Our Reserve Bank and the big four Aussie retail banks are headed for an epic showdown.

At issue is how much risk banks should be allowed to take in this country.

The Reserve Bank is allowed to prescribe how much money the banks have to hold relative to how much they lend.


It has proposed that they hold a lot more than they do now. That will make banking in New Zealand less risky but also less profitable.

Unsurprisingly, the banks - and their shareholders - aren't thrilled about that.

They argue the Reserve Bank is being overly cautious, that its proposed capital requirements are onerous and will cost the local economy more than it thinks.

Reserve Bank Governor Adrian Orr made headlines in financial media across the Tasman when he suggested the big banks operate here as a matter of privilege rather than a matter of right.

He pointed out that our banking sector is the most profitable in the world.

It generated a record $5.7 billion in net profits last year, according to KPMG.

Orr made a strong point, although one that jarred with the traditional (and slightly patronising) Australian attitude that they are doing us a favour by running our banking system.

The Australian Financial Review frames it this way: "New Zealand doesn't have its own banks. Rather, it relies on the subsidiaries of Australia's banks to fund its economy."


Orr and his team now face intense pressure from the banking industry, which is pushing back on the Reserve Bank's research and working hard to win concessions.

The process is independent of government, although one suspects Orr can count on some quiet support from all three current coalition parties.

This is very simplistic take on the whole issue, of course.

I've tried to avoid any of the language typically used to write about it.

That starts with "tier 1 capital ratios" and goes down hill from there.

It's not surprising that a capital-gains-tax-weary public is not clicking this issue to the top of the nation's news lists.

But it's a shame because this is a big one that will affect us all.

If Aussies are right, the tougher capital requirements will raise interest rates, make loans harder to get and slow down the economy.

The flip side is the risk of spending billions of taxpayer dollars bailing out banks deemed "too big to fail", as happened in the US and UK during the Global Financial Crisis.

Broadly speaking, our attitude to risk is an issue that defines the way we live.

We make very personal choices about it.

Are you a bungy-jumping, mountain-biking, sky-diving adrenaline junkie?

Others take risk in business and are rewarded well.

Risk is a fundamental thing to consider when you look at your personal finances.

How much can you bear? Will you sleep at night?

It's also a crucial balancing act for companies that seek public investment.

When we take too much risk there is often a price to pay - broken legs, bankruptcy, even jail.

We have vociferous public debates about risky behaviours with social costs.

How fast should we be allowed to drive? Do we drink too much? Should we tax sugar?

We regulate business for risky investment behaviour, worker safety and consumer rights.

Banking requires another level of regulation because the storage and movement of money is so vital to society.

Along with telecommunications, it is one of the only pieces of vital infrastructure that has been entirely outsourced to the private sector.

In theory we have outsourced the risk to private investors and we have to pay the price in dividends.

But there remains an implicit guarantee that the New Zealand taxpayer would pick up the pieces in the event of a catastrophic financial meltdown.

In fact in 2008, when there was an impending meltdown, that became explicit with a deposit guarantee.

There are interesting arguments on both sides of this debate.

But we need to get them out there.

The Reserve Bank is trying to get more engagement. It has extended the submissions process until May 17 and created and easy-to-use web page.

It's possible the proposed settings are too tight for a small economy like New Zealand.

It's possible the Reserve Bank has underestimated the economic cost.

It is easy to take for granted the value that access to credit creates.

Ironically, right now, the Aussie banks' self-imposed curbs on lending are one of the more pressing headwinds facing the economy.

But let's not forget that the banks ultimately have the interests of their shareholders at heart - not the New Zealand taxpayer.

An ASB Research report recently posited more serious economic downsides to the capital changes - suggesting they could knock more than one per cent off the baseline of New Zealand's total GDP.

That's fine. We should consider a range of views.

Ratings agency Fitch made a similar case but then argued that the Aussie banks will be just fine.

Your view might depend on your relationship to your bank.

A final decision from the Reserve Bank is due later this year and the changes would be implemented across five years.

But, as the consultation deadline draws closer, expect to see the industry push back against these capital changes get more intense.

There are billions of dollars at stake.