Reserve Bank seeks balance in banking sector capital requirements review

New Zealand's central bank has announced a review of bank capital requirements to examine how well the current framework operates and to consider potential improvements.

"In the wake of the global financial crisis, banks and regulators around the world have been reviewing capital standards. It is a complex area with many aspects to consider. The review will cover the definition of capital, the measurement of risks that the banks face and the minimum capital requirements and buffer," Reserve Bank deputy governor Grant Spencer said in a speech to the NZ Bankers' Association in Auckland.

The aim is to agree to a capital regime that ensures a high level of confidence in the solvency of the banking system while avoiding unnecessary economic inefficiency, he said. He underscored that the Reserve Bank will consult the banks and the public on its findings and on any proposed changes to the capital framework.

The specific areas to be addressed will be outlined in an issues paper to be released in April.

"Detailed policy positions and options for changes to the capital framework will be outlined in consultation papers during the year. We aim to conclude the review by the first quarter of 2018," said Mr Spencer, who will end his long career at the Reserve Bank next March, after a six-month stint as acting governor following the departure of the sitting governor, Graeme Wheeler, immediately after the September 23 general election.

Higher levels of capital would improve the soundness of the financial system by reducing the likelihood of bank failures. However, the capital regime could reduce the efficiency of financial intermediation if ratios are pushed too high or standards are made overly complex, Mr Spencer said.

He noted banks and regulators have been revising their assessment of appropriate level for capital since the "traumatic experience" of the global financial crisis. The main international regulatory response has come under the broad banner of the so-called "Basel III Capital Framework," which required a higher minimum and better quality of capital. to help withstand losses during a financial shock.

"In New Zealand, our broad approach has been to adopt the Basel standards, where appropriate, and implement them with a conservative bias," he said. For example, the Reserve Bank has imposed restrictions on components of banks' internal risk models. However, New Zealand has chosen not to adopt some aspects of Basel III, such as the internal modelling approach for market risk, where it has felt that a policy is overly complex or inappropriate for New Zealand conditions.

This conservative approach to bank capital has been warranted by New Zealand's relatively high-risk profile and the Reserve Bank's non-interventionist approach to banking supervision. "Both of these factors are likely to be present going forward," Mr Spencer said.

However, 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.

As a result, "we believe 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," he said.

Consistent with the objectives of the review, Mr Spencer said the central bank will adopt six high-level principles. Capital must readily absorb bank losses ahead of creditors and depositors and capital requirements should be set in relation to the risk of bank exposures. Although there are many methods for determining capital requirements, outcomes should not vary substantially between methods, and New Zealand bank capital requirements should be conservative relative to international peers. The capital framework should be practical to administer, minimise unnecessary complexity and compliance costs, and take into consideration relationships with home country regulators and finally, the capital framework should be transparent to enable effective market discipline.

(BusinessDesk)