Don't believe what banks say about how much capital they should have to hold, Reserve Bank deputy governor Geoff Bascand told the New Zealand Shareholders' Association.
"Shareholders' view of capital will always be lower in the banking sector than is good for the country," Bascand told NZSA's annual conference in Christchurch at the weekend.
"If a bank says it should be this much, know it should be more than that."
Nevertheless, Bascand acknowledged that how much more capital than banks think they ought to have is a fair matter for debate.
RBNZ has proposed to near double the minimum amount of tier 1 common equity capital the four major banks have to hold, from 8.5 per cent of risk-weighted assets currently to 16 per cent. Smaller banks will have to hold 15 per cent.
"Broadly speaking, they borrow 93 per cent" of the money they lend and only about 7 per cent is their own money and "you might be a little bit worried about that," Bascand said.
"We want that level to go up to about 10 or 11 per cent."
That will mean about $20 billion of additional capital for banks that lend in the order of $550 billion.
If one of the banks were to fail, particularly one of the four major banks, the repercussions for the economy would be far worse than the collapse of insurance company CBL, Bascand said.
RBNZ is also proposing changes that will allow a more level playing field for the smaller banks.
Currently, the larger banks are allowed to use their own internal models to calculate how much capital they should hold while the smaller banks are required to use standardised models.
In practice, that greatly reduces the amount of capital the large banks have to hold in comparison with the smaller banks.
For example, in February, Bascand released information showing that ANZ Bank, New Zealand's largest bank, needs to hold just below $3 of capital for every $100 of mortgages on its books while the government-owned Kiwibank has to hold about $5.70.
Bascand told the NZSA that one benefit of holding more capital will be that banks will be able to continue operating in a crisis.
He acknowledged more capital will also lower returns to bank shareholders but said those investors should expect a lower return from a safer investment.
In addition to reviewing the absolute levels of bank capital, RBNZ is having another look at whether hybrid securities - those which normally behave like debt but which can be converted into equity - should be allowed to count towards tier 1 capital. It is also looking at the timeframe for introducing the changes, he said.
Originally, RBNZ had proposed a five-year phase-in period.
The RBNZ is making the proposals in spite of New Zealand's banks have sailed through a succession of stress tests as well as having proved among the safest through the 2008 global financial crisis. The central bank said in April that it came up with its proposals without completing a cost-benefit analysis, although governor Adrian Orr has argued since that it had effectively done a cost-benefit analysis without calling it that.
Nevertheless, RBNZ will produce an actual cost-benefit analysis when it announces its final decisions, expected in November.
Bascand said ahead of those final decisions, RBNZ will release reports later this month from the three independent reviewers it has engaged.