak arguments. Thus

Also, it is worth recalling that capital requirements aren’t like other regulations, in that they don’t create an ‘expense’ for banks. Indeed, in an accounting sense, interest expenses would reduce for the same level of funding.

Does he really expect anyone to take seriously a claim that imposing a whole new funding structure on private sector businesses is really any different in spirit than all manner of other regulations –  especially when the Bank’s own numbers assume overall funding costs will increase.

On he ploughs

Our approach from the outset has been to set capital requirements at a level where we can be confident that these costs are outweighed by the benefits of a safer financial system.

But (a) we know from the published documents that the 1 in 200 year threshold was plucked out of the air at the very end of the process, and (b) since there is still no cost-benefit analysis how can they, let alone the public to whom they are accountable, be so “confident”?  It would be interesting to hear the Deputy Governor’s response to the recent paper issued by the BIS, reporting the work of various senior central bank officials, which would cast considerable doubt –  more generally –  on claims that anyone can be ‘confident” that such high minimum requirements as the Governor is planning offer a positive payoff.

The speech moves towards a conclusion with a page and a half on international comparisons.

We set our capital requirements according to the New Zealand specific risk environment, but we also acknowledge how we ‘stack up’ internationally, and why we may need a more capitalised banking system than those in other countries.

Recall that the Bank has never seriously engaged in public with the PWC work suggesting that effective capital requirements in New Zealand are already materially higher than those in most other advanced countries, and they not once produced any careful evaluation demonstrating how their requirements will stack up with those of APRA (in Australia and in their requirements for the entire banking groups).  Apart from anything else, APRA is a pretty well-regarded regulator on such things, and the benchmark would provide a useful basis for meaningful debate about just what is appropriate for New Zealand.  The short answer, of course, is that New Zealand’s core capital requirements will be materially more demanding than APRA’s, and even the total loss-absorbing capacity will be more demanding. Until now, the Bank has never attempted to articulate why it believes that is appropriate.

In his speech in Wellington in February (which I wrote about here), Bascand used a chart showing how capital ratios might compare across a selection of countries using S&P risk-adjusted capital (RAC) methodology.  He didn’t speak to it much, but it was helpful PR at the time as – the way S&P did things –  New Zealand’s current capital requirements produced the lowest capital ratios of any of the countries on the chart, and the Bank’s proposals put us only in the upper quartile of countries.

But the chart has been updated and this is the current version

bascand oct 4.png

Now – among this particular range of countries –  our current requirements produce ratios (on S&P’s methodology) that are more or less middle of the pack, and the Governor’s proposals would generate – again on the S&P methodology –  capital ratios higher than in any of these countries, other than Iceland.  And you will recall that tiny Iceland had an absolutely awful, world-scale, financial crisis only a decade ago.  Perhaps their caution, extreme risk aversion, is understandable.

Why did the estimated New Zealand capital ratios rise?  Because S&P revised their view of New Zealand’s economic and institutional position and concluded that we weren’t quite as bad as they thought previously.  Their assessments –  the BICRA scores –  move around a bit, and which category they put a country in then affects, quite substantially, the risk-weights applying to credit exposures in a particular country.    Because S&P think New Zealand is a riskier place than most advanced countries, risk weights used here in doing S&P’s calculations are higher than those in most other places.  And even so, on the Governor’s proposals, we still end with among the very highest capital ratios in the world.  If you think, for example, that risks here are greater than in Hong Kong (as S&P do) I have bridge for sale.  Or as risky, economically, as the UK –  where no one, but no one, knows what regime they will be under two week from now…..

International comparisons are hard to do well.  But the Reserve Bank has had a great deal of time to do better than this.  And yet appears not to have even tried. Not even around comparisons with Australia.

(Oh, and why does S&P take such a dim view of New Zealand.  Their methodology has long put great weight on the negative net international investment position.  Big changes (worsenings) in such positions do seem to have been associated with subsequent nasty macro adjustments, but New Zealand’s NIIP position has been at (or above) current levels for 30 years now.  If it were really an indicator of a serious vulnerability, it would almost certainly have crystallised by now.)

