The Reserve Bank's proposals to double minimum bank equity levels will cost New Zealand's economy $1.5-to-$2 billion a year without making banks much safer, according to former long-serving central bank official Ian Harrison.
Worse, he says the bank's decision to base its policy on ensuring that bank collapses occur only once in every 200 years happened at the last minute when it realised that its initial target of limiting bank collapses to once in every 100 years would have meant New Zealand banks already had sufficient capital to meet that test.
This doubling of the time frame happened "on a whim without any consideration of the costs and benefits of the choice," Harrison says.
Harrison, who left the central bank in 2012 and is now a consultant, has also worked for the World Bank, the International Monetary Fund and the Bank for International Settlements, which is the central banker for central banks. He is accusing the Reserve Bank of cooking the books to reach a pre-determined outcome.
He cites one of the background papers, a memo by Reserve Bank official Susan Guthrie dated Oct. 30, 2018 titled "Risk appetite framework used to set capital requirements" which appears to show the Reserve Bank changed its mind about the target number of years.
That memo notes that "the decision about how much capital to require of banks is made under conditions of uncertainty."
It concludes that "we believe a reasonable interpretation of 'soundness' in the context of capital setting is to cap the probability of a crisis at 1 per cent (or 0.5 per cent if we wish to mirror approaches taken in insurance solvency modelling)."
In other words, the one in every 100 years was regarded as the target as late as October 30 last year.
Harrison says the Reserve Bank manipulated its models to produce the "right" answer. "Initially, a 1:100 target was proposed but when this couldn't generate a capital increase, the target was switched to 1:200 at the last minute," he says.
The Reserve Bank has said New Zealand banks on average currently hold tier 1 capital of about 12 per cent of risk-weighted assets, higher than the 8.5 per cent regulatory minimum. It is proposing to raise that minimum to 16 per cent, a decision based on the one in 200-year target, with a five-year phase-in period.
The central bank says the proposals will raise lending margins by 20-40 basis points, although in its technical document it has used 40 basis points, and deputy governor Geoff Bascand last week said that this will amount to "little more than noise."
But Harrison, whose role at the central bank involved developing an analytical approach to assessing risks, says that cost on a $400,000 mortgage would be $1,000 a year more in interest.
Other analysts, notably UBS, have said the cost would be significantly higher than the Reserve Bank's estimate – UBS says the proposals will effectively add as much as $4,880 a year to the interest bill on a $400,000 mortgage.
According to an article in the September 2008 Reserve Bank Bulletin, international ratings agency Standard & Poor's Corp's 'AA-' ratings of the four major banks actually imply a failure rate of one in every 1,250 years, at odds with what the Reserve Bank is saying.
"The bank is now saying that, at current capital ratios, the banking system is 'unsound' because the failure rate is worse than 1:200 and that the New Zealand banking system is not too far from 'junk' status," Harrison says.
"The international evidence does not support the bank's contention that the probability of a crisis is worse than 1:200."
The reason the four major banks have such high credit ratings is that their Australian parents have the same ratings but Harrison says the Reserve Bank is ignoring the fact that the banking system is mostly foreign owned.
There is little point in the four major New Zealand banks having a higher tier 1 equity ratio than their Australian parents "because if a parent fails, then it is highly likely that the subsidiary will also fail because of the contagion effect."
The Reserve Bank is insisting that tier 1 capital should be solely comprised of equity and clearly regards hybrid securities – securities which normally behave like bonds but which can be converted to equity if necessary – as unsatisfactory.
The central bank has described equity as being the ambulance at the top of the cliff and hybrid securities as the ambulance at the bottom of the cliff.
But the Australian Prudential Regulation Authority is taking a different stance. While it is also requiring banks to raise their capital levels, it is allowing them to use hybrid securities to do so.
"This provides the same benefits, in a crisis, as common equity tier 1 capital but at about one fifth of the costs" and the extra cost New Zealanders would be required to wear would have "almost no benefit in terms of more resilience to a severe crisis."
Harrison says most of the costs of a bank failing are due to borrowing decisions made before a downturn.
"With current levels of bank capital, failures will be rare with the main cost likely to be a government capital injection," he says.
"The experience with most banking crises in countries most like New Zealand is that governments have recovered most of their costs when the government's bank shares are subsequently sold," he says.
"The bank is selling a form of insurance to the New Zealand public but is vague about the premium costs and has exaggerated the benefits," Harrison says.
If he's right about the costs being $1.5-2 billion, "an informed, rational public would not buy this policy."