That was the question a radio interviewer asked me this morning, about the talk of new Reserve Bank direct controls on banks’ housing lending.  He wanted a succinct answer.  Mine was simple: No.    The question was about talk of loan to income ratio restrictions, but the answer would be the same even if the question had been about the Financial Stability Report as a whole.

Take the talk of loan to income restrictions on banks’ housing lending first.  There was no mention  of this in the FSR itself, and even in the press release there was just a brief, but telling, reference:

The Reserve Bank is closely monitoring developments to assess whether further financial policy measures would be appropriate.

And yet clearly it is a major issue.  In fact, it dominated the press conference later in the morning.  Journalists asked question after question, and slowly drew information out from the Governor and Deputy Governor.  But there seemed to be no clear communications plan, and no developed messaging.  And none of the material was in the statutory accountability document they had just published.  It wasn’t impressive.

As Treasury pointed out last year, in many ways if the country is going to be dragged down the path of direct restrictions on banks’ loan portfolios, it would have been better to have looked  first at loan to income restrictions (“speed limits”) rather than loan to value restrictions.  Servicing capacity is typically more important than the current value of collateral.  The Reserve Bank could have adopted loan to income restrictions back in 2013.  But the Governor was in a hurry.    There was, in his telling, a desperately urgent issue and the Bank simply couldn’t wait: it had to do something, and LVR restrictions were what could be done very quickly.  The policy process in the lead-up to those restrictions was shockingly bad –  one (unelected) man had a bee in his bonnet, and there was little or no debate or discussion allowed (trying to pose some questions was when I got offside with the Governor).

Back almost three years ago when those restrictions were put in place, all the talk was of the temporary nature of the restrictions.  When people discussed it internally, I think most people had a sense that “temporary” might mean a couple of years.  The true believers thought that the top would have been knocked off the housing market by then, with the LVR restrictions having limited the new debt taken on in the last upward surge, and then things could get back to normal –  leaving bankers to decide the composition of their own portfolios.

But then we had a new wave of LVR restrictions last year.  In 2013, the Bank had not only seen the restrictions as temporary, but it was staunchly opposed to having different policies for different regions. By last year we had new LVR restrictions –  this time some mortgage borrowers were judged better than others, even for exactly the same underlying risk characteristics, and banks were allowed to lend in some places but not others.  And now the drums are beating for yet more restrictions –  perhaps even tougher, perhaps more differentiated, LVR restrictions, or perhaps loan to income restrictions.  There seems to be no end in sight.

Asked about this yesterday, the Bank seemed a bit bashful. The Deputy Governor noted that the Bank had never seen these things are permanent but………housing and financial cycles can be very long, so “temporary” might still be rather a long time.  I suppose exchange controls –  and all the other restrictions that Walter Nash and his successors imposed on us in decades past –  weren’t permanent either.  It “only” took 36 46 years to get rid of exchange controls.

Frankly, the Bank seems torn between two poles, and just hasn’t done the hard thinking or analysis –  or been exposed to the hard questioning by MPs and the media – to reconcile the two stances.

On the one hand, as they note in the opening sentence of the press release “New Zealand’s financial system is resilient”.   (That was also the story three years ago, when LVR limits were first imposed, but then the excuse was “but it might not stay that way if we let things carry on”).   As I noted (at length) last year, the stress tests the Bank had done in conjunction with APRA also suggested that the banking system could cope with very severe adverse shocks (including surges in unemployment on a scale beyond anything ever seen in floating exchange rate countries).  The latest FSR reported the results of new stress tests (reported in Box C of the document), done late last year.  The Bank did not publish a great deal of detail this time, but if anything the shocks look to have been a little more severe than those used in the earlier stress tests (no doubt befitting the further rise in house prices).  Once again, banks seemed to come through largely unscathed.  Total loan losses amounted (over several years) to around 4 per cent of initial assets – similar to the 2014 result.  Of this, 0.6 percentage points related to Auckland property lending.  As the Bank noted, loan loss rates on the housing mortgage books were only around 40 per cent of those observed for most other sectors.    There is simply no evidence that banks –  individually or collectively –  have been doing housing lending in a way that would jeopardise their own financial soundness or that of the financial system.  That is consistent with the international results –  which the Bank has previously cited – in which vanilla housing lending has rarely played an important role in systemic financial problems (especially in floating exchange rate economies).

