NZ Reserve Bank Holds Cash Rate

The Official Cash Rate (OCR) remains at 1.5 percent. Given the weaker global economic outlook and the risk of ongoing subdued domestic growth, a lower OCR may be needed over time to continue to meet our objectives.

Domestic growth has slowed over the past year. While construction activity strengthened in the March 2019 quarter, growth in the services sector continued to slow. Softer house prices and subdued business sentiment continue to dampen domestic spending.

The global economic outlook has weakened, and downside risks related to trade activity have intensified. A number of central banks are easing their monetary policy settings to support demand. The weaker global economy is affecting New Zealand through a range of trade, financial, and confidence channels.

We expect low interest rates and increased government spending to support a lift in economic growth and employment. Inflation is expected to rise to the 2 percent mid-point of our target range, and employment to remain near its maximum sustainable level.

Given the downside risks around the employment and inflation outlook, a lower OCR may be needed.

Meitaki, thanks.

Summary record of meeting

The Monetary Policy Committee agreed that the outlook for the economy has softened relative to the projections in the May 2019 Statement.

The Committee noted that inflation remains slightly below the mid-point of the inflation target and employment is broadly at its maximum sustainable level. The Committee agreed that a lower OCR may be needed to meet its objectives, given further deterioration in the outlook for trading-partner growth and subdued domestic growth.

Relative to the May Statement, the Committee agreed that the risks to achieving its consumer price inflation and maximum sustainable employment objectives are tilted to the downside.

The members noted that global economic growth had continued to slow. They discussed the recent falls in oil and dairy prices, and that several central banks are now expected to ease monetary policy to support demand.

The Committee discussed the ongoing weakening in global trade activity. A drawn out period of tension could continue to suppress global business confidence and reduce growth. Resolution of these tensions could see uncertainty ease.

The Committee discussed the trade, financial, and confidence channels through which slowing global growth and trade tensions affect New Zealand. The members noted in particular the dampening effect of uncertainty on business investment. Some members noted that lower commodity prices and upward pressure on the New Zealand dollar could see imported inflation remain soft.

While global economic conditions had deteriorated, the Committee noted that domestic GDP growth had held up more than projected in the March 2019 quarter. The members discussed disparities in growth across sectors of the economy, with construction strong and services weak. The members also discussed whether some of the factors supporting growth in the quarter would continue.

The members noted two largely offsetting developments affecting the outlook for domestic growth: softer house price inflation and additional fiscal stimulus.

The Committee noted that recent softer house prices, if sustained, are likely to dampen household spending. The Committee also noted the recent falls in mortgage rates and the Government’s decision not to introduce a capital gains tax.

The Committee noted that Budget 2019 incorporated a stronger outlook for government spending than assumed in the May Statement. The members discussed the impact on growth of any increase in government spending being delayed, for example due to timing of the implementation of new initiatives and current capacity constraints in the construction sector.

The members discussed the subdued nominal wage growth in the private sector and the apparent disconnect from indicators of capacity pressure in the labour market. The Committee discussed the possibility of this relationship re-establishing. Conversely, the continuing absence of wage pressure could indicate that there is still spare capacity in the labour market. Some members also noted that reduced migrant inflows could see wage pressure increase in some sectors.

The Committee discussed whether additional monetary stimulus was necessary given continued falls in global growth and subdued domestic demand. The members agreed that more support from monetary policy was likely to be necessary.

The Committee discussed the merits of lowering the OCR at this meeting. However, the Committee reached a consensus to hold the OCR at 1.5 percent. They noted a lower OCR may be needed over time.

Australia’s social housing policy needs stronger leadership and an investment overhaul

Australia will need another 730,000 social housing dwellings in 20 years if it is to tackle homelessness and housing stress among low-income renters. These are the findings of a new report from the Australian Housing and Urban Research Institute (AHURI), which shows social housing is in urgent need of direct public investment; via The Conversation.

Instead of directly investing in social housing, the federal government has sought to establish investment opportunities for other actors, such as pension funds and private corporations.

The vehicle for this investment is the National Housing Finance Investment Corporation (NHFIC), which was established to offer lower cost finance to social housing providers.

The federal government has also encouraged states and territories to focus public resources on supply, land policy reform and the use of planning methods such as inclusionary zoning to deliver affordable and social housing.

These initiatives are worthy, but they won’t generate enough new social housing supply on their own. Without direct public investment in the form of a needs-based capital investment program, the government is unlikely to fill the social housing gap.

