Deposit insurance

April 11, 2016March 21, 2018 Michael Reddell Banking, deposit insurance, Financial stability

Late on Friday afternoon, Stuff posted an op-ed piece calling for the introduction of a (funded) deposit insurance scheme in New Zealand. It was written by Geof Mortlock, a former colleague of mine at the Reserve Bank, who has spent most of his career on banking risk issues, including having been heavily involved in the handling of the failure, and resulting statutory management, of DFC.

As the IMF recently reported, all European countries (advanced or emerging) and all advanced economies have deposit insurance, with the exception of San Marino, Israel and New Zealand. An increasing number of people have been calling for our politicians to rethink New Zealand’s stance in opposition to deposit insurance. I wrote about the issue myself just a couple of months ago, in response to some new material from the Reserve Bank which continues to oppose deposit insurance.

Different people emphasise different arguments in making the case for New Zealand to adopt a deposit insurance scheme. Geof lists four arguments in his article

providing small depositors with certainty that they are protected from losses up to a clearly defined amount;

providing depositors with prompt access to their protected deposits in a bank failure;

reducing the risk of depositor runs and resultant instability in the banking system;

reducing the political pressure on government to bail-out banks in distress – deposit insurance would actually make Open Bank Resolution more politically realistic.

Of these, I emphasise the fourth. I’m not convinced that there is a compelling public policy interest in protecting depositors, small or otherwise (many schemes cover deposits of $250000, sometimes per depositor per bank). There are plenty of other bad things in life that we don’t protect people from (the economic consequences of) – job losses, fluctuating house values, road accidents, bad marriages and so on. The ultimate state safety net is the welfare system, which provides baseline levels of income support. Should “deposits” or “money” be different? I’m not sure I can see good economic arguments why (although there are good reasons why in the market debt and equity instruments co-exist, and debt instruments generally require less day-to-day monitoring by the holders of those instruments).

And there is a variety of ways of providing depositors with prompt access to funds following a bank failure. A bailout is one of them. OBR is another. And deposit insurance, in and of itself, doesn’t ensure prompt access to funds; it just ensures that the insured amount is fully protected (minus any co-payment, or deductible).

I’m also not persuaded that deposit insurance reduces instability in the banking system. International historical evidence has been that in many or most cases, depositors can distinguish, broadly speaking, the weaker banks from the stronger banks in deciding whether to run (I would argue that the UK experience with Northern Rock is one recent observation in support of that proposition). And anything that weakens, albeit marginally, market discipline (in this case, by reducing the incentive on deposits to monitor risk and respond accordingly) can’t be likely to contribute to greater stability in banking systems. Deposit guarantees for South Canterbury Finance only postponed, and probably worsened, the eventual day of reckoning.

But I find the political economy arguments for deposit insurance (at least in respect of large banks) compelling. I outlined the case more fully in my earlier post. If we don’t want governments bailing out all the creditors of a failing bank (large and small, domestic and foreign), we need to build institutions that recognize the pressures that drive bailouts and take account of that political economy. It is futile – and probably costly in the long run – to simply pretend that those pressures don’t exist. In its recent published material, the Reserve Bank again just ignores these arguments, but they know them. In fact, I found a quote from Toby Fiennes, their head of banking supervision, who correctly observed a few years ago that

some form of depositor protection arrangement may make it easier for the government of the day to impose a resolution such as OBR that does not involve taxpayer support – in effect the political “noise” from depositor voters is dealt with,” said Fiennes

As I’ve noted previously, in the last thirty years:

The BNZ was bailed out by the government
Finance company (and bank) deposits were guaranteed by the government
AMI was bailed out by the government

And each of those bailouts/protections was done on the advice of the Reserve Bank and Treasury. Two were put in place by National governments and the other (the 2008 deposit guarantee scheme) was done with the support of the then National Opposition.

We have let other institutions fail, and creditors lose their money. Wholesale creditors of DFC lost material amounts of money in that failure (the few retail creditors were protected, mostly for convenience in dealing with the main creditors), various finance companies failed before the guarantees were put in place, and one other insurance company failed after the Christchurch earthquakes and was not bailed out. So our governments have a track record of being willing to allow people to lose their money when financial institutions fail, if the number of people involved is quite small, or the creditors are foreign. But they have no track record of being willing to allow large numbers of domestic depositors/policyholders to lose money in the event of a financial institution failing – and it is not as if these examples are all ancient history; two were resolved under the current government.

And it is not as if governments in other advanced countries have been any more willing to allow retail depositors to lose money. Most of our major banks are Australian-owned, and Australia has relatively recently adopted a deposit insurance scheme, reinforcing the longstanding statutory preferential claim Australian depositors have over the assets of Australian banks. In the event of the failure of an Australian-owned banking group, why should we suppose voters here will tolerate losing large proportions of their deposits when they see their counterparts in Australia – in the same banking group – protected? The Australian government – in the lead in resolving such a failure – is unlikely to be receptive to such a stance either, and if they can’t force us to protect our depositors, there are lots of strands to the trans-Tasman relationship, and ways of exerting pressure if our government did choose to make a stand.

A deposit insurance scheme heightens the chances of being able to use OBR, and thus to impose losses on wholesale creditors, many of whom will be foreign.

But it doesn’t guarantee it. I noticed that Geof’s article included this paragraph

Since the global financial crisis, many countries, including New Zealand, have developed policies that enable even large bank failures to be handled in ways that minimise the prospect of a taxpayer bail-out, by forcing shareholders, then creditors (including depositors), to absorb losses.

I am less optimistic than Geof here. Countries have been moving in the right direction, of trying to establish resolution mechanisms that would enable bank failures to occur without taxpayer bailouts, and in which large and wholesale creditors would face direct losses. But none of these mechanisms has really been tested yet. I’m yet to be convinced that the authorities in Britain or the US would be any more ready to let one of their major banks fail, with creditors bearing losses, than they were in 2008.

I’m reminded of a story Alan Bollard once told us about his time as Secretary to the Treasury. Faced with the prospect of Air New Zealand failing, the Prime Minister of the time asked if Treasury could guarantee that if Air New Zealand failed the koru would be still be flying the following week. Unable to offer any such assurance, the government decided on a bailout. Faced with the prospect of the failure of one of our larger banks, the Prime Minister might reasonably ask the Reserve Bank and Treasury whether they could assure him that, if he went ahead and allowed OBR to be imposed, other New Zealand banks and borrowers would still be able to tap the international markets the next week. At best, officials could surely only offer an equivocal answer. Bailouts remain likely for any major institution (especially as, in our case, resolution of any major bank involves two governments).

I hope I am too pessimistic in respect of wholesale creditors. And we shouldn’t simply give up because there is a risk that governments might blanch and bail out the entire institution. But the best chance of governments being willing to impose losses on larger creditors in the event of failure, is to recognize that the pressures to bailout retail depositors will be overwhelming, and to establish institutions that internalize the cost of that (overwhelmingly probable) choice. A moderately well-run deposit insurance scheme does that, by imposing a levy on banks for the insurance offered to their depositors.

As Geof notes, he has changed his stance on deposit insurance. Looking around the web, I stumbled on “Deposit insurance: Should New Zealand adopt it and what role does it play in a bank failure” a 2005 paper, by Geof and one of his colleagues (now a senior manager at TSB) on deposit insurance, which has been released under the OIA. It is a useful summary of some of the counter-arguments.

One of the issues it covers is the question of whether, instead of adopting deposit insurance, we could achieve much the same outcome by using the de minimis provisions in the OBR scheme. Under those provisions (built into the prepositioned software) deposits up to a certain designated amount can be fully protected, and not subject to the haircut.

As I’ve noted previously, this provision might be useful if it was only a few hundred dollars – effectively, say, protecting the modest bank balance of a very low income earner or superannuitant, who needed each dollar of a week’s income to survive. It might be tidier to have all these small balances protected than to have all these people turning to food banks. It might also keep down the ongoing administrative costs of the statutory management, by keeping many very small depositors out of the net But the de minimis provisions are not a serious substitute for deposit insurance, on the sort of scale that it is typically offered at. Any preference for very small depositors comes at the expense of the rest of the creditors. That might be tolerable for small balances in a large institutions with lots of funding streams. It is much less so in a bank that is largely retail funded, and quickly becomes impossible in such banks once the level of protection rises above basic weekly subsistence levels. And, of course, no one knows what the de minimis level is, so the risk (facing other creditors) cannot be properly priced. By contrast, a deposit insurance scheme can be set, at priced, at pre-specified credible levels.

If we were to establish a deposit insurance scheme in New Zealand, there are many operational details to work through. One, of course, is the pricing regime. In his article, Geof notes that

‘the cost is small – no more than a small fraction of a percentage point per annum on each dollar of bank deposit”

I’m less convinced that that is the correct answer. There is a market price for insuring against the risk of bank failure, and associated losses on debt instrument. That is what credit default swaps are for. Historically, in the decade or so prior to the crisis, premia on Australian bank CDSs were very low. We used them in setting the price for the deposit guarantee scheme in 2008, and from memory they had averaged under 10 basis points. That isn’t so any longer, and for the last few years the average premium has been more like 100 basis points (fluctuating with global risk sentiment) – nicely illustrated here. Bank supervisors would, no doubt, tell us that these premia far overstate the risk of loss – and I would probably agree with them (and certainly did in 2008, when we used historical pricing) – but it is the market price of insurance. Is there a good reason why government deposit insurance funds should charge less?

It is time to adopt a deposit insurance scheme in New Zealand – not, in my view, because people necessarily should be insulated against losses, but because governments will do so anyway. In the face of such overwhelming pressures (and track record here and abroad) we are best to build institutions that help limit and manage that risk, and which charge people for the protection that governments are offering them, while making it clearer and more credible that others – outside that net – will be expected to bear losses in the event of a bank failure.

Predictable pre-Christmas bureaucrats

December 19, 2015December 21, 2015 Michael Reddell Financial stability, OIA, Prudential regulation

Bureaucrats are mostly rather predictable.