And yet, and yet…..they reach for ever more direct restrictions on banks.  Now don’t get me wrong.  The New Zealand housing market (and especially that in Auckland, which is exposed to more pressures) is a disgrace.  There is no excuse for price to income ratios of 5, let alone those of around 10.  And central and local government policymakers are almost entirely responsible for those outcomes.    The Bank seems to half recognize this.  They talk of the interacting pressures of high rates of immigration at the same time that the urban land supply market isn’t working well.    But they don’t follow this point to its logical conclusion.  If the prices are largely the outcome of structural policy choices, there is no particular reason to think they are the fault of banks, or borrowers, let alone the despised class of “property investors”.    The Reserve Bank’s job is to use its regulatory powers to promote a sound and efficient financial system.  But the stress tests –  and their own regulator judgements, expressed in the press release –  suggest that the system is sound, robust and resilient.  And yet with every new set of restrictions they further undermine the efficiency of the financial system.

There are severe housing market policy problems, but there is no evidence that they are problems the Reserve Bank is responsible for, or needs to take action to try to remedy or ameliorate.  As I noted the other day the Reserve Bank has two main jobs.  The first is the soundness and efficiency of the financial system, and the second is keeping inflation near target.  At present, they are failing at the latter, are continually compromising the efficiency of the financial system, and all while skewing are policy (both regulatory policy and monetary policy) towards action supposedly designed to make safe a financial system that they tell us is already robust.

I couldn’t check this electronically this morning, but my impression was that there was almost no discussion at all in the FSR on the efficiency of the financial system, and the impact of Reserve Bank regulatory measures on the efficiency of the system.  That looks to be out of step with the statutory requirements for these documents.  I also thought it was interesting that there was little or no discussion of banks’ lending standards and practices.  I know the Bank is dominated by people with a macroeconomics background, but surely we expect to learm something in a document of this sort about the judgements the Bank, and its supervisors, are making about credit standards?

I wanted to pick up just three more dimensions of the material the Bank covered in the FSR. 

The Bank went to some lengths to argue that the LVR restrictions might have had only a “transitory” impact on house prices (the Deputy Governor’s words) but had led to a structural improvement in the quality of loans on bank balance sheets.  In support of this claim they produced a chart showing a reduction in the share of mortgages with LVRs in excess of 80 per cent.  In fact, there are all sorts of problems with this claim.  First, they don’t show us what has happened to the proportion of loans with LVRs just below 80 per cent (or just below 70 per cent for Auckland investors).  The difference in the riskiness of a loan with an 80.1 per cent LVR and one with a 79.9 per cent LVR is trivial, and yet regulatory restrictions typically impose these sorts of cliffs, with lots of loans gathered just on the approved side of the limit (and in ways which don’t appear when there are no regulatory restrictions).  The data mean different things in a regulated environment.

But that isn’t the end of the issue.  First, if people couldn’t borrow 85 per cent of the value of a house from a bank themselves, some will deterred from buying for the time being.  They might save a bit more and then go and buy.  But others will turn to other sources of credit.  The Bank correctly notes that there has not been a big increase in housing lending by non-bank lenders (not covered by the LVR restrictions, since the Bank has no legal power to impose such restrictions on them).  In itself, that lack of (this form of)  disintermediation is interesting – and perhaps worthy of further analysis (especially as it points to quite high efficiency costs from the restrictions).

