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RBNZ's flawed bank capital process should be suspended

RBNZ's flawed bank capital process should be suspended to allow further consultation

Wellington (5 December 2019): The Reserve Bank of New Zealand should suspend its decision to increase banks’ capital and re-open the public consultation process says public policy think tank, The New Zealand Initiative.

The RBNZ’s decision to increase the capital banks are required to hold will have adverse effects for borrowers and the wider economy. The effects are likely to be felt most acutely by high loan-to-value borrowers, the rural sector and small-to-medium-sized enterprises.

Yet the Initiative’s submission in response to the RBNZ’s Review of the Capital Adequacy Framework for locally incorporated banks: How much capital is enough? Discussion Paper revealed serious flaws in the RBNZ’s decision-making processes.

Most importantly, the Discussion Paper did not include a full cost-benefit analysis, evaluating the costs and benefits of the RBNZ’s proposals to New Zealanders and the New Zealand economy.

In response to criticism from the Initiative and others, RBNZ governor Adrian Orr promised that a full cost-benefit analysis would be released alongside the RBNZ’s final decisions.

While the RBNZ says it has met this promise with the release of documents supporting its decision announced today, the RBNZ’s approach is “deeply troubling” says Initiative chair Roger Partridge.

“Cost-benefit analysis is a fundamental requirement of good regulatory decision-making. The government’s Expectations for Good Regulatory Practice explicitly require cost-benefit analysis before a substantive regulatory change is formally proposed. The RBNZ’s failure to prepare a full cost-benefit analysis at the outset of the consultation process means its analysis has not had the benefit of testing and challenge during public consultation. This is highly unsatisfactory.” says Partridge.

The Initiative’s submission also highlighted that the RBNZ’s approach suggested it had a preconceived notion of the “correct” level of capital banks should hold. This was apparent both from the RBNZ’s initial failure to justify its 1-in-200-year risk tolerance for bank failure and from the RBNZ’s vocal advocacy in favour of its proposal during the public consultation process.

Partridge says, “The RBNZ’s ex post cost-benefit analysis is susceptible to challenge on the grounds of pre-determination.”

To head off this criticism, the RBNZ should:
• suspend its decision;
• re-open the public consultation process to enable the public to comment on the RBNZ's assessment of the cost and benefits of its proposal; and
• revaluate its decision in light of further feedback received from the consultation process.
The RBNZ’s flawed bank capital consultation process further highlights the shortcomings in the central bank’s governance arrangements revealed in the Initiative's 2018 report, Who Guards the Guards? Regulatory Governance in New Zealand. The RBNZ’s single-member decision-maker model means one person – the RBNZ Governor – has sole responsibility for the RBNZ’s decision to change the capital requirements for registered banks.

Commenting on this, Partridge says, “The RBNZ’s governance arrangements vest unprecedented powers in the hands of a single individual. This would not matter if the bank’s regulatory decision-making was consistently exemplary. But our research found extremely low levels of confidence in the central bank’s decision-making processes (albeit under the bank’s former governor).”

The RBNZ’s governance arrangements are currently under review as part of Phase 2 of the Minister of Finance’s review of the Reserve Bank of New Zealand Act. “Changes to the RBNZ's governance to ensure the governor’s powers derive from the board, and that he becomes accountable to the board for their exercise, cannot come soon enough,” says Partridge.

ENDS

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