And before leaving this chart, I mentioned earlier that the Deputy Governor mentioned the exchange rate only once, and then unfavourably, in his entire speech.  But any serious macroeconomic analyst of financial stability risks recognises that a floating exchange rate can materially increase an economy’s resilience, especially when very bad events happen.  Part of the challenge of Greece and Ireland in the last crisis was that a fixed exchange rate (within the euro area) meant they had no capacity to use monetary policy to lean against demand excesses during the boom, and no capacity for the nominal exchange rate to adjust down when things went badly wrong.  That isn’t the New Zealand and Australian position. And yet on the Deputy Governor’s chart, almost half the countries have fixed exchange rates (and one other has bound itself to enter the euro in future).  That is a legitimate policy choice, but all else equal it would tend to require higher bank capital ratios to cope when things go badly wrong.

The final substantive section of the speech is headed “Relationship with Australia”.  Remarkably, it is a mere three sentences long, two of which are really just mechanical statements about “working closely together while pursuing respective national interests”, and nothing at all (for example) about crisis resolution (even though any banking crisis in one of the big four is inevitably going to be trans-Tasman in nature, and highly political).  The substance, such as it was, was an attempt to defend taking a tougher line on capital than APRA does.

This is the entire “argument”

Our conservatism, relative to Australia, in our bank capital proposals reflects the higher macroeconomic volatility that we have endured, as I pointed out earlier.

That is just pitifully poor, coming from such a senior figure, speaking to an international audience.  And it is not as if it was backed up with detailed discussion in the official consultative documents.  No, that’s it.

Remarkably, he doesn’t even engage with the difference between the New Zealand and Australia numbers in his own S&P chart (see above).  On S&P’s estimates –  and Bascand is quoting them, not me –  New Zealand bank Tier One capital ratios already higher than those in Australia, and would be far higher if Orr’s plans are proceeded with.  And that within a framework –  S&P’s –  that already marks New Zealand down as somehow less sound than Australia (we are grouped with Iceland, Malaysia, Mexico and the like).  Those differences –  alleged greater vulnerabilities – already captured, and we still come out with far higher core capital ratios than Australia.

It is a story –  well, more accurately, a line – I don’t find persuasive at all.

When Geoff Bascand gave his speech in Wellington earlier in the year the question of the appropriate degree of conservatism relative to other countries came up.  I wrote this.

In the question time yesterday, the Deputy Governor was given the opportunity by a sympathetic questioner to articulate why the Bank should be conservative relative to many other overseas banking regulators.   He didn’t offer much: there was a suggestion that New Zealand is particularly subject to shocks, and a claim that New Zealanders are strongly risk-averse (but not evidence, let alone that these preferences are stronger than those of people in other advanced countries).  I can identify grounds on which some regulators might sensibly be more conservative than the median:

  • if you were in a country with a bad track record of repeated financial crises.  But that isn’t New Zealand,
  • if you were in a country where much of credit was government-directed (directly or through government-owned banks).  But that isn’t New Zealand.
  • if you were in a country that depended heavily on foreign trade and yet had a fixed nominal exchange rate. But that isn’t New Zealand.
  • or no monetary policy capability of its own. But that isn’t New Zealand.
  • or if you were in a country where the public finances were sick.  But that isn’t New Zealand,
  • or if you were in a country where the big banks were very complex and you weren’t confident you understood the instruments. But that isn’t New Zealand.
  • or if you were in a country where the big banks had no cornerstone shareholder, were mutuals, or where the cornerstone shareholder was from a shonky regime. But that isn’t New Zealand.

The case just doesn’t stack up.

In particular –  and these are speeches given by the Head of Financial Stability –  there is no attempt to engage with the simple fact that the risks the Australian authorities face are much greater than those New Zealand authorities face precisely because our banks are owned by their banks and parental support is a credible prospect in all but the worst shocks.  By contrast, there is no cornerstone or dominant shareholder of any of the Australian banks and no one for the Australian authorities to look to if things ever go really badly wrong there.  And they could, as they could here.