But non-bank lenders aren’t the only alternative sources of credit, In many cases, parents or family members will have been tapped.  In some cases, those family members will be in a very good financial position and might be happy to lend from their credit balances.  But in other cases, a lower mortgage for the child might be offset by a higher (if still less than 80 per cent) mortgage for the parent.  In a crisis it is not individual loans that threaten the soundness of banks, but the exposures across whole portfolios.  It is quite possible that much of the apparent reduction in risky housing lending is offset by a general weakening in the overall credit quality of the portfolio.  If not, it would still be useful for the Reserve Bank to have engaged with the issue and explained why it concluded that these issues were not material.

Relatedly, the Reserve Bank has simply never engaged with the behavioural responses of banks to direct restrictions on portfolio composition (which we had simply never had in New Zealand prior to 2013).  These are profit-maximizing businesses.  If Reserve Bank restrictions limit high LVR housing lending, it reduces profit opportunities (and use of capital) in that part of the business. But what have banks done to maintain their profits and ensure that capital is fully deployed?  Surely a common take on regulatory restrictions is that they might dampen the risks we can see, while encouraging additional risk taking in less obvious areas.  I don’t know how banks responded to the LVR restrictions, but I’m pretty sure the response to the LVR restrictions wasn’t “you know, Graeme, you are right: we shouldn’t be seeking so much profit, and instead we’ll send the capital we would have been using in that business line back to Australia”.  I think we are owed better analysis of these issues from the Reserve Bank (and its large pool of analysts) before we accept that LVR restrictions have actually improved the soundness of the financial system.

In a sense, what each new set of regulatory interventions seems to do is the provide cheaper entry levels to the market for those purchasers who aren’t directly affected by the regulatory restrictions.  Each time a new set of interventions is announced there is a bit of a pause, and those pauses look like buying opportunities for those who can (at the expense –  pure and simple –  of those who can’t – those upon whom the Reserve Bank looks unfavourably).   The favoured might be the middle-aged trading up, cashed-up New Zealanders returning from abroad, those whose value to the banks means they are favoured recipients of credit from within the speed limits, those with wealthy parents etc (and even the non-resident foreign buyers, a significant part of net new demand in the Auckland market).  In general, the interventions advantage the haves at the expense of the have-nots.    Such redistributive policies might be what we elect politicians to do, but they shouldn’t be what unelected central bankers are about.

One keeps hearing disapproving comments –  including from the Reserve Bank –  about people purchasing residential properties to run  rental services businesses.  I know there is a strong community bias in favour of owner-occupation, and that the rate of owner-occupation has been falling.  But here the Reserve Bank –  and others who engage in this tarring of people in the rental services business –  is simply engaged in scapegoating.  All societies need scapegoats –  to bear symbolic responsibility  for what has gone wrong –  but if they are going to be part of a good policy regime there needs to be rather more robust differentiation between symptoms and causes.  If central and local government policies on immigration, land use, and building, combine to make house prices unaffordably high to young couples starting out, it is hardly surprising that those people end up renting (for longer) instead.  And someone has to own the houses.    The Reserve Bank was again citing yesterday statistics suggesting that around 40 per cent of housing sales are to “investors”, but why would this be a surprise (or even a concern, giving the “rigged” housing market?).  The home ownership rate itself is dropping towards 60 per cent, most rentals are provided by the private sector, and the median investment property is probably turned over a bit more frequently that the median owner-occupied house.

Finally, the Reserve Bank notes –  in a concerned fashion –  that household debt to income ratios are now (just) around the pre-recession peak.  In itself, this is a fair enough observation, but as so often in these documents it is the context or interpretation that is missing.  As I’ve noted before , there was no sign that the level of household debt as it was in 2007/08 lead to serious or systemic  financial problems.  And that was so even though all the research evidence suggests that it is large increases in debt to income/GDP ratios in short periods of time that has often foreshadowed financial crises.  The fact that debt to income ratios now are not materially higher than they were eight years ago –  coming off 15 years in which that ratio had increased enormously –  should be a source of comfort rather than concern.  We simply don’t have a good sense of what an “equilibrium” debt to income ratio is, and (in any case) such an equilibrium is likely to be highly endogenous to the extent to which the housing market is distorted by structural factors.  In Atlanta –  where median house prices are around US$180000 and house price to income ratios ar around 3 –  household debt to income is likely to be much much lower than it is in Auckland.