I’d been conscious that the Reserve Bank had not yet released the results of its “regulatory stocktake”, even though submissions had closed three months ago. The Friday before Christmas seemed like a good day for a release by an institution that might want as little coverage as possible of its decisions. So I kept an eye on my email yesterday, and sure enough at 4.35pm up popped the results of the so-called stocktake. As far I can see, there has been no media coverage so far, and even if any of the relevant journalists are still around, readership interest in anything serious is rapidly waning. NBR had covered the issues earlier, and it has already published its last paper for the year.

The stocktake was never a very serious exercise. I was still at the Reserve Bank when the terms of reference was determined, and the Governor was clear then that he did not want any serious issues addressed. It seemed that it was as much an exercise in appeasing the Minister, to show that the Bank was willing to look afresh at its stock of regulation and perhaps even tidy up some small stuff.

There were, in my reckoning, three main issues dealt with in the consultation document:

Refinements to the disclosure regime, generally with a view to reducing public disclosure
Refinements to the “fit and proper” regime
Some reflections on the Bank’s own policy processes for bank regulation.

I made a submission to the stocktake, along with many of the banks and variety of fairly well-informed individuals including the former Governor, Don Brash.

As far I can tell from reading the document the Bank released yesterday, it had no real interest in any submissions other than those of the banks and of a single rating agency. It does report the gist of some of those individual submissions, but there is no sign that any of them had any impact on the Bank’s thinking, nor an attempt to explain why the Bank regards the arguments made as unconvincing. That is one of the problems in having a regulatory agency set policy as well as implement it – insiders will tend to be defenders of the status quo, and if they are responsive to outside input at all it will tend to be to submissions from those they have most to do with (in this case, the regulated entities, the banks).

The Reserve Bank has been putting progressively less emphasis on public disclosure by banks over the last decade or so. The Bank itself has been quite open that it does not now use the information in the disclosure statements for supervisory purposes, having replaced it with a variety of ‘private reporting’ returns that no one else has access to. Note that the Bank is very enamoured of what it describes as a “non-zero failure regime” – that is, the system is run to allow for the possibility of bank failures (rather than to prevent them all), and with the aim of ensuring that any losses fall, as far as possible, on shareholders and creditors (including depositors). There is no deposit insurance in New Zealand, and the Bank is staunchly opposed to the introduction of deposit insurance. In other words, in their vision the risks from any failure of a bank fall first and foremost on creditors, not taxpayers. And yet those creditors do not get access to the information that the Reserve Bank regards as vital to assess the health of banks. The disclosure statements are really, in effect, just a legacy of history – probably of no real value to creditors (since it isn’t the information the supervisors themselves use).

I pointed this out in my submission, and suggested a rather simpler and cheaper approach which would better reflect the risks the system is designed around – ie providing creditors much the same information as the central bank gets, when the central bank gets it.

The Bank has canvassed an option somewhat along these lines in its consultative document, raising the option of a “continuous disclosure” model, something like what stock exchanges impose on listed entities, for periods between six-monthly disclosure statements (at present, disclosure statements are quarterly).

The Bank did not respond to my suggestion at all. It did respond to the partial continuous disclosure idea. The first argument advanced against it was “banks did not support this option”, but with no statement of why – and recall that we don’t have access to submissions made to the Reserve Bank. The Bank’s own concern seemed to be that it might lead to “confusion in the market”, but quite why it should lead to such confusion, and among whom, is not made clear.

The Bank appears to have settled on a halfway house, that might be workable, but continues to maintain a charade – a disclosure regime that forces banks to disclose some information, but not the information that the Reserve Bank itself uses for supervisory purposes, and only then with a considerable lag. Perhaps there is a good reason for maintaining this distinction, but in its release yesterday the Bank gives no sign of having thought hard about the issues at all.

There is further consultation to come on the Bank’s preferred “dashboard” option for 0ff-quarter disclosure, but a strong hint in the document that the Bank wants to consult only with banks. The Reserve Bank needs to remember that banks are the regulated entities, regulated in the public interest. Registered bank perspectives on cost and workability should be welcomed, but the rationale for supervision is that banks represent a risk to the rest of us, not those in whose interests regulation is undertaken.

On “fit and proper”, again the Bank showed no interest in asking or answering some of the more fundamental challenges some submitters posed (eg straightforward ones such as “is there any evidence that fit and proper tests, applied discretionarily by bureaucrats, have done any good, in promoting the soundness of the financial system?”. I proposed a much simpler and cheaper option than what the Bank has been doing (or will be doing in future): ban anyone with a conviction for dishonesty in the past 10 years and require senior officers and directors CVs to be listed on the website of the regulated entity. I’d be surprised if the Reserve Bank, with the best will in the world, could improve on that option, not being granted the gifts of insight or foresight greater than those of mere creditors and shareholders. Again, the Reserve Bank gave no hint of why it thought this (quicker and cheaper) approach would lead to worse outcomes.

But there was modestly encouraging stuff to come out of the stocktake. In their, still secret, submissions several banks (or perhaps the Bankers’ Association, to protect individual banks) had raised concerns about the Bank’s policy processes.

Various banks had complained that the typical consultation period was far too short, for often rather complex issues. The Bank has agreed that in future its normal consultation period will be 6 to 10 weeks, but this looks like a rather small gain as the Bank reserves the right to ignore this guideline when it suits them (eg when the Governor wants to rush in new LVR restrictions, on very limited evidence).

Various banks also appear to have raised concerns about the robustness of the Reserve Bank’s cost-benefit analysis in support of regulatory changes (unsurprisingly I’d have thought, as I don’t recall any quantitative cost-benefit analysis for this year’s investor finance restrictions) and of the Bank’s regulatory impact statements. Of course, RISs are mostly a sick joke around much of the public sector, but it is good to keep the pressure up on individual agencies – especially independent ones – to improve their game. The Bank doesn’t offer anything very specific in response, but seems conscious of the concerns.

One bank “asked for a requirement that the Reserve Bank publish a summary of submissions and responses (including rationalise) to viewpoints not accepted.”

The Reserve Bank responded that “we currently aim to publish summaries of submissions that take into account responses to viewpoints not accepted. We would welcome specific feedback from industry in cases where they feel this insufficient.”. As I noted, none of the views I and other expressed in this consultation were responded to specifically. Then again, I guess I’m not “industry”. The Bank might want to note that “industry” are not the (only) stakeholders – they are the regulated entities.

Dearer to my heart was this comment:

One bank also suggested that submissions should be available online, in addition to the Reserve Bank publishing the summary of submissions. This bank noted that this is the standard practice for public consultations run by other government departments (e.g. the Ministry of Business, Innovation and Employment).

This is a point I’ve made repeatedly. And it isn’t only government departments. Submissions to Select Committees are public, submissions on City Council consultations are public, and submissions to the Productivity Commission are public. It is simply good practice, taking seriously the idea of open government. Such submissions are not just public after all the decisions have been made, but while deliberations are going on. The Bank has always been very resistant to such openness. However, they have now shifted their ground somewhat:

Our current approach is based on our understanding that respondents prefer to keep their submissions confidential. Prior feedback indicated that banks, in particular, were reticent to share cost information and the Reserve Bank is concerned that the publication of submissions would impact the quality and detail of the submission feedback. On the other hand we also recognise the importance of transparency in the policy-making process, so we will return to this issue and consult on a revised approach under which the default position would be that all submissions are published on our website (although submitters could ask to have any confidential information in submissions redacted). We will add this issue our register of “Future Policy Work.”

I think this statement tells one a lot about the extent to which the Reserve Bank sees its clients as primarily the institutions it regulates, rather than the public the institution exists for. I’m sure that banks would generally prefer to keep their submissions confidential, and it is precisely for that reason that their submissions, in particular, should be made public. It is too easy for a cosy relationship to develop between the regulator and the regulated (Ross Levene among others have written extensively on this topic) ,and although I don’t think it has really happened to a great extent in New Zealand it is a risk that constantly needs guarding against.

In any case, kudos to the Bank for a modest step forward. I’ll look forward to their consultation document on this issue to see whether it represents a serious move to the sort of consistent transparency other agencies adopt. And I’ll be interested to see how they plan to get around the limitations of section 105 of the Reserve Bank Act – which, as I noted a few months ago, really needs amending.

In the meantime, I lodged an OIA request months ago for the submissions on this consultation. I agreed with the Bank to delay the request taking effect until the results of the stocktake were published (otherwise they would just have declined it), so in the new spirit of openness I will look forward to a fairly comprehensive release – not just private individual submissions – in the New Year. Given that they have had the submissions for months already, if they were serious about transparency they could release them right now (“as soon as reasonably practical” is what the Official Information Act says).

I will take some convincing that they are serious about transparency. Recall that in the course of this year they have already:

Refused to publish many of the submissions on the investor finance restrictions consultation (all of them initially)
Refused to publish most of the background material to the 2012 PTA (under threat of heavy charges)
~~Have still not published their forecasting model~~ [UPDATE: a commenter points out that the model has now been released, something I had missed]
Have refused to publish any of the substantive papers as part of their work programme on reforming governance of the Reserve Bank
Have refused to publish any minutes of meetings of the Governing Committee
Have refused to publish any material provided to the Bank’s Board as the basis for the Board’s evaluation of the September Monetary Policy Statement.

And then I had an email from them the other day about another request. I had asked for copies of minutes of the Bank’s Board’s meetings for a couple of years in the late 1980s. I wanted them for two, quite unrelated, pieces of work I was doing. I assumed this would be uncontroversial – it is material that is almost 30 years old, and not conceivably withholdable. Actually, I had made a similar request for a couple of other years’ Board minutes when I was still at the Bank, and was told I was free to photocopy the relevant papers, which I did.

The Board papers are all nicely bound and properly stored, so there is no research or collation involved in meeting my request. I deliberately just asked for all the minutes – perhaps five pages a months, 11 months a year, rather than excerpts, to minimise any effort in meeting the request. All it required was some undemanding photocopying or scanning, taking no more than hour in total.

But the Bank first took almost 20 working days to respond (“as soon as reasonably practicable”?), and even then has not determined whether the information is releasable at all. And it is demanding $276 as a deposit to even begin determining whether the material could be released. Note, by contrast, the easily availability of historical Board (equivalent) minutes at the Bank of England.

