The Reserve Bank's proposals, now policy, to increase bank capital requirements were unnecessarily risky, out of whack with international standards and informed by low quality information.
That's according to independent advice sought last year by then Economic Development Minister David Parker.
Ulf Schoefisch at Strategas Consulting provided the advice in March 2019.
Schoefisch was formerly chief economist at Deutsche Bank NZ, the New Zealand Institute of Economic Research and Martin Jenkins and worked for the RBNZ for six years until May 1996, sitting on its monetary policy committee for more than three of those years when he was head of economic forecasting.
The advice has just been released by current Economic Development Minister Phil Twyford.
Official Information Act requests made in August and September last year were declined to "avoid prejudice to the substantial economic interests" of NZ and because "the withholding of the information is necessary to maintain the effective conduct of public affairs through the free and frank expression of opinions by or to ministers of the Crown."
Twyford said in a letter dated June 5 that he had revisited the matter "as the capital review has now been completed and Cabinet has made further decisions on the second stage of the review of the Reserve Bank Act."
While the governor of RBNZ is appointed by the Minister of Finance on the advice of the RBNZ board and the governor operates under an agreement with that minister, the RBNZ is independent and the government has no direct control over its actions.
In his advice to the minister, Schoefisch said the proposals would have cost the economy more than $1.5 billion a year, nearly double the Reserve Bank's estimate, and that the four major banks would have had to raise $25b in new capital, more than the $19b the RBNZ estimated.
Lack of explanation
While the RBNZ's stated aim was to make banks capable of withstanding failures in a 1:200 year event, Schoefisch said the central bank provided "no detailed explanation why 200 years was preferable to 100 years or 300 years.
"It is difficult to avoid the impression that the RBNZ commenced its analysis with a biased view" and - because it wanted banks to significantly lift actual capital levels, then averaging about 13.4 per cent for the big four - "focused on justifying that preconceived outcome."
There is some evidence to support that view: a technical paper showed that, just a month before the proposals were announced in December 2018, the RBNZ had been working on a 1:100 year proposal.
If it had opted for a 1:100 year event, the trading banks would have needed little or no additional capital.
Schoefisch said the RBNZ failed to assess whether the required additional capital might conflict with the Australian prudential regulator's rules. The big four NZ banks are owned by Australia's big four banks.
"The RBNZ's proposed changes to bank capital requirements are far reaching by international standards," Schoefisch said.
"Considering the potentially significant implications for the banking sector and the economy, this policy change appears unnecessarily risky as it appears to have been informed by low-quality information," he said.
Consideration ought to be given to whether more effective bank supervision could act as a cost-effective substitute for large increases in capital requirements, he said.
The RBNZ's original proposals announced in December 2018 were that the four major banks had to raise tier 1 equity capital from a minimum of 8.5 per cent of risk-weighted assets to 16 per cent over five years - it said the big four could raise that through retaining 70 per cent of earnings. The smaller banks would have had to raise their tier 1 capital to a minimum of 15 per cent over the same period.
In December 2019, the RBNZ announced its decisions modifying the measures to allow the big four banks to include preference shares to make up to 2.5 per cent of the new requirement, rather than it have to be made up solely of equity, and extending the phase-in period to seven years.
The smaller banks will have to raise common equity from an average 11.05 per cent at June 30 last year to 13.5 per cent.
Preference shares are significantly less costly than equity – the RBNZ estimated banks' cost of equity would be 10.56 per cent and the cost of preference shares would be 7.04 per cent.
However, because of the coronavirus crisis, the RBNZ delayed the start date for the new requirements for at least a year until July 1, 2021.
Schoefisch today said he would make no comment on the analysis he provided so BusinessDesk was unable to ask him what difference the RBNZ's modified decisions had made.
His analysis is similar to other criticisms of the RBNZ's proposals and the supporting research, including analysis by former Treasury Secretary Graham Scott on behalf of the NZ Bankers' Association and former RBNZ official Ian Harrison.
Like many who made submissions on the proposals, Schoefisch noted the lack of a cost-benefit analysis. The RBNZ finally released a cost-benefit analysis when it announced its final decisions.
It was required to produce a cost-benefit analysis as part of the regulatory impact statement mandated by the Reserve Bank Act, but critics of the proposals had said the RBNZ should have started with one.
In the event, the RBNZ's analysis estimated the likely impact would be to increase annual GDP by 0.4 per cent.
That's slightly higher than the RBNZ's earlier statement that the hit to GDP would be a permanent 0.3 per cent decline, or about $800 million annually.
But Schoefisch estimated the combined rise in interest costs on borrowing and decline in interest paid on deposits would "most likely be more than $1.5b per annum."
The release of Schoefisch's advice follows the release of the central bank's latest financial stability report last month which said the financial system was in a "solid position" for banks to continue lending, even though bank capital was at levels the RBNZ had previously argued were inadequate.
The RBNZ expects the economy will suffer its largest decline in annual GDP in at least 160 years but has said that's not the same as a one-in-160 year banking crisis, putting the impact on banks at more like a one-in-30 year event.
Reserve Bank governor Adrian Orr made it clear at the financial stability report's media conference that the central bank still wants the trading banks to substantially increase their capital once NZ emerges from the current crisis.