If this was the best case the Reserve Bank could put up –  sending out the least-bad of their senior tier to a professional audience in Australia (it was not a junior manager making the case to the local Rotary Club) –  we should be even more worried about what is going on at the Bank, and the ability to top statutory officeholders to make and articulate good policy, than even I had feared.  Perhaps we should feel a little sorry for Bascand –  he has, after all, to make the case for the boss’s whims –  but he is himself a senior figure, a highly-remunerated senior holder of a statutory office.  If the case as is threadbare as this speech made it seem, the onus is surely on people on him to do something about it.

 

 

 

Culture and conduct in question

Stuff’s new, apparently Canadian, journalist Kate MacNamara is doing a pretty good job of keeping up the pressure on the Governor of the Reserve Bank, Adrian Orr.  It is hard to believe a New Zealand journalist would have done so –  one column perhaps, but not three in a week.  Then again, I’m pretty sure we’ve never had a Reserve Bank Governor behaving in quite such an egregious and unacceptably poor way –  not as a single lapse of judgement either, but as a sustained pattern of behaviour.  Sadly, the conduct of the Board (and the Minister?) in such matters, of which more below, is all too typical of the New Zealand establishment.

MacNamara’s latest (“Orr’s culture and conduct in question”) was in the Sunday Star-Times yesterday.   She frames the issue as one of whether the desired end (a stronger banking system) justifies the means (Orr’s conduct).  I’m not sure that is the best way to frame the issue, but here is her take

In December, the Reserve Bank released its boosted capital reserves proposal and asked all interested parties to make submissions.

It would be an open process, the bank said, welcoming all views. But that characterisation was soon at odds with the governor’s behaviour.

Numerous parties involved in the submission process described a pattern of behaviour by Orr of belittling and berating those who disagreed with him.

Orr has penned his critics letters and threatened to broadcast them. He has confronted submitters on the sidelines of industry conferences. Sometimes he called them up at odd hours to tear a strip off them for their views.

And that is before starting on the not-particularly-robust analysis in support of the Governor’s proposal  –  for a huge increase in bank capital ratios, after years when the Bank assured us the system was sound and robust – that the Bank has, only slowly, been rolling out.  Cost-benefit analysis anyone?  Only after he has made his final decision –  for which there are no rights of appeal –  the Governor tells us.

As MacNamara notes, Orr wields an extraordinary level of power in this area –  unparalleled, as far as I know, anywhere in the advanced world.  He can wheel up a proposal, working to no very well defined parliamentary mandate, has only to jump through process hoops around consultation, and then makes the final decision all by himself.  There are no substantive appeals allowed, and the Minister of Finance cannot overrule him (though could, if he chose, bring other pressures to bear).

One of my criticisms of the Governor is that he doesn’t stay in his lane, and sounds off on all manner of highly political issues in pursuit of his personal ideological agendas (in ways we’d find quite unacceptable if other senior independent figures –  the Police Commissioner, the Chief Justice eg – were to do it).  Sadly, that has become quite common –  especially around climate change – among central bankers globally, and Mark Carney (Governor of the Bank of England) has made pretty clear his personal views on Brexit.  As MacNamara notes, apparently

To provide a little context, Orr was recently compared in his outspokenness to Bank of Engand governor Mark Carney.

Paul Waldie covers Carney in London as the European correspondent for Canada’s Globe and Mail newspaper. Carney was previously governor of the Bank of Canada.

Carney has been criticised for playing politics in his estimations of the cost of Brexit in the United Kingdom.

But Waldie is emphatic. “He’s never rude. He’s never personal. He doesn’t hit back at his critics. He’s cool-headed.”

Carney provides no precedent for phoning adversaries after hours, neither blasting them from the lectern or on the sidelines of industry meetings and events.

He gives serious thoughtful speeches as well.

MacNamara concludes

On the contrary, Orr appears to be unrivalled among central bankers in the developed world for the tempestuous and personally directed venting of his views.

I’ve watched, and participated in, central banking for a long time, and that would be my view too.  MacNamara introduces another overseas expert on such matters.

Annelise Riles of Northwestern University’s Buffett Institute for Global Affairs, who’s studied the behaviour of central bankers and has even written a book about them, couldn’t think of a single comparator in contemporary times.

Central banks certainly use many channels to communicate with banks, she said. And it’s not uncommon for central bankers to let banks know how they feel.

“But berating them publicly is just not seen very much,” she said. And though private exchanges are less visible, she couldn’t think of any examples of bald incivility or hostility.