And the causation runs largely from housing distortions and house prices to debt, and not the other way round.  It is disappointing that the Reserve Bank never explicitly recognizes that if house prices are driven higher by the interaction of immigration and supply restrictions –  and that is exactly what the Governor says – younger generations will need to have more gross debt relative to income to buy the housing stock from older generations, than would be the case in a less distorted (much cheaper) market.

There was some interesting material in trhe FSR, but in the end it fell well short of what we should expect –  or even of what the law requires.  Wielding so much discretionary regulatory authority single-handed –  in a way that simply shouldn’t be happening in our parliamentary democracy –  the unelected Governor surely owes the public much more in-depth analysis of the issues and risks before we lurch into yet another ill-considered hasty patch on the symptoms of a serious problem, responsibility for which rests in the Beehive and –  to a lesser extent – in council chambers up and down the country?   The quality of the supporting analysis for last two LVR interventions was threadbare (or worse).  As they continue to undertake the analysis on further restrictions  – and talk to the Minister and Treasury, as part of getting loan to income limits on the (non-binding) list of tools in the MOU –  lets hope that the quality of the argumentation and research evidence rises to much better levels than we have seen to date.

As a final point, there was some mention in the FSR of the results of the Reserve Bank’s regulatory stocktake released late last year.    In that stocktake there was encouraging talk from the Bank of adopting longer consultative times for regulatory proposals and of possibly finally moving to routinely publishing the submissions they receive (as many other agencies, and select committees do, but which the Reserve Bank has consistently refused to do.).  There was nothing on either of these points in the discussion in the FSR yesterday.  I hope they are not backing away again.

UPDATE: This afternoon the Reserve Bank has put out a consultative document on the possibility of publishing submissions.  It appears to be strongly skewed towards maintaining the status quo.

 

 

The speech and Bulletin put out by the Reserve Bank yesterday made much of the importance of market discipline in the financial sector.  The two documents have slightly different lists of conditions which the respective authors think make it more likely that market discipline will be effective, but a common element is “market participants [must] have incentives to monitor financial institutions”.  Toby Fiennes argues that in the New Zealand context:

“some aspects of the regulatory framework, such as Open Bank Resolution (OBR) and no deposit insurance, reinforce these incentives.”

and O’Connor-Close and Austin, in the Bulletin, add in

“nor is there any policyholder protection scheme for insurance firm customers.”

This has been a longstanding view held by the Reserve Bank.  I’ve long thought it was wrong.

Of course, if you were confident that, were a bank to fail in which you were holding deposits or other interest-bearing securities, you would lose money, and no one would bail you out, you would have quite a strong incentive to pay attention to the health of any institution in which you had a reasonable amount of money, and (to economise on monitoring costs) to hold  your money, as far as possible, with those institutions generally regarded as safest.

Same goes for insurance.  If you had your house insurance with an insurance company, and no one would bail you or it out if the company failed, you’d have quite an incentive to insure with companies that would prove resilient through the worst of shocks.

In the case of banks, OBR is designed to make it more technically feasible for political leaders to let major banks fail.  In that model any losses  (mostly) fall on the creditors, and yet the failed bank can quickly re-open, keeping the day-to-day flow of transactions and routine business credit operational.  It is technically elegant system.  But whether or not it is ever used is not up to the Reserve Bank.  That is matter for whoever is Minister of Finance at the time –  and no doubt the Prime Minister of the day too.

Suppose a big bank is on the brink of failure.  Purely illustrative, let’s assume that one day some years hence the ANZ boards in New Zealand and Australia approach the respective governments and regulators, announcing “we are bust”.

Perhaps the Reserve Bank will favour adopting OBR for the New Zealand subsidiary (since the parent is also failing they can’t get the parent to stump up more capital to solve the problem that way).    But why would the Minister of Finance agree?

