Experts have their say. Did Reserve Bank governor Adrian Orr get new bank rules right?

Reserve Bank Governor Adrian Orr during their press conference. New Zealand Herald Photo, August 2019.

The Reserve Bank's proposal to make banks hold more capital will have a smaller impact on interest rates than it had estimated, according to two experts in an independent review of the process.

The Reserve Bank has this morning made the findings of the independent review public, ahead of its final decision in early December.

All three of the academics commissioned to review the RBNZ's capital proposals agreed that it was robust, considered and did not need to be substantively redressed.

The Reserve Bank is proposing a lift in the amount of risk-weighted capital retail banks hold, from 8.5 per cent to 16 per cent.

The increase is designed to make banks safer and better designed to handle periods of financial stress by holding enough capital to reduce the probability of a financial crisis in New Zealand to a one in 200-year event.

Australian bank bosses have pushed back, calling it overly conservative and warning that it could limit the availability of credit in some sectors of the economy and increase interest costs for borrowers.

But two of the three academics concluded that the RBNZ had in fact overstated the impact of the capital proposals on bank funding costs.

They argued that bank profits in this country are more than strong enough to handle the higher capital ratios meaning the pass through of interest rate costs should be lower than the Reserve Bank estimates.

"If the proposed higher capital requirements have a smaller impact on bank funding costs than estimated by the Reserve Bank, the share of cost that banks pass on to customers in the form of higher interest loans can be expected to be smaller," said Dr James Cumming of Macquarie University in Australia.

This contrasts sharply with major banks such as Westpac which have argued the Reserve Bank underestimated the likely cost to borrowers.

In its submission on the proposals, Westpac said it estimated the increase in capital could up the cost to borrowers by adding more than 100 basis points to the interest rate on a home loan - an increase of around $6000 to an average home loan in Auckland.

Professor David Miles has also argued that the Reserve Bank has overstated the cost of holding extra capital.

He suggests that locally listing on the NZX would be an obvious solution for the big four banks.

Westpac has argued interest rates will rise sharply if the current capital proposals are applied. NZ Herald File Pic.

The big four banks could "raise additional equity financing either by listing in the New Zealand stock exchange or by sourcing through their Australian parent banks.

If they listed in New Zealand the cost of increased equity financing could be further reduced for shareholders through tax benefits of imputation credits on dividends, he said.

A third academic, Ross Levine from the University of California, said that while the RBNZ's working was sound, he saw two exceptions relating to areas that could have had more focus.

He argued the RBNZ had not sufficiently factored in the influence of incentives on bank executives which "limits the analysis of how capital requirements influence bank stability and efficiency."

Levine says there is research which suggests bank regulation shapes the incentives of bank executives and decision makers and those incentives, in turn, shape the stability of the system.

His other area of concern is around was the degree of dynamism within the New Zealand lending sector.

Levine warns that the proposals would lift the cost of banking but that impact on the economy depends on the extent to which non-banks emerge to provide alternative sources of finance.

New Zealand's second-tier lending (finance company) sector was largely wiped out 10 years ago in a series of company collapses.

The heavyweight trio of independent experts are all currently academics although they have a mix of commercial and regulatory experience.

Miles was chief economist with investment bank Morgan Stanley until 2009 and a member of the Bank of England's monetary policy committee from May 2009 through September 2015.

Cummings previously worked for the Australian Prudential Regulation Authority between 2009 and 2013.

Levine has previously worked at the Board of Governors of the Federal Reserve System and the World Bank.

The New Zealand Bankers Association, which represents New Zealand banks, said it did not agree with the findings.

"We differ on the costs of the proposal compared to the benefits. Our banks are already well-capitalised and strong by international comparisons," said NZBA chief executive Roger Beaumont .

Beaumont cited the NZBA's own independent economic analysis - led by former Treasury Secretary Dr Graham Scott - that found that the Reserve Bank proposals will cost households, businesses and our economy around $1.8 billion a year.

"That's a conservative estimate of costs based on the Reserve Bank's assumptions. The cost to our economy could be higher," he said.

The Reserve Bank has indicated it will consider all comments and suggestions made by the independent experts and is also working through points raised in the submission process.

It says it will refine its estimates of costs and benefits, consider a range of perspectives on interest rate impacts, assess the impact of incentives on various groups in the financial system and undertake additional analysis of the definition of capital and processes for determining the level of risk-weighted assets.