Central bank heads often aren’t even close to saints  (just think back a few years to the way Graeme Wheeler and his top team –  including the current Dep Governor – were used in a not-at-all subtle attempt to shut down criticism from the BNZ’s Stephen Toplis), but nonetheless Orr’s sustained pattern of conduct seems to stand out.  Perhaps the only “defence” one might make of it is that what you see is what you get –  he has always been known for these sorts of tendencies.  He can behave fine when he is on top in an unquestioned way, but put him under any sort of pressure and he isn’t someone to conduct himself with dignity, civility, and respect.

I haven’t had particularly bad experiences of Orr’s personal conduct myself. I had quite a bit to do with him in his two earlier stints in the Reserve Bank, but when he was Chief Economist I was in the Financial Markets Department and when he was head of financial markets and bank supervision I was in the Economics Department.  I saw shonky analysis in support of questionable policies, and didn’t have much time for his divisive style (which, remarkably, he owned up to in a farewell speech when he left the Bank the first time).  But I was left some mix of underwhelmed and bemused  –  at this extremely ambitious, outgoing, sometimes amusing, opportunistic, but not fundamentally serious person –  rather than having any particular sense of personal grievance.  When he was appointed Governor I wrote a couple of posts (one here) that I still think read as a pretty balanced treatment, if generous with the benefit of hindsight.

Others have had a much stronger view.  This comment was left on my Saturday post by Geof Mortlock, who worked directly under Adrian during both of Orr’s previous Reserve Bank stints.

None of what we are seeing with Adrian Orr surprises me in the least. It is precisely what I had expected when he was appointed as governor. The problems so clearly revealed now for all to see were very much evident to me and many others when Orr was deputy governor and head of financial stability in the period 2003 to 2007.  He created a sense of panic when there was no need for it. He engaged aggressively with Australian banks when mature, adult dialogue would have been far more effective and appropriate. He facilitated and abetted an aggressive and petulant fight with APRA, RBA and Aussie Treasury over trans-Tasman regulatory issues rather than seeking to resolve them in a considered, intelligent manner. He engaged aggressively with staff and routinely bullied them. He created a deep level of stress in the RBNZ among staff that contributed to the departure of some key people. I can attest to what it was like working with him. I and others departed the RBNZ because of the severe impact he had on morale and because of concerns over mismanagement of issues and because of the appalling culture that he and others created in the RBNZ. Bollard presided over much of this, either unaware or unconcerned, and did nothing to address the matter from what I could see.

Now that Orr is governor, his unsuitability for the job is evident for any impartial observer to see. The lack of judgement, unsuitable temperament, lack of maturity, inadequate knowledge of the issues and a serious failure to intelligently addressthe policy issues are all obvious to anyone who cares to look at his performance.

Sadly, the RBNZ Board seems to lack the competence or mettle to do anything about it. Its recent annual report was a pathetic effort at exercising meaningful scrutiny over Orr. Even more sadly we seem to have a minister of finance who is asleep at the wheel and either turning a blind eye to Orr’s appalling incompetence in handling the tasks entrusted to him or who is happy to see Orr playing an overtly political role that is totally inappropriate for someone holding office as governor.

It is time that the people with authority over Orr did something about his conduct, statements and handling of policy issues. The RBNZ’s credibility is at stake. And serious policy outcomes are under threat. Robertson and the Board need to take action to address the Orr problem.

Ah, the Board.  They got us into this mess.   Assuming they followed the provisions of the Act (and didn’t just take guidance from Grant Robertson) they are the one’s responsible for his appointment as Governor.  They don’t have many other specific powers, but they have an overarching responsibility to keep under “constant review” the performance of (a) the Bank, and (b) specifically, the Governor in whom most of the powers of the Bank are still personally vested.    If the Board isn’t satisfied they must advise the Minister in writing, and may go so far as to recommend the dismissal of the Governor.  (Regardless of the views of the Board, the Minister may also recommend dismissal of the Governor is satisfied that the Governor has not “adequately discharged” the responsibilities of his office.)