First, Australia doesn’t have a system like OBR and no one I’m aware of thinks it is remotely likely that an Australia government would simply let one of their big banks fail.  But in the very unlikely event they did, not only is there a statutory preference for Australian depositors over other creditors, but Australia has a deposit insurance scheme.

I’m not sure of the precise numbers, but as ANZ is our largest bank, perhaps a third of all New Zealanders will have deposits at ANZ.

So, if the New Zealand Minister of Finance is considering using OBR he has to weigh up:

• the headlines, in which ANZ depositors in Australia would be protected, but ANZ depositors in New Zealand would immediately lose a large chunk of their money (an OBR ‘haircut’ of 30 per cent is perfectly plausible),
• and, even with OBR, it is generally accepted (it is mentioned in the Bulletin) that the government would need to guarantee all the remaining deposits of the failed bank (otherwise depositors would rationally remove those funds ASAP from the failed bank)
• and I’ve long  thought it likely that once the remaining funds of the failed bank are guaranteed, the government might also have to guarantee the deposits of the other banks in the system.  Banks rarely fail in isolation, and faced with the failure of a major banks, depositors might quite rationally prefer to shift their funds to the bank that now has the government guarantee.

And all this is before considering the huge pressure that would be likely to come on the New Zealand government, from the Australian government, to bail-out the combined ANZ group.  The damage to the overall ANZ brand, from allowing one very subsidiary to fail, would be quite large.  And Australian governments can play hardball.

So, the Minister of Finance (and PM) could apply OBR, but only by upsetting a huge number of voters (and voters’ families), upsetting the government of the foreign country most important to New Zealand, and still being left with large, fairly open-ended, guarantees on the books.

Or, they could simply write a cheque –  perhaps in some (superficially) harmonious trans-Tasman deal to jointly bail out parent and subsidiary  (the haggling would no doubt be quite acrimonious).  After all, our government accounts are in pretty reasonable shape by international standards.

And the real losses –  the bad loans –  have already happened.  It is just a question of who bears them.  And if one third of the population is bearing them –  in an institution that the Reserve Bank was supposed to have been supervising –  well, why not just spread them over all taxpayers?    And how reasonable is it to think that an 80 year pensioner, with $100000 in our largest bank, should have been expected to have been exercising more scrutiny and market discipline than our expert professional regulator (the Reserve Bank) succeeded in doing?  Or so will go the argument –  and it will get a lot of sympathy.

(There is provision in the OBR scheme for a “de minimis” amount below which the haircut might not apply.   If the de minimis amount is, say, $500 –  roughly a fortnightly New Zealand Superannuation amount for a couple –  it is neither here nor there for the scheme as a whole.  But a high de minimis amount looks a lot like ex post unfunded deposit insurance.)

Note that I’m not arguing that bailouts are “a good thing”, simply that having the OBR tool really does not dramatically alter the incentives politicians will face in dealing, at the time, with the imminent failure of a large bank.   And rational investor know that.  For the case of a large bank, OBR simply isn’t really a time-consistent strategy for politicians.

Some people at the Reserve Bank will accept the point, but argue that we still need OBR to have a credible weapon to wave in front of the Australians in a crisis.  If they think New Zealand might just be “crazy” enough to use it, it might  –  so it is argued – help us negotiate a slightly less unfavourable bail-out deal.  Perhaps.  But Australians can read domestic politics too.  I have no problem with having it in the toolkit –  perhaps it could be useful for a small bank  –  but no one should pretend that it solves bail-out risks and restores retail market discipline, red of tooth and claw.  And the probability of a bail-out, with a focus on protecting retail deposits, probably weakens market discipline at the margin even among wholesale investors.

And what are the precedents?  25 years ago the Bank of New Zealand was bailed out.  Yes, the government was the largest shareholder at the time, but I didn’t detect any sense –  at the very peak of the Douglas-Richardson era – that ownership determined whether the government of the day let the BNZ survive or fail.