The Reserve Bank has announced:

The Reserve Bank has a policy of charging for information provided in response to Official Information requests when the chargeable time taken to provide the information exceeds one hour, and charging for copying when the volume exceeds 20 pages. Our charges are $38 per half hour of time and 20c per page for copying (GST inclusive).

Their stance appears to be technically legal, but hardly in the spirit of open government[1]. I’m curious how many people have been charged by the Reserve Bank under its policy, and am wondering whether I should now expect a bill for (a) the request for submissions on the regulatory stocktake, and (b) the request for information on the Reserve Bank’s volte face on the short-term impact of immigration.

The institution needs serious reform. Among other things, it needs to take on board the spirit of pro-active release. It remains a bit puzzling why the Minister of Finance has closed down work on even reforming the governance provisions. Occasional sideways or mildly critical comments about the Bank’s recent monetary policy mistakes are all very well, but they don’t seem to lead anywhere.

[1] And I’d happily come in to the Bank and photocopy the pages myself, and even cover the photocopying costs.

The RB Financial Stability Report

November 11, 2015November 11, 2015 Michael Reddell Financial stability

This won’t be a long post. Today’s Financial Stability Report was pretty uneventful relative to May’s .

The body of the report had some interesting material, both on dairy exposures and housing lending.

But I had a number of concerns.

My most important was that the Financial Stability Report was, again, in breach of the Act. The Reserve Bank can write as much interesting analysis as it likes, and good analysis is always welcome, but they must comply with the Act. Section 165A says as follows:

A financial stability report must—

(a) report on the soundness and efficiency of the financial system and other matters associated with the Bank’s statutory prudential purposes; and

(b) contain the information necessary to allow an assessment to be made of the activities undertaken by the Bank to achieve its statutory prudential purposes under this Act and any other enactment.

Much the same words are in section 162AA as well. And this document simply does not comply. It hardly comments on the efficiency of the financial system at all, at a time when the Bank is imposing ever more-extensive and complex controls on the activities of banks.

These are the four references to “efficiency”:

The first, on page 52, is simply one item in a list in an Abstract, summarising the chapter
The second , page 54, is purely descriptive, and deals only with payment systems (“the Reserve Bank has an objective of efficiency”)
The third, on page 56, refers to a goal as part of the “regulatory stocktake”, to improve the efficiency of regulation of banks
And the fourth, on page 58, is also purely descriptive (“ The Reserve Bank acknowledges that appropriately robust outsourcing arrangements can improve a bank’s efficiency”)

Not one of these refers to the efficiency of the financial system, and none offers any analytical perspectives. But the Act is quite clear. I hope some MP chooses to ask the Bank about it when they appear at FEC, and that the Bank’s Board – legally charged with holding the Governor to account – poses the question, and perhaps chooses to highlight the omission when they next write an Annual Report. As it is, the accountability model is not working. The Governor is imposing more and more controls, taking us further from an environment of regulatory competitive neutrality (across institutions, across types of loans, across places of loans and so), and he simply does not provide the material that would enable us to assess the Bank’s activities against the statutory responsibility to promote the soundness and the efficiency of the financial system.

Somewhat related to this point around efficiency, the Bank continues to assert that its LVR controls are reducing risk in the financial system. But I don’t think I’ve seen analysis from them, either when the first controls were introduced, or with the latest extension, looking at how banks will choose to maximise profits for their shareholders if they are prevented from undertaking some classes of lending. There may be perfectly satisfactory and reassuring answer, but if banks are not able to undertake their preferred types of lending (which must be the case, or controls would not be binding) surely we should expect them to seek out other opportunities, which might – or might not – be just as risky as those the Reserve Bank is restricting? The concerning dimension is not just the absence of the analysis, but the fear that the silence might suggest the Governor has not even thought about the issue.

What else struck me?

The Bank’s continued obsession with “investors”. When pushed, the Governor will say that the Auckland housing situation is mainly a supply issue, but if supply remains severely restricted by regulation, and demand increases (eg with an acceleration in population growth) quite what would he expect, but some increase in people purchasing in expectation that tomorrow’s price will be higher than today’s? And in a city where the combination of policy failures has pushed the home ownership rate down so far, what is surprising or troubling (from a financial stability perspective) about around 40 per cent of mortgage loans being for rental property purchasers? They haven’t addressed these issues, which again makes it hard to assess their activities.

I was also struck by the mire the Bank has made for itself. The Reserve Bank is primarily a macroeconomic policy agency, and even in its financial stability role it has a systemic statutory focus. And yet we have the Governor and Deputy Governor being quizzed about housing developments in Hamilton and Tauranga (4 and 3 per cent of the country respectively) and the Governor responding in some detail about the nature of the demand in those two markets (although with no apparent sense of any model of equilibrium prices). Fortunately, they did say it was “too early” to be considering Hamilton or Tauranga specific measures. I hope it always is. The Bank, and those holding it to account, should be prompted to reassess and pullback from trying to run system-wide financial stability policy TLA by TLA. More and more they turn themselves into people doing inherently political stuff, with no political mandate, and soon no doubt (if it hasn’t happened already) they will be being lobbied by councils and other entities in Hamilton, Tauranga and who knows where.

It was good to see journalists asking about the Bank’s stress tests. The Governor and Deputy Governor now openly acknowledge that the banks, and the financial system, would be just fine if the system faced a shock of the size (very severe) the stress tests were done on. That really should be largely the end of the matter for them. Instead, they go on about how in a downturn banks might rein in their lending. Indeed, and it is surely up to them – the owners of private businesses – to make choices about whether, and to what, extent it is economic to lend, and (hence) whether to raise new external capital. We have monetary policy to deal with any associated economic downturns that lead to inflation undershooting the target.

Perhaps it is just me, but I continue to be struck by how little thoughtful cross-country or historical comparative analysis is provided in the FSRs (or in other associated documents, such as the Bulletin). No two situations are ever fully alike, across time or across countries, but those comparisons are often the most helpful benchmarks we have. And if the Reserve Bank can illustrate for us which comparators it regards as useful, and which not, and lay out the reasons for those judgements, it can help enable us to better assess how the Bank is handling its responsibilities in this area. One difficulty for people doing the assessment is that almost all the factual and analytical material in this document could have allowed the Bank to have reached quite different conclusions (eg high capital standards, strong liquidity buffers, moderate credit growth, all suggest that despite the rapid growth in Auckland house prices, the financial system is robust and efficient, and no further regulatory measures have been needed over the last couple of years). We know what the Governor thinks, but how are we to know – or at least have greater confidence – whether he is right, or whether the alternative story would have been better? The Bank needs to be doing, and publishing, more research in this area.

Oh, and finally, in the press conference it was hard not to conclude that the Deputy Governor looked rather more gubernatorial and on top of his material than the Governor did. And it no doubt helped that Grant actually looked at the camera and the questioners.

Treasury on investor finance restrictions

October 30, 2015October 30, 2015 Michael Reddell Financial stability, Treasury

Back in August, I OIA’ed Treasury for copies of any material they had prepared on the Reserve Bank’s Auckland investor finance restrictions in the period following the release of the Bank’s consultative document on 3 June. I had written earlier about the pro-actively released Treasury papers, which captured some of the earlier round of discussions Treasury had had with the Bank on this issue. At that time, Treasury was unpersuaded by the Reserve Bank’s case, for a variety of reasons, and were rather grumpy about late notice, inadequate consultation with them etc.

But then I went away, and when I got back and worked through my inbox I didn’t notice that Treasury had (helpfully) replied to my request. In fact, I only realised it earlier this week, when stories started appearing (Politik, MacroBusiness, NBR and the Herald and the Dominion-Post) based on the papers Treasury had released, and which are now available on their website.

There is a curious, rather defensive, tone to the letter I received from Treasury. It looked as though senior management was now quite uncomfortable about the perceptions of a split between the Reserve Bank and Treasury, and so went out of their way to present a sense that everyone was on the same page…..really.

No doubt for this reason they included in the material they released a letter from Gabs Makhlouf to Graeme Wheeler. It looks to be a stock letter, sent by the Secretary to every government department/agency head at the start of the new fiscal year. There is nothing specific about the Treasury/Reserve Bank relationship in the letter – and it was notable mainly for the odd line “we want to create a New Zealand that is prosperous, sustainable and inclusive”. I could object to “create” – government departments have such power? – but it was the “we” that struck me. Surely we elect members of Parliament, from whom governments are formed, to determine policy, and set policy goals. Mere government departments – even The Treasury – have an advisory and implementation role.

However, Treasury seem to have included the letter in the release to me so that they could draw attention to the final paragraph.

The Treasury will continue to provide an independent perspective, and aim to add value to agencies’ business in doing so. Our goal is to be collaborative and challenging at the same time, engaging in a constructive spirit, with a shared sense of ambition and focus on getting better outcomes for all New Zealanders.

No doubt.

But the other thing Treasury was really keen to get across – it was explicitly included in the covering letter – was a sense that everyone was really more or less on the same page, at least on the need for some sort of intervention.

Please note that overall, the Treasury supports the Reserve Bank’s view that recent developments in the Auckland housing market could potentially pose a threat to financial stability over the medium term. Although there may not be signs that a systemic risk may crystallise imminently, there is cause for vigilance. Given the consequences of doing too little too late, we support the case for intervention at this stage on financial stability grounds on the basis of the available data.

I noted those lines when I first opened the documents. And then I was struck by how often they were repeated, word for word. It appears in the Treasury’s submission on the Reserve Bank consultation document. It appears in the Treasury Report to the Minister that accompanied a copy of the submission. And it appears even in an internal briefing note for the Secretary to the Treasury on the critical assessment of the Reserve Bank’s evidence base undertaken by Ian Harrison, and presented in the document A House of Cards.

The paragraph is not elegantly written at all, and it would have been easy to revise the words slightly over time to improve the expression. But it has the feel of words that were haggled over, to get just enough qualifiers included, and then perhaps finally imposed from the top. No one dared deviate, even stylistically, lest it reopen all the old debates and scepticism.