Needs-based capital investment is where decisions on what to invest is not only based on financial return, but also on other factors like the effects on society (so infrastructure investment is one which is needs based).

And needs-based capital investment provides the most cost effective mechanism to influence the scale, location and quality of housing produced.

Social housing supply is dangerously lagging

The Australian Bureau of Statistics estimated 116,000 people were homeless in 2016, living in improvised and severely overcrowded homes.

Our further analysis of the 2016 Census shows 315,000 households rely on very low incomes, paying more than 30% of their income on rent. This is known as housing stress.

To address homelessness and housing stress right now, we need an additional 430,000 social housing dwellings. And this will grow over time.

Between 1951 and 1996, Australian jurisdictions built 8,000 to 14,000 social housing dwellings per year. In those years, social housing building programs were funded through direct public investment, with grants and long-term loans.

But without direct investment, social housing construction levels have languished since the mid 1990s.

In fact, the total number of Australian households increased by 30% from 1996 to 2016, and yet social housing grew by just 4%. This means there is a substantial backlog in supply, and the need for resources is now urgent.

Subsidies alone won’t cut it

It’s naive to think social housing systems can be adequately resourced through demand-side subsidies alone, such as cash support to tenants. In the UK, for instance, we’ve seen that while rent assistance budgets have grown, they haven’t helped to grow an affordable supply of homes, especially in tight, unregulated private rental markets.

In Australia, the Productivity Commission found that even after rent assistance is paid to eligible pensioners, 40.3% of them pay more than 30% of their incomes on rent. This leaves little for life’s other essentials, such as food, medical care and electricity.

What’s more, the spatial distribution of need for social housing is just as important as the overall volume, as the costs for these dwellings vary from A$146,000 to A$614,000, depending on local land values, building types and construction costs in different regions.

So it’s imperative any public investment program is carefully designed and spatially nuanced.

The AHURI report calls for a new National Housing Authority

The AHURI report also assesses the costs of land and construction needed for social housing, which would underpin a capital investment program.

It calls for the creation of a National Housing Authority to inform, co-ordinate and fund the expansion of new social housing supply through a needs-based capital investment program, together with the existing National Housing Finance Investment Corporation (NHFIC).

In the past, social housing relied on external industry bodies, such as the National Housing Supply Council, to advise on Australia’s future housing needs.

But a national housing authority would provide more effective, consistent and authoritative leadership. It would have the responsibility and resources to plan for and fund more inclusive and sustainable housing outcomes. And it would co-ordinate this effort with other key stakeholders including state Housing Authorities, not for profit community housing providers, the National Disability Insurance Scheme and Clean Energy Finance Corporation.

A net benefit to society

The way cost-benefit assessments are conducted must be changed so the social benefits of social housing are properly quantified. This is necessary not only to capture both productivity and social gains, but also for making a coherent rationale for social housing investment.

But there is more work to be done to improve methods for cost-benefit analysis for social housing, the report says.

In contrast to conventional infrastructure, the housing sector has suffered from a long-term lack of investment. This means the methods for cost-benefit analysis are not yet as advanced.

It’s clear there is no fundamental barrier to government sourced large-scale investment in social housing. An improved cost-benefit analysis method can provide assurance to funding agencies that a long-term social housing construction program is viable and cost effective.

Authors: Julie Lawson, Honorary Associate Professor, Centre for Urban Research, RMIT University; Jago Dodson, Professor of Urban Policy and Director, Centre for Urban Research, RMIT University; Kathleen Flanagan, Research Fellow & Deputy Director, HACRU, University of Tasmania; Keith Jacobs, Professor of Sociology, University of Tasmania; Laurence Troy, Research Fellow, City Futures Research Centre, UNSW; Ryan van den Nouwelant, Lecturer in Urban Management and Planning, Western Sydney University

IMF Says New Zealand Faces Downside Risks, But Migration May Help To Mitigate Them

The IMF just published their concluding Statement of the 2019 Article IV Consultation Mission to New Zealand.

They conclude:

New Zealand’s economic expansion lost momentum recently. The near-term growth outlook is expected to improve on the back of a timely increase in macroeconomic policy support. Downside risks to the growth outlook have increased but New Zealand has the policy space to respond should such risks materialize.

Macroeconomic policy settings are broadly appropriate, while macroprudential policy settings are attuned to macrofinancial vulnerabilities in the household sector, which have started to decline but remain elevated.