Last week I suggested that one omission from the first MacNamara article was any sign of having approached the Board.  I didn’t expect she’d get much if she asked, but what the chair said was likely to be telling, even if he simply stonewalled.   Anyway, for this week’s article MacNamara went to the chair, the economist academic (and Vice-Chancellor of Waikato) Neil Quigley and sought comment.  This is what she got.

Orr’s chequered behaviour is not something on which the Reserve Bank chairman, Neil Quigley, is prepared to act.

“I have not received a formal complaint from any party about the governor’s interaction with them,” he said. “The Board has full confidence in Adrian Orr’s leadership.”

Some people will argue that Quigley had little choice but to express full confidence (for a corporate board you back the incumbent until you sack him or her).  I don’t agree with that take, given that the Reserve Bank’s Board is explicitly set up as a monitoring and accountability body, with its own public reporting responsibilities etc separate from those of the Bank.     It isn’t an executive body.

But what startled me wasn’t the formulaic “full confidence” line  so much as the rest of the comment.  Here is how Eric Crampton phrased his response to Quigley’s comments

eric orr.png

Quite.   Of course, Orr doesn’t have much power over some people who have been badly treated by him –  for example, the academic Martien Lubberink –  but the general point, that one is dealing a very powerful man here, is well made.  How did the Board so diminish its own sense of its role that the only thing they’d be interested in is a “formal complaint”?  And why would they suppose anyone would bother them when the Board –  under Quigley and his predecessors (think of the Toplis business or the OCR leak) –  has a long record of really only acting as fronts for successive Governors (even on rare occasions when something approaching a “formal complaint” has been made).    It is almost like a climate in which everyone knows there has been, say, a culture of sexual harrassment in an organisation, perhaps starting from the top, but no one quite has the courage to lodge a formal complaint –  the fact that “everyone knows” something should still put a Board on notice that there is something to get to the bottom of, something that needs addressing.   Quigley and his colleagues surely are reading the newspapers and other commentary and they should be keeping an ear open on the cocktail party circuits etc they no doubt frequent. It is their job –  “constant review”, not simply responding to a “formal complaint”, whatever one of those might be in this context.

That is what serious people doing the Reserve Bank Board job would be doing.  But, of course, no one –  with the possible exception of the Governor –  has any confidence in the Board to do its job.  It is why the government has made an in-principle decision to remove that role from them, but in the meantime perhaps they do a public service in demonstrating just what a pointless useless entity there are.  I gather the Board has its monthly meeting on Friday,  It is time for a rethink, and for beginning to finally take seriously the growing concerns about the Governor, not waiting for “formal complaints” Perhaps Quigley’s comment could even perhaps spur a few people to consider lodging ‘formal complaints” –  not necessarily because as individuals they can’t cope with a rude bully, but because we should expect much better standards of behaviour from powerful public figures.

The whole episode –  the bank capital review –  has been characterised by poor process, poor substance, and astonishingly poor conduct, all of which are the Governor’s personal responsibility.  He needs to be called to account –  and not just by a journalist and a few specialist commentators –  by those formally charged with doing the job (Board and Minister), but also by his own senior managers (eg he has a deputy governor with a secure statutory position and earning $600000 per annum), decent people who must be getting increasingly uncomfortable with the boss’s style.   Apart from anything else, it is simply a shocking model for up and coming central bankers and financial system regulators.  People are shaped, for good and ill, by those who lead the organisations they are part of.   Rigour, detachment, courtesy, openness, gravitas, judiciousness and so on are the sorts of qualities we should expect to find in a Reserve Bank Governor.  Not one of them seems to characterise the incumbent.  It isn’t a single lapse of judgement, but a systematic pattern of  the sort of culture and conduct that should alarm anyone who cares about good governance and high-quality policymaking in New Zealand.

Portrait of a strongman

It didn’t seem like the best weekend for Reserve Bank Governor Adrian Orr.

First, there was Radio New Zealand’s Insight documentary on the Governor’s bank capital plans, and other possible new regulatory burdens.  I was impressed with the huge amount of time and energy that was put into the programme, although inevitably there are limitations in what a programme designed for a mainstream Sunday morning audience can deal with.     In some ways, the best public service now would be if Radio New Zealand and/or the Reserve Bank agreed to release the full interview Guyon Espiner did with the Governor –  we were told it was an hour long, but no more than five minutes would have been used in the programme (I presume this was par for the course on Espiner’s background work, as I did an interview with him that went for perhaps 40+ minutes).