After all, it does not say that the Treasury supports the Auckland investor finance restrictions coming into force this weekend (or the relaxation of the LVR limit in the rest of the country). Indeed, it does not say much at all. It doesn’t say that recent developments in the Auckland housing market “do” pose a threat to financial stability, but simply that they “could potentially” do so, and even that is qualified by “over the medium term”. Then follows the awkward sentence “although there may not be signs that a systemic risk may crystallise imminently” – but not even Graeme Wheeler has suggested imminent crystallisation – “there is cause for vigilance”. Well, yes, but then that is what taxpayers pay bank supervisors for – we hope they are always “vigilant”.

But then they conclude rather oddly, “given the consequences of doing too little too late” they support “the case for intervention at this stage”, not unconditionally but “on the basis of the available data”. I’m not sure at all what that final qualifier is supposed to mean, or how its hedges the Treasury position, but my interest is the first phrase in the sentence. Surely that just makes the whole argument circular, and bases policy on a straw man? By definition, no one wants to have done “too little, too late”. If the financial system is, in fact, going to collapse in a heap if we do nothing then they support doing something. Most people – although not everyone – would.

But how do we know? How, for example, do we deal with the many countries that have had rapid credit growth (unlike New Zealand at present) and house price inflation, but no subsequent systemic problems. The Treasury lines just assumes an answer rather than demonstrating it, assumes that intervention can make a material sustained difference “over the medium term”, and does not even address the costs of intervention, or the consequences of being wrong. It is a poor quality conclusion, that seems to rest on rather poor quality analysis. It is, for example, exactly the sort of line that could have been run in 2005/06, on the back of the larger, and more pervasive (regions and asset classes), credit and asset boom. And yet the banking system came through the subsequent severe recession almost totally unscathed

There are some useful comments in the papers, if not always that clearly expressed. And Treasury seems to be torn. For example, buried in their comments is the telling observation “there is little evidence that lending standards are declining, a crucial component for assessing systemic risk”. If lending standards are not declining materially, history suggests there is almost no chance of the sorts of credit losses that would trigger a systemic financial crisis. Treasury and the Reserve Bank should be challenged to cite any exceptions they are aware of. Treasury might have highlighted the point in their advice to the Minister.

Many of the stories around these papers have highlighted an apparent Treasury preference that if there is going to be a direct regulatory intervention it should be done using debt to income limits rather than loan to value restrictions. In principle, I think they are probably correct – and that some of the comments in the Dominion-Post this morning are just wrong. But they lack the courage of their instincts – after all if there is no sign of systemic risk “crystallising imminently”, why didn’t they push back more strongly against the rushed use of LVR limits again? The Bank’s excuse in 2013 was that it didn’t have time, and something urgent had to be done. They were clearly wrong then, and it is now 2015. Good policy takes time, and rushed interventions rarely end that well.

Curiously, even though Treasury are the guardians of regulatory quality in New Zealand, there is no reference at all in the comments to the “efficiency” dimension of the Reserve Bank’s statutory responsibilities. Surely a challenge and review body should be more sharply posing questions around the balance between soundness and efficiency, and offering perspectives on how to think about policy proposals that might make some modest difference to soundness, but which certainly come at some cost to the efficiency of the financial system? Treasury do note that the regime is already becoming much more complex than was envisaged when the Reserve Bank first lurched into direct controls in 2013, but pay no attention to disintermediation risks or the distributive consequences of the policy, simply rather lamely concluding that ‘this is new territory for both the RBNZ and the Treasury and we will need to work together to ensure we continue to develop our understanding of these policy settings.

The one aspect of the new policy that Treasury is slightly stronger on is pushing back against the relaxation of the LVR restriction outside Auckland Here I’m not sure I really understand their argument – something about the risk of inconsistent signals. I think they are wrong on that – the logic of the Reserve Bank’s position seem clear, in trying to target specific areas of exuberance. There isn’t much sign of exuberance in Gisborne, or Invercargill, or Nelson, or Wellington or Christchurch. I don’t agree with the controls, at all, and I think regionalisation of prudential policy is another dangerous step towards politicising the Reserve Bank (akin to discretionary regional fiscal policy), but Treasury have already accepted the case for an Auckland restriction, so they’ve already abandoned that line.

These documents highlight the ongoing tussle between the Reserve Bank and the Treasury over prudential policy (as distinct from its application to individual institutions). In principle, I mostly side with Treasury. The Reserve Bank has far too much independent power to set policy without the direct involvement of the Minister of Finance – both the ability to vary banks’ conditions of registration, and the far-too-extensive scope the legislation seems to allow them to set conditions on. In my view, policy in these areas should be set by the Minister of Finance, with advice from the operating agency (the Reserve Bank) and the Treasury. The Reserve Bank’s operational independence in this area should be more narrowly restricted to matters relating to the implementation of policy and its application to individual institutions.

Institutional rivalry and tension is probably inevitable, and hardly unique to the relationship between our Treasury and our Reserve Bank. It isn’t helped by both institutions being led by people who had come in, not just from outside the public sector, but from outside New Zealand altogether, or by the rather weak senior leadership team at Treasury. But there is also something about the quality of what the Treasury brings to the table. The Reserve Bank tends to foster a rather closed environment, resistant to questioning, challenge, or even comment. That is true of monetary policy to some extent, but it is even more true of their regulatory roles. Some of that is about the individuals involved but it has fairly consistently been backed by more senior management. The Bank has tended to foster an attitude that it is better and smarter than those it deals with, than other government agencies, and than outside agencies more generally. If such an attitude was ever warranted (and humility is always a virtue), it has certainly not been so for a long time.

But Treasury does not help itself in this area. The people they have involved have often not been very impressive. Sometimes they are able individuals, but with no background in the subject matter – a common issue at Treasury, especially among managers. Sure the Reserve Bank can be difficult to deal with, but your case is a lot stronger when what you are bringing to the table is incisive and thoughtful. Even when the recipients are inclined to be dismissive anyway, it is easier to simple dismiss lightweight contributions than those with depth. On the evidence of these papers, Treasury unfortunately still has some way to go.

A new wave of financial interventions and controls come into force this Sunday, as the Reserve Bank continues to undermine the efficiency of our financial system. The case for the interventions has never convincingly been made by the Reserve Bank, and we have what feels like a knee-jerk policy intervention, that materially affect the lives and businesses of ordinary citizens, based on little more than the hunches of a Governor, who has already been shown to have got his monetary policy consistently wrong. In the earlier papers, Treasury showed some sign of challenging the weaknesses of the proposal, but as time went on instead of standing their ground, they have pulled their punches. And the remaining concerns are not argued in a clear and compelling manner.

If this is the best that our two premier macroeconomic and financial agencies can come up with we should be pretty worried about the quality of economic policymaking and advice in New Zealand. Responsibility for that rests, in particular, with the individuals in charge of those institutions, and those paid to appoint them and hold them to account.

(But, I continue to note that Treasury applies the Official Information in a much more helpful, and within the spirit of the Act, way than the Reserve Bank. I made this point in the Ombudsman’s survey – which I would encourage anyone else who has made OIA requests to complete.)

A partial backdown from the Reserve Bank

September 16, 2015September 16, 2015 Michael Reddell Financial stability, OIA

Last week I ran a post about the Reserve Bank’s refusal to release the submissions on the new investor finance restrictions, and in particular the reliance the Bank appeared to be putting on the confidentiality provisions in section 105 of the Reserve Bank Act. Those provisions appear to prohibit the Bank releasing any information it received from anyone “ relating to the exercise, or possible exercise, of the powers conferred by this Part” of the Act.

As I noted then

This seems like a travesty of democracy. Submissions – on major new public policy initiatives – can be disclosed to foreign central banks or supervisors, but not to the New Zealand public. Any views banks or members of the public might submit to the Reserve Bank on monetary policy would typically be discoverable under the OIA, but those on prudential matters are apparently not. And this is so, even though for for monetary policy there is a relatively specific objective for which the Governor can be held to account, while there is nothing remotely specific about how the statutory objectives for prudential policy should be measured.

…..

A system in which the Governor can tell us as much, or as little, and then with his own slant, on the submissions he receives should be seen as simply unacceptable. In this case, quite a simple amendment to the Reserve Bank Act would rectify the situation, making explicit that submissions on proposed changes to conditions of registration, or any other restrictions that affect all institutions, are not covered by the section 105 exemption, and should routinely be published on the Reserve Bank’s website.

And noted that.

Of course, if anyone else wants to request copies of the submissions, the Bank should presumably respond immediately declining their request and explaining why. Unless they want to reconsider and change their interpretation of section 105, any delay would itself be a breach of the Official Information Act.

I knew then that another request had been made and had not been responded to immediately.

Today, the Reserve Bank has responded to that request, and there has been a major change of heart .

Having told me that it would be too much work to release the papers, that the summary of submissions met the statutory requirements (both laughable arguments), and that in any case much of the each of the submissions would have to be withheld, they have had a (welcome) re-think. The Reserve Bank has now released in full, on its website, the submissions made by all people and entities who are not banks regulated by the Reserve Bank.

This is a significant step forward. It is probably the first time the Reserve Bank has released any submissions on proposed regulatory changes. I hope that this now sets a precedent, and to check that I have requested copies of the submissions on the regulatory stocktake.

However, the Reserve Bank is still refusing to release submissions made by banks. It asserts that these are protected by the confidentiality provisions in section 105 of the Reserve Bank Act. I describe it as an “assertion” because there is no supporting argument or evidence in the letter to Jenny Ruth as to how section 105 protects bank submissions but not those made by other submitters. Here is what the Act says:

This section applies to—

(a) information, data, and forecasts supplied or disclosed to, or obtained by,—

(i) the Bank:

(ii) a person appointed under section 99(2)(b), section 101, or section 119—

under, or for the purposes of, or in connection with the exercise of powers conferred by, this Part:

(b) information and data derived from or based upon information, data, and forecasts referred to in paragraph (a):

(c) information relating to the exercise, or possible exercise, of the powers conferred by this Part.

There is no hint I can see of any legal differentiation between material supplied by banks, and material supplied on the same issue by other parties.