Financial sector reform in the context of the Review of the Capital Adequacy Framework and the Review of the Reserve Bank of New Zealand Act should provide for a welcome further strengthening of the resilience of the financial system and regulatory framework.

The government’s structural policy agenda appropriately focuses on reducing infrastructure gaps, increasing human capital, and lifting productivity, while seeking to make growth more inclusive and improve housing affordability.

Within the statement they warn that:

Risks to the outlook are increasingly tilted to the downside. On the domestic side, the fiscal stimulus could be less expansionary if policy implementation were to be more gradual than expected, and the domestic housing market cooling could morph into a downturn, either because of external shocks or diminished expectations. On the external side, global financial conditions could be tighter and dairy prices could be lower. Risks to global trade and growth from rising protectionism have increased, and this could have negative spillovers to the New Zealand economy, including through the impact on China and Australia, two key trading partners. High household debt remains a risk to economic growth and financial stability, and it could amplify the effects of large, adverse shocks. On the upside, in the near term, growth could be stronger if net migration were to decrease more slowly than expected or if the terms of trade were to be stronger.

With regard to macroprudnetial they warn:

The scope for easing macroprudential restrictions is limited, given still-high macrofinancial vulnerabilities. The shares of riskier home loans in bank assets (those with very high LVRs, high debt-to-income, and investor loans) has moderated due to the combined impact of the LVR settings and tighter bank lending standards. However, with the RBNZ’s recent easing of the LVR restrictions, improvements in some macroprudential risk factors such as credit growth have recently stalled or started to reverse. Further easing of LVR restrictions should consider the possible impact on banks’ prudential lending standards, as well as the risks to financial stability from elevated household debt.

Government hints at major super changes

With the super industry set to undergo a range of changes in the coming days, the new assistant minister for financial services has hinted that further changes are still to come., via InvestorDaily.

As of 1 July, the government’s Protecting Your Superannuation laws will see automatic life insurance cover be turned off for members whose accounts have been inactive for over 16 months.

Other changes coming include closing inactive super accounts with a balance of less than $6,000, which will be transferred to the ATO before finding its way to members’ active accounts.

Fees will also be capped on low-balance accounts, and exit fees will be removed along with a variety of changes aimed at helping older Australians.

However, Assistant Minister for Superannuation and Financial Services Jane Hume has now suggested that 2021 will see the industry change yet again.

2021 is currently the year that the compulsory superannuation guarantee will rise from 9.5 per cent to 10 per cent and is now potentially the deadline for a system overhaul.

The superannuation guarantee was a hot topic during the election campaign as Labor had vowed to increase the guarantee to 12 per cent by 2025, while other groups called for the planned guarantee raises to be cut.

Chief policy officer for the Association of Superannuation Funds of Australia Glen McRea told Investor Daily that the overwhelming majority of Australians support the increase of the guarantee.

“Recent polling for ASFA by CoreData indicates that an overwhelming majority of Australians support the current compulsory superannuation system and want to see the Superannuation Guarantee (SG) increased to 12 per cent of wages. It found around 80 per cent of respondents across a range of demographics either support or strongly support the increase,” he said.

Ms Hume’s plans for super do not touch upon the guarantee, rather the senator has told the industry that 2021 is the deadline to have the overhaul in order.

“If a system is compulsory and it quarantines nearly $1 in every $10 that you earn for up to 40 years, it is imperative that the government make that system as efficient as possible,” she told the Sydney Morning Herald.

Ms Hume plans to reintroduce super legislation that would make all insurance opt-in for those aged under 25 as well as implementing further recommendations of the Productivity Commission’s review.

The $2.8 trillion super industry is something Australia should be proud of, said Ms Hume, but there were inefficiencies that needed to be ironed out.

Options on the table included the default best-in-show list that has been criticised by the industry and spring cleaning of underperforming funds.

Mr McRea said the ASFA supported the initiatives by the government to improve outcomes and would continue to do so where appropriate.

“ASFA supports recent initiatives to increase efficiency and improve outcomes for members – including significant investment in technology, reducing rollover and transaction processing times, and continuing to reduce the incidence of multiple accounts,” he said.

The best-in-show was a suggestion from the Productivity Commission which doubled down on its call for a top 10 list earlier this year.