In commenting on the substance of the programme one then has to be a bit careful.  The selection of quotes and the framing is Espiner’s (and I did notice a couple of small errors) and although he is a responsible senior journalist, the way he presented material isn’t necessarily the way the Governor himself might have chosen to.  Then again, the Governor has plenty of communications media open to him and after 18 months in the job still hasn’t given a speech about financial regulation topics, for which he personally has huge personal policy freedom.

But as RNZ presented the Governor’s arguments, they were less than impressive.  They seemed to be playing distraction more than engaging with what should be the core issues.  Not once, at least according to my notes, did he engage on the possible costs and distortions his proposals would introduce (whatever the possible benefits). Not once, for example, did he engage with how comparable his proposals are to the regime that will apply in Australia to the respective banking groups (hint, Orr’s are much more onerous).

Instead, we got irrelevancies.  The Governor decreed that banks were earning too much money in New Zealand.  Not only that, in his tree god and garden imagery, the (Australian) banks were “darkening the garden”, such that the market was not as competitive as it should be.  Perhaps there is something to those arguments, but they are simply not the Governor’s job and should be irrelevant considerations in proposing to exercise regulatory powers under the Reserve Bank Act (directed to promoting the soundness and efficiency of the financial system).  We have a Commerce Act, there are powers now for the Minister of Commerce or the Commerce Commission to initiate a market study.  But that has nothing at all to do with the Reserve Bank, the prudential regulator, not the competition authority.

Orr came a little closer to his own ground, and to respectable arguments, when he suggested that existing capital (and leverage) ratios were just too low, and thus that banks were “too risky”.  That might have been a touch more persuasive if, for example, he’d engaged with the standalone credit ratings of the banks operating here, or talked about the differences between a strongly-diversified big bank and an individual borrower (instead he tried to imply that the risks, and hence appropriate capital, were much the same).  There was the rather weak claim that “at times” housing crises have led to banking crises, but no attempt to unpack that claim, or to engage with the repeated stress tests his own institutions has done this decade.  Let alone, to consider the experiences of banking system like our own (or Australia’s or Canada’s or Norway’s) that with floating exchange rates and governments out of the housing finance market have proved resilient over many decades.

Instead we got another attempt at distraction, suggesting that the New Zealand experience in 2008/09 was really rather a close-run thing.  He knows it wasn’t so. He knows that the issues the New Zealand banks (and their parents) faced in 2008/09 were about liquidity, not about credit quality or loan losses.  There had been a degree of complacency among the banks about liquidity in the 00s –  I recall one discussion with the head of risk at a major bank in about 2006 who simply could not conceive of a world in which funding liquidity markets would dry up almost completely.   But liquidity is a different issue than loan losses –  which were modest in a fairly deep recession after a period of very rapid credit growth – and even the liquidity/funding issues New Zealand banks faced never threatened to bring any of them down.  And the Bank addressed the funding/liquidity issues almost a decade ago, with much more stringent policy requirements.    And risk-weighted capital ratios are already higher than they were going into the last recession  –  partly under regulatory pressure, partly market pressure  –  a recession when (to repeat) the loan losses were pretty modest and not at all threatening.

Then we had more rhetoric about how the Bank was not going to “keep falsely subsidising bank businesses”, although the nature of any such “subsidy” was never clear given (a) the resilience of banks to the Reserve Bank’s own stress tests, and (b) the central place the Bank has long argued OBR should have in handling any bank failures in New Zealand.   But it probably sounded good.  And then he fell back on attempts to exaggerate the costs of financial crises, with talk of “generations of lost employment opportunities”, mental health failures, and vague allusions to various “challenges” of the world right now –  the Brexit, Trump duo again I suppose – being down to insufficient bank capital.    Evidence and sustained argumentation would help –  if not on a short radio programme then, for example, in speeches and robust consultative documents and –  perish the thought –  upfront cost/benefit analyses (as distinct from the ex post one they might eventually show us).