If the Bank has a strong legal case, they should let us see it. I’m certainly not suggesting that they should break the law and release bank submissions if they are legally prohibited from doing so, although I suspect that they may be doing so by releasing any submissions at all

Whatever the law currently says, is there a case for withholding bank submissions? I think the answer is no, and if anything it is much more important that bank submissions are discoverable than that those of other submitters are. After all, banks are regulated entities and the idea that regulated entities should be able to lobby the regulator in secret, and we (citizens) have no ability to see what arguments they have made goes strongly against the principles of open government. Those concerns about regulators and the regulated getting too close were what motivated Ross Levine to write an entire book, The Guardians of Finance (which I wrote about here). If anything, there is probably a case for more material on banks to be made public, as I noted in yesterday’s post, but certainly their submissions on policy proposals should not have legislative protection.

In conclusion, I wanted to make two other observations.

First, the Bank has asserted that the “summary of submissions we’ve published accurately and fully summarises the responses received from banks”. If that is so, it would certainly be welcome, but as their summary certainly didn’t accurately or fully summarise my submission, we have no reason to be confident as to how they have reported bank submissions.

And second, I received a letter from the Reserve Bank this afternoon attempting to rationalise their refusal to release anything to me when I sought the same material. Here is what they had to say:

Subsequent to publication of our summary of submissions and response to submissions for our consultation on adjustments to restrictions on high-LVR residential mortgage lending, the Bank received another Official Information request seeking copies of all submissions. The timing of these two equivalent requests is a differentiating factor in the Bank’s responses to these requests.

Your request was made prior to us doing the necessary work to collate, assess, and consider our response to the submissions and then publish our summary and response.

The subsequent request, from a newspaper, was made on 24 August, after we had completed our assessments and published the summary and our responses.

The difference in timing is significant because one of the primary reasons for declining to provide information to you was, as envisaged by section 16(2)(a) of the Official Information Act, that doing so would impair efficient administration due to the need to repeat the work assessing submissions for their primary purpose while also assessing them to respond to your request. With the primary assessment work completed, we do not need to repeat it for the Official Information request made on 24 August. Accordingly, our response to the request we received on 24 August is that we are releasing submissions made to us by individual and by non-bank organisations that we do not regulate,

Again, this simply not persuasive, and appears to be a rather desperate ex post rationalisation for what is clearly a change of view. For any OIA request, the Bank has 20 working days to respond, and can (and has previously, and regularly, done so) extend that time by another 20 working days if necessary. There was no need for any repetition, or any disruption to their deliberations (especially as they had openly signalled that they intended to turn the submissions around, and announce the Governor’s decision, quite quickly).

I don’t hold it against people when, having reflected more fully on the issue, they change their minds. I’ve welcomed the partial step forward reflected in the release of the material today. But it would best not to pretend that the two requests were so different that they had good legal grounds to refuse my request altogether, but were also legally required to release today’s material . One decision was a mistake – hopefully not a wilful one.

As I noted last week about section 105

Like so much about the Reserve Bank Act, it is past time to reform these provisions. Good access to official information is vital if we are to ensure that such a powerful institution is to be robustly accountable. At present, there is far too little effective accountability and scrutiny. A system in which the Governor can tell us as much, or as little, and then with his own slant, on the submissions he receives should be seen as simply unacceptable. In this case, quite a simple amendment to the Reserve Bank Act would rectify the situation, making explicit that submissions on proposed changes to conditions of registration, or any other restrictions that affect all institutions, are not covered by the section 105 exemption, and should routinely be published on the Reserve Bank’s website.

The Reserve Bank’s “regulatory stocktake”

September 15, 2015 Michael Reddell Financial stability

The Reserve Bank has had out for consultation a document described as a “regulatory stocktake of the prudential requirements applying to registered banks”. In fact, it covers only a limited range of issues, as most of the more important issues were ruled out in the terms of reference. Submissions close tomorrow.

I hadn’t really planned to make a submission, but some discussions got me thinking a bit more about disclosure requirements and the way in which this document seemed to risk leading to less information being available to depositors and creditors, while more information was provided confidentially to the Reserve Bank itself. That seems wrongheaded, when the focus of the regulatory regime has long been intended to be to support a framework in which creditors carry the risks if things go wrong, not the government or the Reserve Bank.

So I have written a brief submission, which is available here.

Submission to RBNZ regulatory stocktake Sept 2015

I focused on only two aspects. The first is around the “fit and proper” tests the Reserve Bank imposes for directors and senior managers. There is no evidence that this process is adding any value in promoting the soundness of the New Zealand financial system. I raised some questions, and proposed a much less discretionary, disclosure-focused, alternative approach to the issue:

No doubt there will be people (and perhaps there already have been) who were employed by failed finance companies coming up for Reserve Bank approval in the next few years. In some cases, those people will have had no responsibility for the failure, and in others there may have been some culpability. But business failures happen, and they aren’t always a bad thing (indeed, unlike some systems, our banking regulatory system is explicitly designed not to avoid all failures). Why is the Reserve Bank better placed than the registered bank concerned to reach a judgement on whether any previous involvement with a failed finance company should disqualify someone from a future senior position in a bank (or other regulated financial institution)?

In a similar vein, I wonder if the Reserve Bank has done any sort of retrospective exercise and asked itself how likely it is that, with the information available at the time, it would have rejected any (or any reasonable number) of those responsible for the 1980s failures of the DFC and the BNZ. Done in a suitably sceptical way, it would be an interesting exercise

I’m not suggesting there be no rules at all. My two specific proposals would be as follows:

conviction for an offence involving dishonesty in the previous 10 years should be an automatic basis for disqualification from such senior positions. It wouldn’t be a perfect test, but it is certain and predictable, and probably better than a “we don’t like the cut of your jib” sort of discretionary judgement exercised by regulatory officials. And it doesn’t hold the false promise of regulators being able to sift out in advance people who might, in the wrong circumstances, later be partly responsible for a bank failure.

a requirement that a summary CV for each director and key officer be shown on the registered bank’s website. Those summary CVs might be required to list all previous employers or directorships, and any previous criminal convictions and formal regulatory actions against the individual.

By contrast, the current fit and proper tests seem to be an additional compliance cost, for no obvious (or demonstrated) public policy benefit in safeguarding or promoting the soundness of the New Zealand financial system.

And the second area I commented on was around financial disclosure requirements. I noted that if the disclosure statements were not providing the information the Reserve Bank needed (as they state), they clearly couldn’t be providing the information that a prudent creditor/depositor would find useful in evaluating his or her bank. Accordingly, I proposed changes that would materially reduce compliance costs and materially increase the availability of rather more timely data to creditors/depositors – those, that is, whose money is at risk.

In the consultative document, the Reserve Bank canvasses the possibility of further reducing the amount of information made public, while potentially further increasing the amount of private information the Reserve Bank itself obtains from banks. That seems a wrong-headed approach, and quite inconsistent with the desire to promote (a) market discipline and (b) an expectation that government bailouts are not the option of first resort if a bank runs into difficulty. If the Reserve Bank has revealing private information not available to depositors, and the Bank subsequently fails, why would a reasonable small depositor not argue with some force that the responsibility for her loss of money rested, proximately, with the Reserve Bank? Such arguments, correct or not in some narrow economic sense, will strengthen the (already high) likelihood of government bailouts.

My alternative proposal is to reshape disclosure requirements so that depositors and creditors are given the same information that the Reserve Bank considers necessary for it to be able to monitor the health, and emerging risks, in individual banks.

In other words, scrap the existing disclosure requirements completely (which would, no doubt, materially reduce compliance costs), and require instead that all regulatory returns that banks provide to the Reserve Bank be published on the relevant bank’s website within, say, an hour of the information being sent to the Reserve Bank. If the private information is valuable to the Reserve Bank it would also be valuable (at least in principle) to depositors/creditors and those in the private sector monitoring banks on their behalf. It is, after all , the money of the depositors and creditors that is at stake, not that of the government or the Reserve Bank. And private readers have rather more incentive to use the information well than officials at the Reserve Bank do (however able or well-intentioned the latter may be).

Moving in the direction discussed just above would, of course, represent a substantial change in approach. Timely statistical returns of the sort banks supply to the Reserve Bank can’t first go through a full audit sign-off and director attestation, but the Reserve Bank itself – by its own revealed preferences – clearly thinks that in terms of knowing what is going on on a timely basis, those protections are less important than getting timely information. If things are very timely there will almost inevitably be the occasional error, but that is not an argument against the idea. After all, even Statistics New Zealand (perhaps even the Reserve Bank) occasionally finds mistakes in its data. The concern shouldn’t be errors – people are human and will err – but about the risk of being deceived. But adequate protections against deliberate attempts to deceive either the Reserve Bank or creditors (by deliberately supplying erroneous or misleading information) surely either already exist in statute or common law, or could be legislated separately. And the fact that the Reserve Bank’s own analysts would be reliant on the same data that were going public would provide an additional layer of comfort – since the Bank is readily able to ask, and require answers to, probing follow-up questions.

…..

I am also not suggesting an absolutist approach to this issue. I have no problem with the answers to ad hoc inquiries by the Reserve Bank of an individual bank not being published. And in times when an individual institution may be approaching crisis, there probably needs to be greater confidentiality around the handling of the detailed information involved in crisis management (although such material should probably still be discoverable after the event). Indeed, protecting that sort of information was a part of the justification for the (now abused) section 105 secrecy provisions in the Reserve Bank Act. There is no foolproof dividing line, but I would suggest as a starting point that any statistical returns which are (a) regular, and (b) required of all (or a significant subset of) banks should be subject to my immediate disclosure rule. And perhaps the Reserve Bank Board could offer an attestation in its Annual Report that it has satisfied itself that staff and management are operating the system in a way that ensures all regular supervisory information is being made available to depositors and other creditors.

Housing, the Reserve Bank, and an advisory

September 12, 2015 Michael Reddell Financial stability, Housing

In the wake of Thursday’s Monetary Policy Statement there has been a round of further comment on house prices and the risks around the housing market. In fairness to the Reserve Bank, it wasn’t a focus of their document, and comments from the Governor and Deputy Governor seem to have been made in response to questions, at the press conference and at the Finance and Expenditure Committee.