“This new approach will support member engagement by ‘nudging’ members towards good products without forcing them to pick one. Members will retain the option to choose from the wider set of MySuper and choice products (or establish their own SMSF), and elevated ‘outcomes tests’ will help to weed out persistently underperforming products from the system,” the report read.

However, Dr Martin Fahy from the ASFA at the time said he was disappointed in the suggested as it risked creating an oligopoly in default superannuation.

The suggestion was also not supported by Labor with then shadow treasurer Chris Bowen expressing concerns that the list may have unintended consequences.

Fed Chair On Economic Outlook and Monetary Policy Review

Jerome H. Powell spoke at the Council on Foreign Relations, New York.

He said when the FOMC met at the start of May, tentative evidence suggested economic crosscurrents were moderating, so they left the policy rate unchanged. But now, risks to their favorable baseline outlook appear to have grown with concerns over trade developments contributing to a drop in business confidence. That said, monetary policy should not overreact to any individual data point or short-term swing in sentiment.

They are also formally and publicly opening their decisionmaking to suggestions, scrutiny, and critique.

It is a pleasure to speak at the Council on Foreign Relations. I will begin with a progress report on the broad public review my Federal Reserve colleagues and I are conducting of the strategy, tools, and communication practices we use to achieve the objectives Congress has assigned to us by law—maximum employment and price stability, or the dual mandate. Then I will discuss the outlook for the U.S. economy and monetary policy. I look forward to the discussion that will follow.
During our public review, we are seeking perspectives from people across the nation, and we are doing so through open public meetings live-streamed on the internet. Let me share some of the thinking behind this review, which is the first of its nature we have undertaken. The Fed is insulated from short-term political pressures—what is often referred to as our “independence.” Congress chose to insulate the Fed this way because it had seen the damage that often arises when policy bends to short-term political interests. Central banks in major democracies around the world have similar independence.
Along with this independence comes the obligation to explain clearly what we are doing and why we are doing it, so that the public and their elected representatives in Congress can hold us accountable. But real accountability demands more of us than clear explanation: We must listen. We must actively engage those we serve to understand how we can more effectively and faithfully use the powers they have entrusted to us. That is why we are formally and publicly opening our decisionmaking to suggestions, scrutiny, and critique. With unemployment low, the economy growing, and inflation near our symmetric 2 percent objective, this is a good time to undertake such a review.
Another factor motivating the review is that the challenges of monetary policymaking have changed in a fundamental way in recent years. Interest rates are lower than in the past, and likely to remain so. The persistence of lower rates means that, when the economy turns down, interest rates will more likely fall close to zero—their effective lower bound (ELB). Proximity to the ELB poses new problems to central banks and calls for new ideas. We hope to benefit from the best thinking on these issues.
At the heart of the review are our Fed Listens events, which include town hall–style meetings in all 12 Federal Reserve Districts. These meetings bring together people with wide-ranging perspectives, interests, and expertise. We also want to benefit from the insights of leading economic researchers. We recently held a conference at the Federal Reserve Bank of Chicago that combined research presentations by top scholars with roundtable discussions among leaders of organizations that serve union workers, low- and moderate-income communities, small businesses, and people struggling to find work.
We have been listening. What have we heard? Scholars at the Chicago event offered a range of views on how well our monetary policy tools have effectively promoted our dual mandate. We learned more about cutting-edge ways to measure job market conditions. We heard the latest perspectives on what financial and trade links with the rest of the world mean for the conduct of monetary policy. We heard scholarly views on the interplay between monetary policy and financial stability. And we heard a review of the clarity and the efficacy of our communications.
Like many others at the conference, I was particularly struck by two panels that included people who work every day in low- and middle-income communities. What we heard, loud and clear, was that today’s tight labor markets mean that the benefits of this long recovery are now reaching these communities to a degree that has not been felt for many years. We heard of companies, communities, and schools working together to bring employers the productive workers they need—and of employers working creatively to structure jobs so that employees can do their jobs while coping with the demands of family and life beyond the workplace. We heard that many people who, in the past, struggled to stay in the workforce are now getting an opportunity to add new and better chapters to their life stories. All of this underscores how important it is to sustain this expansion.
The conference generated vibrant discussions. We heard that we are doing many things well, that we have much we can improve, and that there are different views about which is which. That disagreement is neither surprising nor unwelcome. The questions we are confronting about monetary policymaking and communication, particularly those relating to the ELB, are difficult ones that have grown in urgency over the past two decades. That is why it is so important that we actively seek opinions, ideas, and critiques from people throughout the economy to refine our understanding of how best to use the monetary policy powers Congress has granted us.
Beginning soon, the Federal Open Market Committee (FOMC) will devote time at its regular meetings to assess the lessons from these events, supported by analysis by staff from around the Federal Reserve System. We will publicly report the conclusions of our discussions, likely during the first half of next year. In the meantime, anyone who is interested in learning more can find information on the Federal Reserve Board’s website.¹
Let me turn now from the longer-term issues that are the focus of the review to the nearer-term outlook for the economy and for monetary policy. So far this year, the economy has performed reasonably well. Solid fundamentals are supporting continued growth and strong job creation, keeping the unemployment rate near historic lows. Although inflation has been running somewhat below our symmetric 2 percent objective, we have expected it to pick up, supported by solid growth and a strong job market. Along with this favorable picture, we have been mindful of some ongoing crosscurrents, including trade developments and concerns about global growth. When the FOMC met at the start of May, tentative evidence suggested these crosscurrents were moderating, and we saw no strong case for adjusting our policy rate.
Since then, the picture has changed. The crosscurrents have reemerged, with apparent progress on trade turning to greater uncertainty and with incoming data raising renewed concerns about the strength of the global economy. Our contacts in business and agriculture report heightened concerns over trade developments. These concerns may have contributed to the drop in business confidence in some recent surveys and may be starting to show through to incoming data. For example, the limited available evidence we have suggests that investment by businesses has slowed from the pace earlier in the year.
Against the backdrop of heightened uncertainties, the baseline outlook of my FOMC colleagues, like that of many other forecasters, remains favorable, with unemployment remaining near historic lows. Inflation is expected to return to 2 percent over time, but at a somewhat slower pace than we foresaw earlier in the year. However, the risks to this favorable baseline outlook appear to have grown.
Last week, my FOMC colleagues and I held our regular meeting to assess the stance of monetary policy. We did not change the setting for our main policy tool, the target range for the federal funds rate, but we did make significant changes in our policy statement. Since the beginning of the year, we had been taking a patient stance toward assessing the need for any policy change. We now state that the Committee will closely monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion, with a strong labor market and inflation near its symmetric 2 percent objective.
The question my colleagues and I are grappling with is whether these uncertainties will continue to weigh on the outlook and thus call for additional policy accommodation. Many FOMC participants judge that the case for somewhat more accommodative policy has strengthened. But we are also mindful that monetary policy should not overreact to any individual data point or short-term swing in sentiment. Doing so would risk adding even more uncertainty to the outlook. We will closely monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion.

