The Reserve Bank thinks its proposed bank capital rules will have almost no effect on economic growth, in stark contrast to bank economists who fear it could hamper it.
The Bank has proposed a dramatic increase in the amount of capital the commercial banks are required to hold. This will likely increase costs for the banks, which they are likely to pass on either by decreasing the amount of lending they do or cutting returns for depositors and increasing costs for borrowers — or some combination of the two.
Big banks, including ANZ and the Swiss investment bank UBS think it will have a massive impact on costs. ANZ’s most recent Quarterly Economic Outlook, published in January, said that “while the magnitude of the impacts are highly uncertain, it is unambiguous that they will result in a tightening in financial conditions during the transition that will weigh on economic activity even if partially offset by a lower OCR”.
But the Reserve Bank’s Monetary Policy Statement – the bank’s quarterly economic check-up – took a very different view.
It acknowledged the changes would be likely to affect the economy “through a number of channels”, but that the impacts “are likely to be outweighed by other factors impacting the business cycle, such as global economic conditions”.
The statement said it anticipated banks’ lending rates and the rates at which they borrow to settle at around 20 to 40 basis points higher as a result of the change. This is miles away from UBS’ projection that banks would have to revalue their mortgage books by as much as 125 basis points.
Reserve Bank Governor Adrian Orr said he “seriously struggles” with the UBS forecast.
“We don’t at all buy in to that story,” he said.
Orr acknowledged there could be cost impacts.
“The cost of funding could rise for the banks. The question is by how much and what capability do they have to either pass that on or maintain their current level of earnings by either taking on other risk or constraining credit,” he said.
But he believed that in the long run, the capital requirements would help the banks become more profitable.
“In a competitive market that will be their judgment on the way through, what we’ve observed globally is that well-capitalised banks tend to be able to lend more and be more profitable,” he said.
This was outlined in the monetary policy paper, which noted that the bank expected the long-term effects of the capital to be a reduced risk premium associated with investing in New Zealand.
“The cost of both equity and debt funding for banks would also decrease,” it said.
It said that because banks’ returns on equity would be less variable, investors’ required rate of return would also decline. The statement also noted that a “larger equity cushion would reduce the probability of bank creditors facing losses” which would lead to creditors demanding less compensation for credit risk.
Orr said it was important that the appropriate level of risk was borne by banks.
“Returns can be privatised, losses can be socialised and what we’re saying is how can we shift that balance back a bit,” he said.
The Bank left open the possibility that it could use monetary policy to “respond” to a decline in demand, meaning there could possibly be a rate cut if capital requirements led to a downturn after their gradual implementation – which begins at the end of this year.
The Bank remained dovish on Wednesday, pushing out its scheduled OCR hike to March 2021 from September 2020 and revising down GDP projections.