I had been a little sceptical of the strength of the nationwide housing market, and pressures are clearly still concentrated in Auckland and, to a lesser extent, nearby cities. But, equally, the overall level of activity appears to have picked up. Here is my favourite timely chart, of per capita mortgage approvals.

Earlier in the year. mortgage approvals were running no faster than they were last year. In the last couple of months the pace has clearly picked up. That shouldn’t be surprising, as the interest rate increases last year have gradually been reversed, but it is worth bearing in mind not only that the rate of approvals is still below the decade average, but it is barely two-thirds the rate in the peak years of this series, 2005 and 2006. And the mortgage approvals series does not go back far enough to capture 2003, the year when national house prices rose 23 per cent. There is no nationwide house price boom.

Housing market activity has clearly picked up. As it should have. I don’t think I’ve seen any commentator make the (perhaps too obvious) point that cuts to official interest rates work by a combination of lowering the exchange rate, and encouraging more interest-sensitive expenditure. In part, that is about bringing forward some spending from tomorrow to today. But it is also about boosting the prices of long-lived fixed assets, which (in part) encourages people to build instead of buy. If house prices hadn’t risen to some extent – relative to some unobserved counterfactual – in response to lower interest rates. there would probably be reason for concern. Real long-term interest rates have fallen by around 50 basis point since this time last year (15 year inflation indexed bond).

But, of course, this brings us back to the question of what is a fixed asset. Houses are long-lived assets, but – in principle – a new house can be built quite quickly. And lower interest rates actually reduce the cost of new building a bit (finance costs are non-trivial). Land is in fixed supply, but unregulated land isn’t particularly valuable or expensive. Good dairy land goes at perhaps $50000 per hectare. Lower expected long-term interest rates should raise the unregulated market price of land – at these low interest rates, a 50 basis point change in long-term real interest rates might make quite a large difference, all else equal. The unregulated price of land is a small component in the cost of a suburban house+land. But the unregulated price isn’t what we observe. Instead, what has driven land (and thus house+land) prices sky high is the interaction of two policies – high levels of inward immigration, mostly under direct government controls, in conjunction with tight land use restrictions. The combination has been disastrous in Auckland. Non-resident purchases probably haven’t helped either. With much looser land use restrictions, house+land prices would be much less sensitive to demand pressures (whether from population or interest rates) than they are now.

The Reserve Bank talks of the Auckland market being in “dangerous” territory, but mostly that seems to be slightly inflammatory rhetoric more than the fruit of hard analysis. Yes, house price to income ratios are higher than in most cities around the world. And yes, that is a social and political scandal. But it is largely the outcome of real forces – not underlying economic ones, but mostly government policy-controlled ones. They also aren’t, by contrast, the result of some speculative frenzied lending binge (unlike many of the boom-bust markets in the US last decade). Of course, many property purchases need credit, but credit growth remains pretty subdued, and housing market activity (per capita) remains well below previous peaks. And the Reserve Bank has pointed to no evidence of a material deterioration in credit standards. If that sort of deterioration is going on, it is surely incumbent on the Reserve Bank to illustrate the evidence (as, say, Waynes Byres recently surveyed the Australian evidence). Moreover, banks operate on a nationwide basis, and as the Governor observed the other day, the “problem” is largely an Auckland one. That suggests looking at Auckland-specific causes – and the interaction of immigration policy and land use restriction policy is the most obvious one.

The Deputy Governor was quoted the other day as telling MPs that “it’s always very difficult to pick the top of any asset price cycle”. Indeed, and nor is it the job of officials to do so. But it is also very difficult to know what the equilibrium price of an asset is, especially when the market for that asset is so heavily distorted by policy interventions, in this case policy-driven population growth running head on into land use restrictions. Auckland prices are very high, scandalously so, but there is nothing that guarantees – or even offers a high degree of certainty – that real house prices will settle any lower over the longer-term. I hope they do, and I’m sure most of those currently shut out of the Auckland market do, but this is not just (or even primarily) a market process. The same goes for Sydney, or London, or Vancouver, or San Francisco. All the Reserve Bank should be doing is monitoring lending standards, and – most importantly – ensuring that banks have ample capital to cope with things going badly wrong. They’ve done the second part of that job, and on their own numbers they (and the banks themselves) have done it well. Beyond that, if they can add in-depth and considered research that sheds light on the housing issues that might be welcome – although the research resources might be better spent on getting monetary policy right – but beyond that the housing market just isn’t their job.

Just briefly, I noticed a soft interview with the Governor in today’s Herald. It is a platform for the Governor to advance his (remarkably upbeat) case, rather than an occasion when the journalist posed any searching questions. Some of it is just misleading, or straight out wrong. New Zealand’s economic performance in the last few years has been mediocre at best – better, certainly, than many of the euro area countries, but generally underwhelming – poor by historical standards, and no better than, say, the United States which was at the epicentre of the financial crisis. There has been no per capita real income growth at all in the last 18 months, and real per capita GDP is not much higher than it was in 2007. That isn’t (mostly) the Bank’s doing, but it isn’t a good performance either. Oh, and the unemployment rate – had I mentioned that before – has hardly come down since the severe recession of 2008/09.

The Governor attempts to rebut some (currently straw man) critics.

Wheeler is keen to make the point that the bank is anything but robotic with its primary focus on inflation.

Critics, particularly on the political left, have called for the bank to broaden its outlook.

“Some people say … we don’t care about growth. But I think every central bank thinks quite deeply about how the economy is going, what’s happening to demand, to investment, to unemployment.”

Perhaps, but right at the moment – and for the last five years – a rather more “robotic” focus on actual inflation might have produced better outcomes than we’ve seen. The Governor seems totally unbothered about his persistent inflation errors, or about the increase in the already high unemployment rate. As I noted the other day, at present there are no nasty trade-offs between real activity and inflation. Easier monetary policy would be likely to lower the exchange rate – something the Governor calls for at every opportunity – to boost economic activity, lower unemployment, and – not incidentally – get inflation averaging somewhat closer to the 2 per cent target midpoint that he agreed three years ago to deliver.

And finally an advisory. There won’t be many posts here in the next few days, and none for several weeks from next Thursday. We are taking the kids off to see museums and art galleries (and a few other things) in the United States, and to reintroduce two of them to the land of their birth. Despite a suggestion from one reader, I won’t be blogging about the lead up to the presidential primaries, fascinating as those races always are, or anything at all. I’ve been quite taken aback by the level of interest in this blog, and have really appreciated the many typically thoughtful comments and questions. I’ve also written much more than I had ever expected, or intended to (and especially more than I intended to about the Reserve Bank), but it has been fun. As for the future, I have quite a large pile of topics I haven’t yet got to write about – in some cases ones that were on the pile on 2 April when I left the Reserve Bank – so I expect I’ll be back writing here once the rest of the family is back to school and work on 13 October.

Does the law prohibit the Reserve Bank releasing submissions?

September 9, 2015September 9, 2015 Michael Reddell Financial stability, Reserve Bank

After my post earlier this afternoon someone mentioned the possibility of getting copies of the submissions on the investor finance restrictions under the OIA. You might have thought so too. At the time submissions closed, I did. But no.

A few weeks ago I posted briefly about the response I had received from the Reserve Bank to my request for copies of each of the submissions they had received on the (then) proposed investor finance restrictions.

The Bank refused my request, arguing that it would be met by the then-forthcoming “summary of submissions” which they would prepare. Moreover they argued that while the OIA obliges the Bank to provide documents in the form sought by the requester, there was an exception if to do so would “impair efficient administration” or “be contrary to any legal duty of the …organisation in respect of the document”.

The Bank argues that it would “impair efficient administration” to provide me copies of the documents, with appropriate redactions, and that providing a summary of the submissions will fulfil its statutory requirements. That is clearly not so. I requested copies of all the submissions, which includes the ability to look at them individually. When it produces summaries of submissions the Bank attempts to distill themes or representative arguments, on which it then comments. If it were providing summaries of each of the submissions individually, I might be content, but a self-selected summary across a whole range of submissions is simply no substitute. As I have pointed out previously, the contrast with submissions to select committees of Parliament is striking. The submissions on the legislation relating to offshore buyers’ and tax numbers are on the website in full. Submitters include some of the same people who submitted on the Governor’s proposals ( eg one bank, and the Bankers’ Association).

And, as I noted this afternoon, the actual response to submissions that the Bank released did not contain, even remotely, a representative sense of the nature of the issues raised in my own submission (the only one I have a copy of).

In its response to my OIA request the Reserve Bank also noted that “much of the information contained in the submissions that you requested must be withheld in order to comply with the confidentiality provisions of section 105 of the Reserve Bank of New Zealand Act”. And it seems that this provision is probably at the heart of the issue.

What does it say? Here are the key provisions

105 Confidentiality of information

(1) This section applies to—

(a) information, data, and forecasts supplied or disclosed to, or obtained by,—

(i) the Bank:

(ii) a person appointed under section 99(2)(b), section 101, or section 119—

under, or for the purposes of, or in connection with the exercise of powers conferred by, this Part:

(b) information and data derived from or based upon information, data, and forecasts referred to in paragraph (a):

(c) information relating to the exercise, or possible exercise, of the powers conferred by this Part.

2) Information, data, and forecasts to which this section applies shall not be published or disclosed by the Bank, any officer or employee of the Bank, or a person appointed under section 99(2)(b), section 101, or section 119, except—

(a) with the consent of the person to whom the information relates:

(b) to the extent that the information is available to the public under any Act, other than the Official Information Act 1982, or is otherwise publicly available information:

(c) in statistical or summary form arranged in such a manner as to prevent any information published or disclosed from being identified by any person as relating to any particular person:

(d) for the purposes of, or in connection with, the exercise of powers conferred by this Part:

(e) in connection with any proceedings for an offence against this Act:

(f) to any central bank, authority, or body in any other country which exercises functions corresponding to or similar to those conferred on the Bank under this Part for the purposes of the exercise by that central bank, authority, or body of those functions.