Bank requirement leaves brokers “entirely exposed”

A professional indemnity (PI) specialist has expressed grave concern over new requirements for brokers to confirm that there are no signs of financial abuse when they assist clients in securing a loan; via Australian Broker.

The action has been taken by the banks in response to the Australian Banking Association’s updated code of practice requiring a higher standard for dealing with vulnerable customers. However, Darren Loades, the FBAA’s dedicated PI insurance specialist for Queensland and the Northern Territory, has questioned the sudden announcement, the lack of clarity as to what the agreement entails, and the days-long timeframe before the 1 July implementation.

“Do you think that’s by accident? I sure don’t,” said Loades.

“The main point is that it’s been rushed through, no one has actually seen the details, and it could have very far-reaching and onerous implications for brokers. Do not sign anything for the moment.”

Loades highlighted the serious liability concerns of signing an agreement that could likely take brokers out of their current coverage and leave them “entirely exposed.”

“Professional indemnity policies only respond to claims made under common law. Signing one of these declarations could incur contractual liabilities, over and above the liabilities a broker would owe at common law,” he explained.

“The standard PI policy out there on the market will not pick up any liabilities owed under contract. Brokers could potentially be left exposed and not insured at all.”

Last week, FBAA managing director Peter White expressed concern that “PI insurance could increase tenfold to cover a declaration like this.”

“To try and ram this through with little notice is not only ridiculous and ill-conceived, but creates massive risks for brokers with almost no benefit to borrowers,” he added.

As White expressed last week, Loades finds it suspect that the agreements the banks are asking brokers to sign have yet to be made accessible.

He continued, “But knowing the banking industry, the documents are going to be pretty far-reaching with some nasty little clauses in there along the lines of, ‘If you drop the ball in this area, you agree to indemnify the bank against any losses.’ Otherwise, why would they be going to this trouble?

