How to Create a Recession
Late last year, the Reserve Bank released its Capital Review, which basically proposes large banks will have to hold twice as much capital as they currently do to remain registered. People from all walks of life have approached Free Press about the implications of this proposal. It may make the banking system safer, or throw the country into recession, or deliver us Chinese-owned banks, all under plausible scenarios.
The 101 is this: The Reserve Bank is responsible for registering banks, so it can stipulate how much capital they hold. How much capital a bank holds means how much of its total funds are from shareholders rather than depositors. When things go bad the shareholders lose their money first, so nobody wants to be a shareholder in an irresponsible bank. Most central banks stipulate how much a bank must hold.
Scenario 1: Safer Banking
The Reserve Bank says it’s trying to make us safer. It figures that bank failures are really bad, so we need to be more careful it doesn’t happen. The theory is that making shareholders put up twice as much money for a given bank will increase its cushion when things go bad. The problem, as Geof Mortlock argues, is that the Reserve Bank hasn’t based the risk on the state of actual banks, but international research. At the same time, it wants New Zealand banks to hold high levels of capital by international standards.
Scenario 2: A Recession
As the New Zealand Initiative’s Roger Partridge has pointed out, UBS has estimated the changes will raise mortgage rates by a 0.9-1.1 percentage points. Bank shareholders, they figure, will want a bigger return if they have to invest twice as much capital in the same bank. The country is filled with anecdotes that the economy is running out of puff. Putting up mortgage rates by a full point is one way to tip a fragile economy into recession.
Scenario 3: Chinese Banks
Another scenario is that the Aussie owners of the big four banks say “yeah, nah” to putting in twice as much capital for the same return and decide to sell. Who is out there in the world market that’s prepared to give cheap capital to advance global influence? Someone who sees New Zealand’s population and economy as akin to a small town? If people get het up about Aussie-owned banks, wait ‘til they hear about Chinese-owned banks.
The Wider Problem with the Reserve Bank
The Reserve Bank is swerving out of control. The first problem was when the new Governor, Adrian Orr, decided that the banking system is a forest and the Reserve Bank is Tane Mahuta, God of the Forest. We are not making this up, it is in their annual report. Then there was the Banking Conduct and Culture Review. The self-initiated Review cost $2 million and found nothing, but instead of showing some humility, the Reserve Bank went on to lecture the private sector about its culture anyway. Now they are quite literally threatening the entire banking sector as we know it on the basis of some theoretical evidence, and they are accountable to nobody.
What Can be Done
There are good reasons why the Reserve Bank should be independent. Monetary policy was set at arms-length from the politicians of the day through the Policy Targets Agreement. Rather than the abomination that was the Reserve Bank Act last year, the Minister of Finance needs to think about how a Government ensures trade-offs such as bank stability versus the cost of capital are managed, because right now it is amateur hour at the Bank.