There are lots of words, but if public submissions on proposed new regulatory controls could be considered as “information, data and forecasts” supplied to the Bank then it would appear, under 105(2)(c), that the Bank cannot release any information about individual submissions, except in summary form. Even when policies, like the LVR restrictions, are to be applied generally (as distinct from supervisory intervention that might affect only one banks) we cannot know the substance of the submissions made on those proposed restrictions.

This seems like a travesty of democracy. Submissions – on major new public policy initiatives – can be disclosed to foreign central banks or supervisors, but not to the New Zealand public. Any views banks or members of the public might submit to the Reserve Bank on monetary policy would typically be discoverable under the OIA, but those on prudential matters are apparently not. And this is so, even though for monetary policy there is a relatively specific objective for which the Governor can be held to account, while there is nothing remotely specific about how the statutory objectives for prudential policy should be measured.

Probably no one has any real problem with keeping confidential some private information about individual businesses. But opinions and material supplied as part of a law-making process, which is what these consultative processes are, should be a quite different matter. Submissions to Parliament’s select committees are published, and yet select committees are not even the final decision-maker on anything. On proposed new statutes the whole House has a final vote, and on proposals that came initially from a Minister and Cabinet. By contrast, when (unelected) Graeme Wheeler makes laws – having proposed them himself – citizens are apparently not entitled to see the evidence, and submissions, he receives before making these decisions.

Like so much about the Reserve Bank Act, it is past time to reform these provisions. Good access to official information is vital if we are to ensure that such a powerful institution is to be robustly accountable. At present, there is far too little effective accountability and scrutiny. A system in which the Governor can tell us as much, or as little, and then with his own slant, on the submissions he receives should be seen as simply unacceptable. In this case, quite a simple amendment to the Reserve Bank Act would rectify the situation, making explicit that submissions on proposed changes to conditions of registration, or any other restrictions that affect all institutions, are not covered by the section 105 exemption, and should routinely be published on the Reserve Bank’s website.

Of course, if anyone else wants to request copies of the submissions, the Bank should presumably respond immediately declining their request and explaining why. Unless they want to reconsider and change their interpretation of section 105, any delay would itself be a breach of the Official Information Act.

Two central banks on property: a study in contrast

September 9, 2015September 9, 2015 Michael Reddell Australia, Financial stability, Housing

Luci Ellis, head of the Reserve Bank of Australia’s Financial Stability Department,yesterday gave a speech titled “Property Markets and Financial Stability: What do we know so far?, at a real estate symposium at the University of New South Wales.

The Reserve Bank of Australia is a fairly hierarchical organisation, and so although Ellis is a department head, there is an Assistant Governor (several of them) and a Deputy Governor and the Governor above her. It is a reminder of how deep a bench of talented people the RBA has.

I didn’t agree with everything in Ellis’s speech by any means – among other things there is an uncharitable dig at the 1990s RBNZ, and I was surprised to find no references to land use regulation at all – but it is the sort of speech that one comes away from with plenty of food for thought. It is thoughtful and balanced, offering some fresh insights, and reframing other material in an interesting way. It will repay rereading. Taken together with the speech from Wayne Byres, chairman of APRA, that I discussed recently, it is the sort of material that gives one some confidence that the key Australian institutions have thought carefully and deeply about property market issues and risks. And that they have sought to use historical experiences, and those of other countries, for illumination and not just for support. Not everyone in Australia will agree with Luci Ellis’s way of looking at the issues, but it would be foolish not to grapple with the arguments and evidence that people like her advance.

The contrast with our own Reserve Bank is a sorry one. Our central bank does plenty of speeches, but most of them are pretty lightweight affairs. As they will, and must, market commentators scour them for hints about near-term policy direction, but I don’t think any reasonably well-informed observer comes away from a Reserve Bank speech – whether from Wheeler, Spencer, Fiennes, McDermott, or Hodgetts – feeling that they now understand the isssues, or even the nature of the questions, better. Sadly, it isn’t only the Reserve Bank: the quality of the economic analysis from our key economic policy agencies more generally now seems patchy at best. I bang on here about the New Zealand’s slow continued relative economic decline, but when I look at the quality of the policy advice etc (whether it is MBIE or Treasury on (eg) immigration, or the Reserve Bank) I sometimes wonder if we should really be surprised.

I’m not going to try to excerpt Luci Ellis’s speech, simply encourage anyone interested in the substantive issues to read it. Little of it is Australia-specific and many of the insights and questions are relevant to the discussions and debates that should be occurring in New Zealand.

Rather than excerpt the core content of the speech, I want to draw attention to just one section about good public policy processes. Here is what Ellis has to say:

But the policy imperatives inspiring the work make it even more important to be scientific in our approach. By scientific, I mean the idea that the celebrated physicist Richard Feynman talked about in a much-cited university commencement address (Feynman 1974).

“Details that could throw doubt on your interpretation must be given, if you know them. You must do the best you can – if you know anything at all wrong, or possibly wrong – to explain it. If you make a theory, for example, and advertise it, or put it out, then you must also put down all the facts that disagree with it, as well as those that agree with it.”

It’s an argument for nuance, for being rigorous about your approach and for being prepared to admit you might be wrong. But I don’t want to understate the challenges this poses in a policy institution.

I hadn’t come across Feynman’s speech previously, but it is also worth reading. Here is the fuller version of the bit Luci Ellis quoted from.

It’s a kind of scientific integrity, a principle of scientific thought that corresponds to a kind of utter honesty–a kind of leaning over backwards. For example, if you’re doing an experiment, you should report everything that you think might make it invalid–not only what you think is right about it: other causes that could possibly explain your results; and things you thought of that you’ve eliminated by some other experiment, and how they worked–to make sure the other fellow can tell they have been eliminated.

Details that could throw doubt on your interpretation must be given, if you know them. You must do the best you can–if you know anything at all wrong, or possibly wrong–to explain it. If you make a theory, for example, and advertise it, or put it out, then you must also put down all the facts that disagree with it, as well as those that agree with it. There is also a more subtle problem. When you have put a lot of ideas together to make an elaborate theory, you want to make sure, when explaining what it fits, that those things it fits are not just the things that gave you the idea for the theory; but that the finished theory makes something else come out right, in addition.

In summary, the idea is to give all of the information to help others to judge the value of your contribution; not just the information that leads to judgement in one particular direction or another.

The easiest way to explain this idea is to contrast it, for example, with advertising. Last night I heard that Wesson oil doesn’t soak through food. Well, that’s true. It’s not dishonest; but the thing I’m talking about is not just a matter of not being dishonest; it’s a matter of scientific integrity, which is another level. The fact that should be added to that advertising statement is that no oils soak through food, if operated at a certain temperature. If operated at another temperature, they all will–including Wesson oil. So it’s the implication which has been conveyed, not the fact, which is true, and the difference is what we have to deal with.

And this, I think, is what most seriously troubles me about our own Reserve Bank’s contributions to the discussion of property risks etc. Whether it is speeches from the Deputy Governor, the Governor’s own comments at FEC, consultation documents, and responses to consultation documents, we’ve seen far too little of the sort of scientific integrity that Feynman was talking about. We might not expect much from advertising agencies, or from politicians. But we really should expect it from an independent technocratic agency such as a central bank.

We had some glaring examples of how not to do policy in the Reserve Bank’s processes that led to the decision to treat lending on investment properties as riskier than other housing lending. Ian Harrison documented various examples of selective quotation, dubious use of published studies etc. I gather that the Bank reckons it has found some holes in Ian’s arguments, but it shouldn’t have needed him to be raising the issues at all. We should expect an organisation like the Reserve Bank to go out of its way to make its case, and to make its case more convincing by showing that it was aware of, and had drawn attention to, any potential pitfalls or weaknesses in the arguments, or case, it was making.

My own concern is much more with the new investor finance restrictions. Perhaps they are an appropriate response to the situation, but even if so we will never be able to have a well-founded confidence in such a conclusion because of the poor quality, highly selective, case the Bank has made, the secrecy with which it guards the submissions that were made on its proposals, and the cursory or non-existent responses it has made to concerns and criticisms of its consultative document.

My submission to the Reserve Bank on the proposed restrictions is here. Here is an extract that summarised some of my key concerns

My concerns about the substance of the proposal fall under five headings:

The failure to demonstrate that the soundness of the financial system is jeopardised (this includes the failure to substantively engage with the results of the Bank’s stress tests).

The failure of the consultative document to deal remotely adequately, with the Bank’s statutory obligation to use its powers to promote the efficiency of the financial system.

The failure to demonstrate that the statutory goals the Bank is required to use its power to pursue can only, or are best, pursued with such a direct restriction.

The lack of any sustained analysis (here or elsewhere in published Bank material) on the similarities and differences between New Zealand’s situation and the situations of those advanced countries that have experienced financial crises primarily related to their domestic housing markets.

The failure to engage with the uncertainty that the Bank (and all of us) inevitably face in making judgements around the housing market and associated financial risks, and the costs and consequences of being wrong.

The absence of any substantive discussion of the likely distributional consequences of such measures is also disconcerting. Distributional consequences are not something the Reserve Bank has ever been good at analysing. In many respects they were unimportant when the Bank’s prudential powers were being exercised largely through indirect instruments (in particular, capital requirements) but they are much more important when the Bank is considering deploying direct controls. In particular, the combination of tight investor finance restrictions in Auckland and the continuing overall residential mortgage “speed limit” is likely to skew house purchases in Auckland to cashed-up buyers. In effect, to the extent that the restrictions “work” they will provide cheap entry levels. New Zealand first home buyers and prospective small business owners will be disadvantaged, in favour of (for example) non-resident foreign owners. At very least, it should be incumbent on the Bank to spell out the likely nature of these distributional effects.

Conclusion

The restrictions proposed by the Reserve Bank do not pass the test of good policy. The problem definition is inadequate, the supporting analysis is weak, and the alignment between the measures proposed and the statutory provisions that govern the use of the Bank’s regulatory powers is poor..

The Reserve Bank refuses to release the submissions it receives (unlike, say, parliamentary select committees) and instead published what it loosely describes as a “response to submissions”, together with a Regulatory Impact Assessment(RIA). I had intended to comment in detail on these documents, but did not get round to it when they came out a few weeks ago, and won’t bore readers with that now. Instead, lets take a higher level approach.