“This seems to be a push from the banks to transfer their liability onto the broker, which isn’t all that fair or realistic.”

While Loades does acknowledge that brokers are the ones to have face-to-face interaction with the borrower, he has serious doubts that a set of written guidelines provided by the bank could translate to brokers being able to identify signs of abuse in real life stations.

“That’s a whole different ballgame. Brokers aren’t qualified or licenced to provide advice in this area of financial abuse,” he said.

“What happens if the broker happens to innocently miss a situation where there is financial abuse? The bank is going to rely on this document to say, ‘Well, you signed off. You’re the one who is liable.’”

Credit resurgence could have ‘undesirable’ impact

The fall in interest rates and an easing of lending standards will “breathe life” into the property market, but not without consequences, according to Moody’s Analytics, via The Adviser.

Financial intelligence agency Moody’s Analytics has released its Second Quarter 2019 Housing Forecast Report, in which it has noted its outlook for the Australian housing market.

Drawing on CoreLogic’s Hedonic Home Value Index, the research agency noted the correction in residential property prices, which it said was “a long time coming” after a “strong run-up” in values across more densely populated markets, particularly in Sydney and Melbourne.

However, Moody’s has observed that while residential home prices have moderated from their peak in September 2017, the decline has not led to a “material” improvement in housing affordability, with values still 20 per cent higher than during the pre-boom period in 2013.

Nonetheless, Moody’s has reported that it expects the Reserve Bank of Australia’s (RBA) cut to the official cash rate and proposals to ease home loan serviceability guidelines from the Australian Prudential Regulation Authority (APRA) to rekindle demand for credit and spark activity in the housing market.

“An important driver of the slowdown in Australia’s housing market has been tighter credit availability, partly as a consequence of the regulator – the Australian Prudential Regulation Authority – tightening lending conditions, which has made it relatively more difficult to purchase a property, particularly for investors,” Moody’s noted.

“These serviceability requirements were eased in May.

“Expectations of further lending reductions flowing on from RBA cash rate reductions will also breathe life into the property market and add weight to our view that the national housing market will reach a trough in the third quarter of 2019 and gradually improve thereafter.”

However, Moody’s warned that a resurgence in the housing market activity could further expose the economy to risks associated with high levels of household debt.

“This could see the household leverage-to-GDP ratio climb, making Australia stand out further amongst its peers,” Moody’s stated.

“This is an undesirable position to be in, particularly given the questions around sustainability of the potentially rising debt load.”

Moreover, recent changes in the regulatory landscape have been interpreted by some observers as as a sign that the economy could be at risk of falling into recession amid growing internal and external headwinds.

Treasurer Josh Frydenberg recently acknowledged that “international challenges” could pose a threat to the domestic economy.

Fears of a looming recession have prompted some observers, including the CEO of neobank Xinja, Eric Wilson, to encourage borrowers to pocket mortgage rate cuts passed on following the RBA’s decision to lower the cash rate.

Mr Wilson claimed that resisting the urge to accrue more debt would help borrowers build a buffer against downside risks in the economy.

The Australian Bureau of Statistics’ (ABS) Australian National Accounts data for the quarter ending March 2019, reported GDP growth of 0.4 per cent, with annual growth slowing to 1.8 per cent – the weakest since September 2009.

However, Moody’s economist Katrina Ell has said she expects the RBA’s monetary policy agenda to help revive the economy.

“The combination of increased monetary policy stimulus, expectations of the housing market reaching a trough in the third quarter of 2019, and fiscal policy playing a relatively supportive role including via income tax cuts should boost GDP growth to 2.8 per cent in 2020,” Ms Ell said.

NZ Reserve Bank Says Deposit Insurance To Happen

In the Phase 2 document released today, Deposit Insurance, funded by a bank levy is proposed. Unlike the Australian $250k scheme (which is not activated until the Government says so, and is taxpayer funded initially), the NZ scheme is for a lower amount with a protection limit in the range of $30,000 – $50,000. Implementation will probably take at least two years.

One question so far not answered is the interaction with the deposit bail-in. Generally bail-in stops a failing bank from failing, whereas deposit guarantees are activated on failure. So bail-in might stop deposit guarantees even being called on…

Depositor Protection

Why is a range of $30,000 – $50,000 for the proposed depositor protection scheme proposed?

