The high-risk profile of New Zealand banking system and the fast evolving global and national markets are likely to prompt the Reserve Bank of New Zealand (RBNZ) to revisit the capital held by commercial banks and lending institutions.
A hint to this effect came from RBNZ Deputy Governor and Head of Stability Grant Spencer during his address to the New Zealand Bankers’ Association in Auckland on March 7, 2017.
While a review of the capital regime is a part of the central bank’s anxiety to maintain stability of the financial market, any upward revision of adequacy ratio will take into account the need and capacity of the banks.
RBNZ follows a conservative and non-interventionist approach in its role as the Banks’ Bank and has in some instances refrained from applying all provisions of Basel Standards over the years.
“Our broad approach has been to adopt the Basel standards, where appropriate, and implement them with a conservative bias. For example, the Reserve Bank has imposed restrictions on components of banks’ internal risk models. New Zealand has chosen not to adopt some aspects of Basel III, such as the internal modelling approach for market risk, where we have felt that a policy is overly complex or inappropriate for New Zealand conditions,” Mr Spencer said.
The Crisis and After
The Global Financial Crisis was a testimony to New Zealand’s robust banking system with the commercial banks and other lending institutions taking appropriate precautions to maintain their risk profile. Credit expansion was restrained but the banks were able to assist their customers to steer through the problems without affecting their profitability.
Mr Spencer said that RBNZ followed a conservative approach to bank capital and was dictated by New Zealand’s relatively high risk profile and RBNZ’s non-interventionist approach to banking supervision.
Both factors are likely to be present in its future dealings, he said.
“In the changing international regulatory environment, it is becoming less clear whether New Zealand’s historical position on bank capital is being maintained relative to Australia and other peers. We believe that it is time to review New Zealand’s position and review more broadly our capital framework in light of international and domestic developments and our experience with the current regime,” Mr Spencer said.
Stating that RBNZ will undertake an extensive review of the capital requirements of commercial banks and lending institutions in the coming financial year (April 2017 to March 2018), he said that the aim is to identify the most appropriate regulatory framework for setting capital requirements for New Zealand banks.
Mr Spencer said that consistent with the legislative framework of RBNZ, minimum capital requirements should promote maintenance of a sound and efficient financial system.
“In broad terms, higher levels of capital will improve the soundness of the financial system as the likelihood of bank failures is reduced and the potential impact of credit cycles is moderated,” he said.
The inherent risks
Mr Spencer admitted that the capital regime may reduce the efficiency of financial intermediation if ratios are pushed too high or standards are made overly complex.
“Capital is a more expensive form of funding for the banks and hence higher capital ratios can potentially increase the overall cost of funding the system as well as improving its soundness. Our aim is to agree on a capital regime that ensures a very high level of confidence in the solvency of the banking system, while avoiding unnecessary economic inefficiency,” he said.
The Review would examine three key components of the regulatory capital regime, including (a) the definition of eligible capital instruments (b) the measurement of risk, in particular, the risk weights attached to credit exposures and (c) the minimum capital ratios and buffers.
“These three factors are interdependent and the links between them must be carefully considered. The calibration of the capital ratios needs to be set in the context of the risk weights applying to exposures as well as the capacity of eligible capital instruments to absorb losses. Also, the role of capital buffers versus hard minimum requirements needs to be considered,” Mr Spencer said.