The RIA is barely five pages long, and two of those pages are largely devoted to three simple charts. There is no attempt at a cost-benefit analysis, or to quantify any of the judgements. There is also little or no engagement with the relevant statutory provisions of the legislation the Reserve Bank operates under.

The response to submissions was 10 pages long, but most of this is devoted to operational details of the proposal, with only three pages given over to the policy issues themselves (is such a restriction an appropriate, and net beneficial, policy response to a real and substantive issue). Although the document is described as a response to submissions, most of the points I included in my summary above are not even mentioned, let alone dealt with or responded to. Since the Bank keeps submissions secret, it is only if submitters themselves choose to publish their own submissions that we can know what points are being made. We should be able to count on a more honest reporting of the issues that have been raised (there were, after all, only 13 submissions).

The Bank may have a strong case for its position, but all it has done – in the consultation document and response – is a piece of advocacy work. It has made no sustained attempt to outline the strengths and the weaknesses of its case. There is, for example, no substantive discussion of the efficiency issues even though financial system efficiency is a key element in the statutory objective and LVR limits cannot but impair the efficiency of the system. And there is no recognition, or consideration of the implications, of the fact that many countries have had rapid credit growth and high house prices, while avoiding a financial crisis. It is simply poor science (in Feynman’s terms) and poor public policy. And the points around the distributional effects of the policy are not even touched on. Such selectivity speaks poorly of the Bank as a public policy agency.

I don’t want to idealise the Australian institutions, which (being comprised of human beings) have made their own misjudgements over the years. But at present the quality of the material the RBA and APRA are putting out shows up the Reserve Bank of New Zealand in a particularly poor light. New Zealanders deserve better from such a powerful institution, and from those who are paid to hold it to account.

Let’s hope they manage a better quality of argument and engagement in the Monetary Policy Statement tomorrow.

A tale of two regulators

August 29, 2015August 29, 2015 Michael Reddell APRA, Financial stability, Reserve Bank

Earlier this week two banking regulators gave speeches about housing. Both began the same way – one noting that housing is a “hot topic of dinner conversation” and the other that it is “not unusual…for the topic of conversation over a meal – be it a dinner table with friends, or a barbeque in the backyard – to turn to the subject of real estate”.

The first speech was by Grant Spencer, Deputy Governor (with responsibility for financial stability functions) of the Reserve Bank of New Zealand. The second was by Wayne Byres, Chairman of the Australia Prudential Regulatory Authority (APRA). The speeches are really like chalk and cheese – very different and the differences largely reflect positively on APRA.

I’ve already touched on a few points from Spencer’s speech, mainly around the tension between the encouraging results of last year’s demanding stress tests and the Reserve Bank’s increasingly intrusive and expensive lending restrictions. In that post, I also passed on an observation someone had made to me that Spencer’s speech had a very strong macroeconomist’s flavour to it, with little sense that he, or the Bank, had much feel for the credit standards being applied by the banks. At one level, that isn’t surprising: Spencer (and most of his senior colleagues) has a background in macroeconomics. But Grant Spencer has now been responsible for financial stability and regulatory functions for eight years, and spent the best part of a decade in fairly senior positions in the ANZ.

Byres, by contrast, appears to have been a bank supervisor/regulator for most of his career. And it shows. He knows that banks get into trouble when they make bad loans (and banking systems get into trouble when enough banks make enough bad loans). At one level that is a truism, but it seems to drive Byres, at least on the evidence of this speech, is to focus on the quality of the loans banks are making, and the standards banks (management and Boards) are applying in advancing credit

Byres articulates APRA’s goal as “to preserve the resilience of the banking system”, rather similar to the Reserve Bank’s statutory goal to “promote the maintenance of a sound and efficient financial system”. And that seems to be his focus: to ensure that banks have enough good quality capital to withstand shocks when they come, and focus on monitoring the quality of banks’ lending behaviour to help (a) ensure those capital buffers are large enough, and (b) reduce the risk of a large number of loans turning very bad.

Rightly, in my view, he does not seem to see it as APRA’s role to stabilise house prices, nationally or in any particular city/region. Other stuff happens, and it is the responsibility of the banking supervisor/regulator to ensure that the banking system can cope if things go wrong. Stress tests are one component of that – and Byres gave a good speech on them late last year.

Here is Byres on what drives the housing market

Any discussion on housing market conditions these days typically starts – and sometimes ends – with housing prices. It’s clear that Australian housing prices are high. On common metrics such as pricesto-incomes or prices-to-rents Australian housing prices are at the higher end of the spectrum, measured either historically or internationally. There are many reasons proffered for why this is: a strongly growing population, geographic and regulatory constraints on supply, the impact of lower inflationary expectations and financial deregulation, and taxation arrangements all feature prominently in explanations of the level of Australian housing prices.

He doesn’t seem to see it as APRA’s role to praise (or damn) aspects of government policy, or to lecture others (based on no underlying research or analysis) on what needs to be done. He just accepts that there are active debates on many of these issues and, whatever the cause, Australian house prices are high. That might become an issue for a banking regulator, and to know that one needs to understand the quality of the loan books (individually, and across the system as a whole) and the capital banks have.

Contrast that with Grant Spencer’s speech, written as if the Reserve Bank were a pre-eminent source of wisdom on wider housing market issues, impatient that mere politicians have been slow to get with the Bank’s preferred programme. Tax changes are “essential”, “much more rapid progress” is needed in improving housing supply, and so on. And all the time, other areas of policy, which might be inconvenient to the current government (eg the role of new first home buyer subsidies, active immigration programmes) are passed over in silence. The issue is not whether Spencer is correct in any of his individual observations – on some I think he is right, and in others probably not – but that he cites no evidence or research for his views, and that such advocacy on highly controversial political issues, is just not the role of a banking regulator (or a central bank). “Tax” appears a lot more often in Spencer’s speech than phrases such as “lending standards”, “loan quality”, “origination standards” or the like (as far I can see, those phrases don’t appear at all).

Byres appears to know better. He concentrates on banking; on what banks do, and on the regulatory role of APRA. Doing banking regulation well is not always easy. No doubt plenty of supervisors in the United States, Ireland and the United Kingdom thought they were doing a fine job in the years running up to 2008. It turned out not to be so. Lending standards will, of course, often look rather better before a crisis, or even a recession, than they do in the wake of such events. But if we are going to have official prudential supervisors – and for better or worse we do – we need people with enough knowledge of the industry to ask the hard questions, and sceptically sift and weigh the evidence. As Byers notes (if only we heard this line more often from our Reserve Bank).

“lower credit quality portfolios may not necessarily be worrisome if the strategy is a conscious one, the additional risk is appropriately priced and managed, and adequate capital is held. That is really what much of our work has been designed to test”

And much of the rest of his speech is devoting to talking through what evidence there is on these points. It is what one might expect from a bank supervisor.

He observes that there is no evidence in Australia that investor loans have been riskier than owner-occupier mortgage loans, while noting the need to be cautious about extrapolating that experience into a more stressful scenario. Our Reserve Bank does not even seem to have gathered the data on the New Zealand experience, including in the last few years in which some regions have had material falls in nominal house prices.

Byers steps through data on third-party originated loans, interest-only loans, high LVR loans (interestingly, he focuses on loans with LVRs greater than 90 per cent, not (say) the above 70 per cent loans the Reserve Bank is about to control in Auckland), and loans approved outside standard loan parameters. I’m not sure I saw anything specific about pricing. But I came away from the speech with a sense of better understanding the market, but also with a sense of a supervisory agency that knew, and could talk judiciously, about what was going on.

The impression I took from Grant Spencer’s speech was rather different. There was very little about indicators of risk arising from the behavioural choices of banks. We’ve seen no evidence advanced that credit standards have been deteriorating (eg specifically in the Auckland investor property finance market), let alone that any such deterioration was not appropriately matched by pricing, and capital, that covers the risks. There might be problems looming, but the Reserve Bank just does not set out the evidence, even though it has rushed in with a succession of heavy-handed policy interventions. There is a sense of an institution flailing around, citing this statistic and that, but without a coherent and well-grounded analysis of the issues and risks to the banking system.

There are limitations to Byres’s brief speech. He is no more inclined that the Reserve Bank to acknowledge that supervisors and regulators get things wrong. And perhaps he is light on the sort of big- picture macro-oriented, internationally-informed analysis of systemic risks. But when the Reserve Bank tries to offer this latter perspective it does not do it well. As far as I’m aware no country has ever run into a systemic banking crisis when credit has been rising no faster the nominal GDP (and perhaps especially when nominal GDP itself has been growing slowly by historical standards). But you won’t learn that from any Reserve Bank document, even though that is the current New Zealand (and Australian) situation. You also won’t get any sort of systematic analysis, or even a summary distillation of such analysis, on the similarities and differences between what has been going on in New Zealand in recent years and, on the one hand, what happened in the crisis countries, and on the other hand, what happened in countries that avoided crises. Grant Spencer and Graeme Wheeler repeatedly invoke Ireland and the United States, but no serious observer thinks developments in New Zealand remotely parallel the specifics of those two (quite different) country experiences.

There has been a tendency in some quarters to lionise APRA – I’ve been in meetings where it has been lauded as the world’s best bank supervisor. I’m not in that camp. Apart from anything else, the minimum risk weights the Reserve Bank has insisted on for housing loans have been more conservative than those required in Australia, and APRA is only now catching up. And I’m also not convinced by arguments that we should out-source our bank supervision and regulation to APRA – ultimately much about bank supervision is about crisis management, and in crises managing national interests matters a lot. But for the time being, APRA presents a much more credible and convincing face to the world, conveying a calm and balanced sense that they understand banking and banking risk, than does the regulatory/supervisory side of the Reserve Bank of New Zealand. New Zealand deserves better than that.

Perhaps it is another dimension for the Reserve Bank Board to assess in its forthcoming Annual Report?

croaking cassandra

Economics, public policy, monetary policy, financial regulation, with a New Zealand perspective

Financial stability