More recently, the retail deposit guarantee scheme was put in place in late 2008 – not just for finance companies, but for the big banks too.  The decision was made by the previous Labour government – but it was endorsed by the Key/English led Opposition, and was recommended (in substance if not in precise detail) by the Reserve Bank and Treasury. I wrote many of the papers.

And more recently still, AMI was bailed out –  by the current government, on the recommendation of the Reserve Bank and Treasury.

In his speech, Fiennes note that

“it is of course true that many people expect governments to stand behind their deposits. That expectation was reinforced by the widespread Government guarantees (including in New Zealand) during the GFC.  The existence of an expectation, though, is not a sound reason to adopt deposit insurance”.

That might be true if depositors had no leverage.  But they do. It is called the ballot box, and politicians are very well aware of it.

If depositors, or policyholders, expect bailouts, and political leaders have incentives to respond to, and deliver on those expectations, then it may be a much less inferior option to adopt an explicit retail deposit insurance scheme upfront.

Deposit insurance need not be a substitute for OBR, but may actually make it a little more credible that OBR could be allowed to work.  If there is a bail-out, it will benefit not just New Zealand retail depositors, but wholesale lenders too, domestic and foreign.  There is likely to be much less political appetite for bailing out the wholesale creditors (especially the foreign ones), but a simple bailout does not enable one to distinguish.  By contrast, a properly specified deposit insurance scheme enables one to be very clear upfront which deposits are likely to be covered, and which not –  and to charge for that coverage accordingly.  In event of a bank failure, OBR could be applied to all creditors, with the deposit insurance scheme “reimbursing” the retail depositors to the extent defined in the scheme.  And in the event of a serious bank failure, the ability to impose loss on (particularly) foreign lenders (though in practice all wholesale creditors) is a net welfare gains to New Zealanders.  Letting losses fall on New Zealand retail depositors might be reasonable economics, but (a) it probably doesn’t work politically, and (b) it simply transfers the losses from one set of New Zealanders to another.

Deposit insurance schemes are not ideal –  and the Reserve Bank speech and article repeat some of the challenges.  But bailouts are not ideal either, and experience suggests very strongly that bailouts remain the preferred default option at the point of crisis.  As someone put it to me recently, in some sense if you don’t have an explicit limited deposit insurance scheme then, de facto, you have an implicit unlimited deposit insurance scheme (ie bailouts).  And reasonable depositors will know it.

And if deposit insurance schemes aren’t ideal, they are fairly ubiquitous.   As this recent IMF Working Paper points out (p32) every single advanced economy member of the IMF has an explicit deposit insurance scheme, with the exception of Israel, San Marino, and New Zealand.  San Marino aside, every European country, advanced or emerging, has such a scheme, and Africa is the only continent where a majority of countries do not have such schemes.  It has never been clear why the Reserve Bank thinks New Zealand can, or sensibly should, sustain being different, given the political economy pressures that all governments face.

And it is not as if deposit insurance has been withering since the financial crises of 2008/09.  As the IMF paper illustrates, coverage has often been extended, and co-payments wound back.

I noted this morning that, for all its insistence on having regular private data that creditors can’t get access to, the Reserve Bank continues to assert that, in effect, it has no financial “skin in the game” –  the risks are with creditors. In a second-best world, a deposit insurance scheme actually helps ensure that government agencies really do directly have skin in the game; financial risk if things go wrong.  That might actually sharpen accountability.

It was really rather naughty, and unhelpful, of the Reserve Bank not to have devoted some space to the political economy pressures, and the New Zealand bailouts/guarantees to which they (and The Treasury) have been party.  Of course, it might have been difficult to have done so, and would have undermined a good story, but it would have got us closer to better understanding the real choices and tradeoffs that societies face and make in this area, ex ante and ex post.

