How much capital is enough?
The Reserve Bank is currently consulting on a proposal to get New Zealand banks to hold more funds. This would reduce the risk of banks failing so that, in the event of a ‘run on the bank’, there would be enough funds keep the bank operating.
There are a number of problems with this proposal, not least that the risk the Reserve Bank is focusing on is a 1-in-200 year event, and the additional funds that would need to be held by the banks could be up to $20 billion. Further to this:
- The more money banks are required to hold, the less money they can lend. This in turn could increase the cost of loans, and may mean that some loan applications will be declined; $20 billion is a lot of money to take out of the banking system.
- It doesn’t really matter how much money a bank is required to hold. In an extreme ‘run on bank’ scenario, no amount of money will be enough; the extra funds would simply delay the inevitable.
- The Reserve Bank’s proposal will only reduce the risk, but will not eliminate it; is that really enough?
The risk the Reserve Bank is seeking to address, the extreme ‘run on a bank’ scenario, will in all likelihood be addressed by Government intervention, and history tells us this is the likely outcome. These situations occur as a result of severe economic conditions, such that the Government will be forced to respond anyway. We saw this during the recent Global Financial Crisis, where Government intervention by printing money effectively eliminated the risk of bank failure.
As with all risk mitigation, a cost benefit analysis must be undertaken; is the cost of mitigating the risk worth the benefits that could be achieved?
To assess the risk, there needs to be an assessment of the quality of New Zealand’s regulatory systems and the state of our economy, and an evaluation on how vulnerable it is to bank failure.
I believe we have a quality regulatory system in New Zealand, and our economy is at especial risk to bank failure. Personally, I believe the risk is relatively low.
But - and here comes my key point – our economy is strong because of our robust primary sector and our other exports.
When we export our produce, we are competing with companies based in the countries we export to.
We are already at a disadvantage, as we are a long distance from our markets, and the cost of land and labour are relatively high in New Zealand.
If our overseas competitors have better access to development loans, along with more attractive interest rates, then New Zealand exporters will be further disadvantaged.
This will then weaken our economy, and increase the risk of bank failure, an ironic effect of trying to reduce that risk.
I believe that the best risk mitigation of bank failure is for the New Zealand economy to be strong and buoyant. To achieve this, the Reserve Bank’s contribution can be to keep loan interest rates as low as possible, and to ensure that loans for developing our export capability, adopting robotics and new technology, and so on, are readily available; you can read Horticulture New Zealand's submission on this here.
The Reserve Bank should not require banks to hold more cash, but should instead facilitate an efficient and competitive banking market to best enable continued economic growth.
- Mike Chapman, CEO