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Banks should hold more capital, experts say

Friday, August 2, 2013

Banks should hold more capital, experts say

Banks should be required to hold more capital to protect the financial system from a potential bust in the property market, monetary policy experts have told students at a Massey University panel discussion.

At an event put on by the Massey Business Student Group, former Reserve Bank governor Don Brash said the Reserve Bank should have access to macro-prudential tools and that the “counter-cyclical capital buffer is the best of the options”.

The counter-cyclical capital buffer, which requires banks to hold more capital during credit booms, is one of four macro-prudential tools being considered by the Reserve Bank to cool the property market. However, the Reserve Bank currently favours another of the tools – restricting loan-to-value ratios for mortgage lending.

Dr Brash went on to say that interest rate increases would not provide a solution. “Whenever a herd mentality develops around any asset class, as there is around property, it’s very hard to see any plausible interest rate change dampening that down,” he said.

“Eight per cent, which is where interest rates were before the global financial crisis, didn’t have an impact. Twenty per cent might, but that would do significant damage to the rest of the economy, so another instrument was always going to be needed.”

AMP chief economist Bevan Graham agreed that “counter-cyclical capital buffers have probably got a greater role to play”.

“If this is about financial stability, then banks holding more capital if things go pear-shaped is a good thing,” he told students.

Associate Professor David Tripe, director of Massey’s Centre for Financial Services and Markets, said he also believed the counter-cyclical capital buffer was the best way for the Reserve Bank to deal with a property boom.

“The best protection against a bust in property prices is the banks, collectively, to be more strongly capitalised so they are protected, individually, against the failure of other banks,” he said.

He also rebutted arguments that the tool would take too long to implement to have any immediate effect.

“One of the arguments for restricting loan-to-value ratios is it can be implemented quickly. But if the banks knew today that they would need to hold higher capital levels as of March 2014, they would think about the lending they are undertaking now. We could see them cutting back on their lending more generally.

“Meanwhile LVRs might restrict some bank lending, but it won’t stop people bidding for expensive properties. Other sources of funding are always available.”

With all the discussion of macro-prudential tools, Dr Brash also pointed out that the “best instrument for dealing with the property bubble is one that the Reserve Bank doesn’t control – releasing more land”.

“That’s what’s driving the bubble in Auckland land prices. When you have to pay $400,000 for an eighth of an acre in Flatbush, you know you’ve got a bubble,” he said.

Tim Ng, acting head of economics at the Reserve Bank, agreed that achieving the organisation’s objective of financial stability was not an easy task.

“It’s not at all easy and it’s relatively new territory at least in the sense that, prior to the global financial crisis, the prevailing philosophy was that you didn’t really have to worry about the activities of the financial system in generating financial instability. Since the crisis, most people have said that was obviously wrong, and there has been considerable international focus on reducing risks to the financial system.

“[With macro-prudential tools] we are very much in a second-best to third-best world. Macro-prudential tools build on the existing prudential framework to further promote financial system stability. With house prices rising and no evidence it’s going to stop, what we’re trying to do is protect the banking system. The more enduring solution, though, is to fix constraints in the housing market at various points in the building process.”

All four speakers were part of an expert panel discussion called ‘This Is Your Livelihood – Contemporary Monetary Policy Challenges in New Zealand’, put on by the Business Student Group at Massey University’s Albany campus.

Audience participation was encouraged through a live, online platform called Xorro.com, which allowed people to post questions to the panel and answer survey questions while the discussion was taking place. The audience was asked what they believed was the best tool for dealing with the overheated property market. The most common answer was ‘Introduce a capital gains tax’, followed by ‘Release more land for residential developments’.


Picture caption: ‘This is Your Livelihood’ panel of experts (L-R): Bevan Graham, Dr Don Brash, Tim Ng, Associate Professor David Tripe.

ENDS

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