There was some discussion of dairy lending.  As the Governor fairly noted there had been some fairly aggressive and unwise lending to that sector over the last 15 years (in the early part of that period the impression was that the offshore parents had little real idea of what the subsidiaries were doing in that sector).  Dairy farm economics doesn’t look as it once did, for various market and (actual/proposed) regulatory reasons, so no doubt there isn’t the same bank risk appetite there once was.  But it is quite unconvincing for the Governor to try to pretend his capital proposals won’t exacerbate pressures in that sector, or in other sectors where specific hard-to-extract and manage  knowledge/experience is key to good lending.  Big corporates, for example, who can simply turn to banks not affected by the Governor’s proposal (overseas-based banks, and even the parents of the NZ locally-incorporated banks).  I doubt credit supply will be too adversely affected for residential mortgage finance either.  But for other sectors, including dairy, who does the Governor expect to step into the gap?  Wasn’t he talking (see above) about insufficient competition?  Won’t these proposals weaken that competition, especially as all the locally-owned banks are themselves capital constrained?

The Governor also tried to claim that the Bank’s existing capital rules had somehow “caused” the banks to run into problems on dairy lending, citing differences in risk weights used by various banks for apparently similar lending.   Even to the extent there is an issue there, it is worth remembering that (a) by far the biggest increases in dairy lending occurred (last decade) before the advanced models approach came into effect, and (b) good banks get things wrong from time to time, and none of the actual or stress-tested dairy losses pose any threat to systemic stability.  The Governor’s numbers tell him so.   We want banks to lose money from time to time –  were they not doing so the Governor (on another day, another trope) would probably be complaining about them taking insufficient risk, holding back opportunities etc.

And then, of course, there was the cavalier line I wrote about on Friday: the Governor in essence telling the banks that if they don’t like his rules (and him as prosecutor, judge and jury in his own case) they can just take their money and go.  I wrote about this  irresponsible line on Friday.

Perhaps we should see his talk –  all it appears to be at present – about banning people from serving on both the boards of parent and New Zealand subsidiary at the same time, as all part of that same mentality of suspicion of Australian banks.  The Governor shows little or no sign of appreciating the value New Zealand, and New Zealanders, get from having banks that are part of much larger banking groups, from a country with a track record of a stable and well-managed banking system.  He talks a lot about the standalone capacity of New Zealand subsidiaries in a crisis, but very little about the benefits of integrated banking operations in more normal circumstances (ie at least 99 per cent of the time).  He seems to be hankering for the Australian banks to sell down their shareholding in the New Zealand subsidiaries –  acting as, in effect, an agent for NZX and the New Zealand funds management industry – while showing no sign of recognising that a more arms-length New Zealand operation might also be one less well-placed to receive parental support if something ever does go wrong.

All in all, I just wasn’t persuaded that Orr was even trying to make a serious sustained analytical case for the specific policy he is pursuing.  Playing distraction seemed to be more the style.  (Perhaps I’m wrong and the tape of the full interview would no doubt tell us more.)  That, after all, is the problem with the regime: at least formally, under the law, having dreamed up this proposal all by himself, the only person he actually has to convince of its merits is….himself (final decisionmaker).

Oh, and I almost forgot to mention Auckland University economics professor Robert MacCulloch’s comments.  He highlighted the “sheer lack of raw intellectual firepower” at the Bank, and claimed that neither the Board nor the senior management were really up to the job.  I probably wouldn’t have put it quite that strongly –  there are still able people but in the Board’s case they seem to have no interest in doing anything other than covering for the Governor, and in the staff’s case, personal self-protection –  with a Governor who does not welcome challenge –  is a deterrent to people speaking up even if they have (a) stayed on, and (b) disagreed.      The Bank has lost a lot of good people this year, for various reasons, but few would have had much involvement in the bank capital issues.  MacCulloch’s other comments resonated more strongly with me: there is no history of extreme fragility in the New Zealand banking system (“rather the opposite in 2008”) and that the Governor’s style is undermining confidende in the Reserve Bank, at home and abroad.

Of course, only a few geeks would try to unpick the Insight programme.

