RBNZ's Orr defends bank capital plan, attacks sector returns

He was speaking at a press conference following the release of the New Zealand central bank's decision to leave its key cash rate at 1.75 per cent and guide toward no change in rates in either direction until 2021. The result was less dovish than the market was looking for.

"More capital means sounder financial institutions," the governor said. "The capital levels we are talking about are still well within the range of norms. We have spent a lot of time trying to compare apples with apples."

Governor Orr acknowledged that, in theory, banks operating in New Zealand and opposed to the new capital requirements could try and hold the central bank and the government hostage by crimping new lending and de-leveraging. That assumes when the current consultation period concludes it results in the rules being introduced unmodified.

"Well that's an option for them. I'm not ruling that out. But, as I say, it's a competitive market and there are many banks, and all banks are going to be affected slightly differently from these current starting capital levels — from their desire to build their balance sheet, from their desire to become a large bank, and so on."

If the risks are lower for banks then they should expect a lower return on equity, Mr Orr said. "Every investor knows that you need to be rewarded for the risks you are taking. If those risks have declined then you would expect some of the reward for that activity to decline."

Reduced exposure

He warned that any move to reduce exposure to New Zealand could be counterproductive for lenders.

"New Zealand's banks are among the most profitable in the world. Why would they really want to shrink that business in a significant way when they are making large amounts of money from it?" the governor asked. Should the new capital rules be introduced, the playing field will be more level, he argued.

"At the moment it is being used as a competitive tool for some banks. They have been able to have considerably lower capital holdings lending against exactly the same asset classes as their competitor bank."

The Reserve Bank of New Zealand wants its banking system to be able to withstand any once-in-200-years shock. The RBNZ has said the New Zealand economy's "principle vulnerabilities" are high levels of household and agricultural sector debt and believes its bank capital buffers should be conservative relative to international markets. The changes form part of a review into bank capital that began in early 2017.

"What we are talking about is levelling that playing field where the internal risk based banks, the advanced banks that have their own models, can still use those as they should be – which is to think hard about how to allocate that capital across the asset class," Mr Orr said.

"This capital proposal would significantly reduce the gap between banks around capital they need to hold but retain that ability to allocate within banks as banks see fit. Society is safer, competition is improved and capital allocation is being managed appropriately."