Of course, the decision on a deposit insurance scheme is not one for the Reserve Bank.  It is a government decision, and one that would require legislation to implement. It is understandable that the current government feels badly burned by the cost of the guarantee of South Canterbury Finance.  But given the incentives that governments will inevitably face if a major bank, or insurer, is on the brink of failure, it is surely time to shift direction, and put in place an explicit insurance scheme, for which depositors would be charged. Doing so would probably, overall, strengthen market disciplines a little, not weaken them as the Bank argues.  Bailouts of all creditors might still happen –  between Australian government pressure, and the threat of disrupted access to foreign funding markets –  but at least (a) the government would have raised some revenue in advance of the costs, and (b) we would be able to have more rational, and emotionally (and politically) plausible, arguments about the reasonableness of allowing unsophisticated investors who had taken little or no obvious risk (deposits in one of our larger banks) to face large unanticipated losses.

At interest.co.nz, Gareth Vaughan recently had a nice piece also making the case for deposit insurance in New Zealand.

 

The Reserve Bank has been firing out on-the-record speeches this week. I discussed the Governor’s troubling effort here, and may come back to that again in the next few days.  I probably won’t say much about the Assistant Governor’s lecture yesterday –  except perhaps to draw attention to his claim that ‘there are times when the Bank will know more about the economic situation and outlook than does the public or market participants’.  Really?   I guess the last three years, when the Governor has consistently failed to get inflation near the 2 per cent target, and has had to dramatically and grudgingly reverse his own rather strident policy stance, hasn’t been one of those times.

Perhaps more interesting were the two releases late yesterday afternoon on the role of market discipline in the context of prudential regulation of banks (in particular).   Toby Fiennes, the head of the Bank’s prudential supervision area delivered a speech to some of those he regulates headed “Regulation and the Importance of Market Discipline” , and an issue of the Bulletin by two of his staff headed “The importance of market discipline in the Reserve Bank’s prudential regime” was released.    In both of yesterday’s releases there is a refreshing reaffirmation of the importance of market discipline –  even if the actual direction of policy isn’t really that consistent with the rhetoric.

The Fiennes speech is a mix: in part a lecture on the Bank’s view of the importance of market discipline, and partly a report on the outcome of the Bank’s recent tidying up exercise, the so-called  “regulatory stocktake”.  I wrote about the results of that process here (and a mere four months after first requesting them I have recently had released to me around half of the submissions the Bank received on the stocktake consultation ) [1].

I wanted to touch on just two aspects of the stocktake material.  I was one of several submitters who had made the case that all submissions on Reserve Bank consultative documents should be published (as is now common practice in other government agencies and parliamentary select committees).  The Bank has always been very resistant to such openness. But in its release in December, there were encouraging signs

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).

Unfortunately, the discussion in last night’s speech –  when Fiennes went out among the banks –  was weaker than what they put out in December.

Some submitters suggested that we publish all written submissions on our public consultations. Our current approach is based on prior feedback, which indicated that respondents prefer to keep their submissions private on the grounds of commercial confidentiality. We will test this more rigorously with stakeholders. The alternative would be to publish all submissions by default unless submitters ask for them to be withheld or redacted.

Talk of a new default position of publication has disappeared.  What I wrote in December seems even more apposite in light of last night’s comments

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

I hope that the Reserve Bank remembers that its primary stakeholders are the public, and the representatives of the public (the Minister and members of Parliament), not the entities they are statutorily charged with regulating.

But to balance that unease, I want to give Fiennes kudos for one aspect of his speech. In my submission to the stocktake I had argued that if the Bank was serious about promoting market discipline, it shouldn’t be devoting undue time to refining disclosure statements, which the Bank quite openly states don’t contain the information the Bank itself uses. Instead, I argued, the Bank should require that all the private information the Reserve Bank now collects should be published on the relevant bank’s website at the same time it is supplied to the Bank.  Recall that the Bank is keen to emphasise that creditors, not the Reserve Bank or the Crown, bear the losses in the event of a bank failure.

The Bank’s published response to the submissions did not deal with that proposal at all.  But last night’s speech did.  Here is what Fiennes said

As some of you may have read, several submitters argued that we should publish all of the information we receive through private reporting, potentially publishing a monthly dashboard of this information.

While this principle has some appeal, there are two main reasons why we do not consider it appropriate.

