Reserve Bank governor Adrian Orr says a proposed doubling of capital that banks have to hold isn’t fixed in stone.

“We are and will be open-minded to the submissions that come back,” Orr said at yesterday’s monetary policy statement press conference.

The underlying message the central bank is sending the banking sector with its capital proposals is that more equity is better and that more quality capital is better, he said.

“More capital means sounder financial institutions.”

The Reserve Bank had been making it clear for some time that it was going to require banks to hold more capital.

But most were shocked when late last year its formal proposal was that the big four banks, which account for about 88 percent of the banking system, would have to hold a minimum of 16 percent of their risk-weighted assets as tier 1 capital.

That’s far more tier 1 capital than any other country requires their banks to hold and compares with the current regulated minimum tier 1 capital of 6 percent plus a 2.5 percent buffer.

Not only that, but the Reserve Bank wants only equity, and not any form of quasi-equity, to count as tier 1 capital.

Yet another impost on the big four banks will be limiting the advantage they gain from using internal models to calculate capital to 90 percent of the level of capital required using the standard rules.

KPMG has calculated that for loans requiring $100 million of capital using the standard rules the big banks only need to hold $76 million, giving them a significant advantage over the smaller banks.

All the smaller banks will be required to hold minimum tier 1 capital of 15 percent of risk-weighted assets, which should also help level the playing field.

On Thursday, after Orr and Finance Minister Grant Robertson had signed the Reserve Bank’s new remit to replace the Policy Targets Agreement as monetary policy moves away from being the purview of the governor alone to being decided by committee, Robertson was asked his opinion of the proposed new capital levels.

He said he has been “listening carefully” both to what the banks are saying and what Orr has been saying. “This is a decision that’s up to the bank and therefore I have to respect that,” and it’s a matter for the Reserve Bank to decide, Robertson said.

Asked whether he’s on board with such high levels of capital being required, he said: “No, it’s not my role to be on board with them.

“It’s unwise for ministers of finance to go down that path. We have rules about the Reserve Bank’s independence for a reason.”

The Reserve Bank’s monetary policy statement argues that the actual amount of additional capital the banks will have to find is much less than the increase in minimum requirements. The current industry average of tier 1 capital is about 12 percent of risk-weighted assets.

If the proposals go ahead, Orr said it will be up to individual banks how much additional capital they hold.

However, since banks currently go out of their way to hold more capital than is statutorily required, it seems safe to assume they will not hug the 16 percent tier 1 requirement if that is the Reserve Bank’s final decision, he said.

He acknowledged that banks would want to avoid getting a phone call from the central bank if their tier 1 capital was falling and near the minimum requirement.

Orr also argued that the proposal is “still well within the range” of global norms, and that while other countries may set their minimum capital requirements at lower percentages, different countries have a range of “opaque” requirements that overlay the formal minimums.

Deciding an optimum level of bank capital is a balancing act and “we think there’s safe zone where you can have a safer bank without the loss of efficiency.”

A number of commentators and economists, including those from ASB Bank and Westpac, have estimated that the additional capital will lead to the banks paying less for deposits and charging higher interest rates.

That’s because they will want to maintain their return on equity.

UBS has estimated the extra impost on loans would be 80-125 basis points, meaning that a two-year fixed rate mortgage currently bearing a 4 percent interest rate could rise to as much as 5.25 percent.

The Reserve Bank’s view is that the additional level of interest rates banks will charge “will settle in the range of around 20 to 40 basis points.”

In Orr’s words, any impact will be “lost in the wash” of the many other factors that impact interest rates and the economy.

“We seriously struggle with the analysis” of UBS, Orr said.

Deputy governor Geoff Bascand said the UBS analysis is “a real outlier” and that there are other calculations that are much lower.

Orr dismissed the suggestion that banks could simply stop lending in order to comply with the new rules if they are implemented as proposed.

“In a competitive market, that will be their judgement,” he said, adding that “at the moment, the return of equity for banks is incredibly strong.”

Bascand said New Zealand banks are amongst the most profitable in the world and questioned why they would want to abandon such a market.

KPMG says the banking sector’s annual net profit in the year ended September last year rose 11.2 percent, or by $580 million, to $5.77 billion. The big four banks accounted for $482 million of that increase.

KPMG partner John Kensington has expressed concerns that the proposed minimum bank capital levels are so high that they will lead to banks wanting to lend in areas that require the least amount of capital, such as low loan-to-valuation mortgages.

In particular, Kensington is concerned that banks won’t want to continue lending to parts of the economy including dairy farms, construction and small-to-medium enterprises, because of the extra capital such lending requires.

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