The Reserve Bank's 2019 decision to nearly double bank capital requirements has raised borrowing costs and tightened lending criteria. Photo / Getty Images
The Reserve Bank's 2019 decision to nearly double bank capital requirements has raised borrowing costs and tightened lending criteria. Photo / Getty Images
THE FACTS
The Reserve Bank’s 2019 decision to nearly double bank capital requirements has been controversial and costly.
Parliament’s finance and expenditure select committee found that high capital requirements may undermine efficiency and competition.
A new RBNZ Financial Policy Committee will be formed to oversee capital settings, but independent analysis is needed.
Most New Zealanders would struggle to explain what bank capital requirements are, let alone why they matter. Yet the Reserve Bank’s controversial 2019 decision to nearly double these requirements affects every mortgage holder and business borrower in the country.
After years of criticism, the bank (RBNZ) finally begana review of that decision, releasing proposals for consultation in late August. Submissions closed last week. But what is proposed are little more than tweaks. Fundamental questions about regulatory gold-plating remain unanswered.
Higher capital requirements mean banks must hold more equity relative to their loans, which makes lending more expensive. The costs get passed straight through to borrowers as higher interest rates and tighter lending criteria, hitting hardest those who already struggle to access credit. So it is important that capital requirements are not set too high.
The select committee recommended reinstating "market efficiency" as a key objective and enhancing RBNZ's governance. Photo / Getty Images
The RBNZ’s 2019 decision was extraordinary by international standards, targeting an unprecedented “one-in-200-year” risk of bank failure, rather than a more conventional one-in-100-year target. Independent analysts suggest the cumulative burden of the RBNZ’s conservative capital and related regulations may be costing the economy up to 2% of GDP – around $10 billion annually.
This extreme conservatism leaves New Zealand banks holding materially more capital than many international peers. It also encourages banks to favour lower-risk residential mortgages over productive business lending.
The RBNZ’s decision-making process in 2019 was also controversial. The bank announced its proposals first, then backfilled with cost-benefit analysis to justify them after submissions had closed. Yet the dramatic departure from international norms deserved rigorous testing through public debate.
The big question now is whether the RBNZ’s 2019 decision was efficient – or fell into the trap of regulatory gold-plating. Unfortunately, the current review does not answer that question. However, RBNZ consultation documents do acknowledge some problems with its capital settings.
Oliver Wyman’s RBNZ-commissioned international comparison confirms New Zealand’s outlier status. The consultation proposes two modest recalibration options for the major banks – who together hold around 85% of banking system assets – that would reduce capital requirements somewhat. But they rely on the same inadequate cost-benefit analysis used to bolster the original decision. There is no independent analysis and no consideration of full international alignment.
Independent analysis suggests regulation could be costing the economy 2% of GDP.
Over the past year, Parliament’s finance and expenditure select committee has conducted its own inquiry into banking. The committee heard extensive evidence about the economic costs of the 2019 decision and concluded that high capital requirements may be undermining efficiency and competition.
The committee recommended that the Government should reinstate “market efficiency as a key objective” in the Reserve Bank of New Zealand Act 2021. It also recommended enhanced governance of the RBNZ’s prudential regulatory function, including establishing a dedicated committee with prudential expertise.
The RBNZ board has responded to the governance concerns, announcing this week the formation of a new “Financial Policy Committee”, comprising board members and up to two external experts, with formal decision-making authority over capital settings. This is some progress – though it underscores the need for the RBNZ board to have more prudential regulatory expertise.
Costly caution: Why RBNZ’s capital play still misses the mark. Photo / 123RF
The select committee also called for an independent review of the 2019 decision. Here, the RBNZ’s response has been less encouraging. The bank released its consultation documents just days after the select committee’s report, rather than pausing to consider Parliament’s concerns. This looks more like institutional resistance than genuine reassessment.
The banks themselves will be relatively impervious to whatever regulatory settings are imposed. They will adapt and remain profitable. This is precisely why capital settings demand rigorous analysis. When set too conservatively, the costs fall on household and business borrowers who face higher costs – and on the broader economy.
The RBNZ’s prudential regulatory function is subject to political oversight because of its far-reaching economic impacts. The 2021 act gives the Finance Minister significant leverage over the RBNZ’s settings through the Financial Policy Remit mechanism. This allows Nicola Willis to set clear expectations for regulatory efficiency, as she did in her December 2024 remit directing the RBNZ to “encourage efficient provision of financial services”.
Nicola Willis has been urged to order an independent review of RBNZ capital settings. Photo / Mark Mitchell
Willis should go further. She should encourage the RBNZ board to halt both implementation of the remaining 2019 increases and the current review pending a comprehensive, independent reassessment.
The new Financial Policy Committee will be operational in early 2026, with external experts specifically appointed for their prudential expertise. These major capital decisions should be the FPC’s first priority, informed by proper independent analysis rather than the current consultation’s limited options.
In the meantime, Willis should commission Treasury to conduct the independent analysis Parliament requested. As the monitoring agency for the RBNZ’s performance as prudential regulator, Treasury could ensure proper scrutiny of settings that affect borrowers across the economy.
The fundamental test for any regulation should be efficiency: do the likely benefits plausibly justify the costs? The RBNZ has not compellingly shown that its 2019 settings meet this test. Banking stability matters. But without a proper reassessment of its 2019 decision, New Zealand risks indulging risk-averse regulators and making Kiwis worse off.
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