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

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

This is what I wrote about what we might expect

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

That may be a useful guide for bank supervision.

[UPDATE: Rereading this years later, I think I misinterpreted Miles on this point.]

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

But there were new weak arguments. Thus

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

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

On he ploughs

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

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

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

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

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

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

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

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

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

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

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

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

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

This is the entire “argument”

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

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

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

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

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

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

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

The case just doesn’t stack up.

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

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