But the Sunday Star Times did us a public service with a big double-page article on the Governor that was distinctly less than flattering.  The online version ran under the title “Portrait of the Governor as a strongman”.  I’d encourage you to read the article. Several critics were actually willing to go on the record –  not, of course, ones from among the banks (the “strongman” has a lot of power over them).

Here is an extract, starting with reference to the heavyhanded stance Orr took with veteran and highly capable journalist Jenny Ruth at a recent press conference

The video of the conference remains on the Reserve Bank’s website. Some reporters said they were stunned Orr would air his anger so publicly and called it bullying.

But other observers were not surprised. Details of Lubberink’s experience were already circulating in Wellington and industry sources say they match a pattern of hectoring by Orr of those who question the Reserve Bank’s plan.

“There is a pattern of [Orr] publicly belittling and berating people who disagree with him, at conferences, on the sidelines of financial industry events,” said one source who’s been involved in making submissions to the Reserve Bank on the capital proposal.

There have also been angry weekend phone calls made by Orr to submitters he doesn’t agree with.

“I’m worried about what he’s doing.”

The source said some companies have “withheld submissions,” for fear of being targeted by Orr.

“They’re absolutely scared of repercussions. It’s genuinely disturbing,” he said.

(Orr told someone recently he didn’t read what I write –  his perfect liberty of course –  so I guess I’m safe from the “angry weekend phone calls”.)

Sadly, one can’t really say it is shocking.  It is, more or less, what one might have come to expect.  But it is appalling, and a far cry from the sort of standard the public has a right to expect from such a powerful public servant.  Wielding so much power singlehandedly, with few checks and balances, we need someone with a judicious and calm temperament, happy to engage openly and non-defensively, and so on. Instead we have Adrian Orr.

The article reports that Orr refused to be interviewed.  But perhaps the bigger question is why the journalist responsible –  for a very useful and courageous article –  showed no sign of having sought comment from Neil Quigley, the chair of the Bank’s Board who is paid to hold the Governor to account.  And there was no sign either of having sought comment from Grant Robertson, the person who actually has the power to dismiss the Governor and whom –  as voters –  we might expect to be visible when concerns like these are raised.  (And if the Minister of Finance isn’t visible, why isn’t the Prime Minister insisting that her Minister do his job?)  The behaviour as reported should be unacceptable in a democratic society governed by the rule of law and conventions of acceptable conduct.

Another quote from the article

In the cut and thrust of the debate, Orr’s jokey style and everyman charisma fell away. In recent months he’s dogmatically insisted the cost of his plan would be minimal and has picked personally at critics in the media, academia, and the financial services industry.

He’s been variously described as defensive, bullying, and perilously close to abusing his power.

“He’s in danger of bringing scorn on his office,” said long-time industry watcher David Tripe, professor of banking at Massey University. “I used to know him well. I no longer feel so confident.”

I was exchanging notes last week with someone about comparisons between Graeme Wheeler and Adrian Orr.   The SST article reports insiders claiming that Wheeler had not been keen on the idea of big increases in capital requirements for locally-incorporated banks.  If so, that is to his credit.

Not much else was. I’m not going to repeat his failings, but recall just how unpopular he had become with key stakeholders by late in his term (the survey the New Zealand Initiative undertook). By the end, his departure was almost universally welcomed, and must almost have been a relief to him too, as someone never at all comfortable in the public spotlight.

Orr is more a polarising figure, in that he does still have some supporters, but they must be getting quite uncomfortable with his style, even if they are sympathetic on substance.  But a rerun of that NZI survey would be unlikely to show up the Bank in a good light.  The more time goes on the more unsuited Orr appears to be for the office to which the Bank’s Board and the Minister of Finance appointed him.     He degrades the standing of the Bank here and abroad, as well as eroding its internal analytical capability and whatever spirit of robust internal debate was left after Wheeler, and undermines confidence in the institution’s ability to manage real threats.  It is rather sad to watch, but perhaps only a slightly more extreme example of the sustained degradation of policy capability and leadership in New Zealand public life and public sector this century.

 I hear on RNZ this morning the Governor was quoted as pushing back – I think mainly against MacCulloch – suggesting that criticisms were “narrow nitpicking”.  But there is a long list of sceptics, and of reasoned critical submissions on what is proposing, and how he is doing it. For anyone interested, here was my formal submission