First, the potential trade-off between timeliness and data quality. We sometimes accept a marginal reduction in data quality in private reporting in exchange for receiving the information quickly. While this is appropriate for supervisory purposes, public disclosure needs to maintain a high minimum accuracy in order to support the credibility of the regime. This is underscored by the penalties in the legislation for false disclosure, and is an issue we are giving careful thought to in the design of the dashboard.

Second, there is the issue of commercial sensitivity. Often the private data we received is commercially sensitive, or might be open to misinterpretation if released without the appropriate context – especially if this was occurring in a situation of rapidly rising financial system risk.

At least now we can better understand the Bank’s objections. But I don’t find the counter-arguments persuasive.

Fiennes asserts that the Bank can “sometimes” live with a “marginal reduction in data quality…in exchange for receiving the information quickly”,  but that they can’t possibly expose the public to this “marginal reduction”.  But it is the money owned by the public that is at stake in these banks: Reserve Bank staff and management have nothing directly at stake.  More generally, the Bank doesn’t seem to recognise that all sorts of real and financial markets trade on imperfect information all the time –  in monetary policy, the constant revisions to GDP data for years afterwards are just the most obvious example.  If the information is sufficiently valuable to the Reserve Bank that it will use statutory powers to compel banks to supply it (without charge) that information, then such timely information should be at least as valuable to the public who are investing with the banks.  If the data really helps shed light on the financial positions of banks, investors have more use for it than officials.

The Reserve Bank’s other counter-argument is “commercial sensitivity”.  But if the Reserve Bank really needs this timely information to do its job, how can depositors and other lenders not need it to evaluate the changing nature of the risks they are running?  No doubt the same sorts of arguments were run when disclosure statements were first developed in the 1990s.  Fiennes is also concerned that data might be “open to misinterpretation if released without the appropriate context” –  but nothing stops the disclosing bank itself, or the Reserve Bank , or any private sector commentators providing that context.  Any data can be misinterpreted   – and can also be explained.  Fiennes amplifies the point by arguing that misinterpretation is perhaps especially likely “in a situation of rapidly rising financial system risk”.   But disclosure isn’t overly valuable to any creditor in good times – the value of having that information is precisely when actual and perceived risks are rising.  And, to be boringly repetitive, it is depositors’ and investors’ money that is at stake.

Here was some of my discussion of the issues in my original submission:

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 inevitably needs to be a degree of confidentiality around the handling of that 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.

I still think the case for full and immediate publication of all regular bank statistical returns is strong.

New Zealand’s regime around depositor protection is extremely unusual internationally –  something I will come back to in a follow-up post.   We don’t protect depositors.  Perhaps keeping information private –  having the real oil only going to the Reserve Bank –  might be acceptable in some idealised world in which bank regulators were consistently wise, insightful, benevolent and consistently right. (“we’ll look after everything for you”).   But they aren’t.  They are human beings, and their track record (around the world) isn’t particularly good.  That isn’t a comment about the Reserve Bank of New Zealand in particular –  it hasn’t been put to the test in the last 20 years –  but about bank regulators more generally (and other regulators for that matter).

Regulators simply do not have the incentives to process and interpret information correctly –  and it isn’t their money at stake.  Sometimes they get too cosy with those they regulate.  At other times, they get too cosy with their political masters. And often enough – being human –  they simply pursue their own bureaucratic interests –  a bigger agency, with more power, more information, not too much scrutiny and a quiet life.  There isn’t much reason to think that Reserve Bank regulators will consistently make better use of ‘private data’ from banks better than the people who have lent to those banks will.  Disclosure can be messy, and bureaucrats abhor messiness.  But the contest of ideas and interpretations, and the intense scrutiny of available information (partial as it might often be), is the essence of competitive market processes.  Tidiness, not so much.   If regulators need data promptly, so do those who invest with the banks they regulate.

 

[1] The Bank told me a week ago they were going to post that release on their website (here), but have not yet done so.  If anyone wants a copy of those submissions please email me.  [UPDATE: The Bank has now posted the release.]