Available data suggests that a protection limit in the range of $30,000 – $50,000 could fully protect from loss more than 90 percent of individual bank depositors in New Zealand, while leaving the majority of banks’ deposit funding exposed to risk. This would strike the right balance between protecting small depositors from loss and enhancing public confidence in the banking system on the one hand, while maintaining private incentives to monitor bank risk taking on the other. It would also be broadly consistent with international schemes in terms of the share of deposits and depositors that would be fully protected (albeit relatively low in terms of the absolute dollar value of protections).

More work will be required to choose the limit within this range that is the best for advancing the public policy objectives chosen for the protection scheme. The consultation seeks feedback on these choices.

The Reserve Bank is proposing high capital requirements for banks which should reduce the risk of bank failure. Why is depositor protection required if the risk of bank failure is small?

Even with high capital requirements, banks can still fail for a variety of reasons. Regulation, supervision, resolution, and deposit protection all make up a ‘financial safety net’ that supports a stable and resilient financial system and protects society from the damage caused by bank failures. The safety net tools interact and overlap, which can make it seem that not all of the tools are necessary. However, if the safety net is incomplete, it will be difficult to find effective solutions for dealing with serious problems in the banking system. This means that capital tools that help to keep banks safe and sound at the ‘top of the cliff’, must be complemented by robust tools to deal with banks that may still fall to the bottom.

The OECD and IMF have warned that, without depositor protection, New Zealand is vulnerable to contagious bank runs. Bank runs can escalate into banking crises that destroy social and financial capital. For New Zealand’s safety net to be effective in good times and bad, the tools within the net must each be strong in its own right, and work well together.

How will the risks associated with moral hazard be addressed in the proposed depositor protection scheme?

Moral hazard arises when people are protected from the consequences of their risky behaviour. If deposit protection is introduced, depositors may take less care when assessing the risks associated with their banks, and banks may take less care with depositors’ money. Moral hazard costs are part of the reason why New Zealand has until now chosen not to have a depositor protection regime.

There is considerable international experience on how to design an effective deposit protection scheme, within the broader financial safety net, that mitigates moral hazard. International experience demonstrates that strong regulatory monitoring of deposit-takers’ corporate governance and risk management systems goes a long way to addressing the moral hazard of depositor protection. Maintaining private monitoring incentives is also important, and can be achieved through carefully calibrating the protection scheme’s scope of coverage. For example, setting the protection limit at a level that fully covers most household and small business depositors, but leaves large institutional depositors exposed to risk, will support private monitoring incentives. In conjunction, having effective resolution tools (that make it more credible investors’ money is at risk should their institution fail) can sharpen monitoring by institutional investors.

International practice and guidance, as well as the views of experts and the public, will inform the design of New Zealand’s depositor protection scheme.

What are the costs of funding the proposed depositor protection scheme and who will bear these costs?

A primary tool of the protection scheme will be insurance. Deposit insurance transfers the risks and costs of bank failures away from depositors onto an insurance scheme. This will come with upfront costs of establishing a deposit insurer, and ongoing operational costs.

Modern deposit insurance schemes are normally funded by levies on member banks, supported (where necessary) by temporary lending paid for by taxpayers. If the insurance scheme is accompanied by a depositor preference, this might also increase banks’ non-deposit funding costs as risks are transferred from depositors onto institutional investors.

Details of the scheme, including costs, are still to be worked out in the next phase of the work programme. To the extent that depositor protection increases banks’ average costs, this might be passed on to customers through higher mortgage rates or lower deposit rates. Alternatively, costs might be absorbed by banks’ own margins and retained earnings. The extent to which costs are shared between banks and their customers depends on competition and contestability in the sector.

A fuller cost-benefit analysis will follow as we learn more about the specific design features of New Zealand’s depositor protection scheme.

When will the depositor protection scheme be introduced?

A work programme running alongside the Reserve Bank Review process will develop a depositor protection scheme that is best for New Zealand. The work programme will be guided by a framework setting out some key design principles for an effective scheme, and will draw (where relevant) on international standards and best practice. The work programme will determine the:

mandates and powers
governance and decision making structure
coordination arrangements with other safety net providers
membership and coverage arrangements
funding and pay-out mechanics, and
design features to mitigate moral hazard

that are appropriate for New Zealand’s protection scheme. The Review Team’s discussions with the global coordinating body for deposit insurers indicates that the path from policy recommendations to scheme implementation will probably take at least two years.

18 US Banks pass Federal Reserve stress test

On 21 June, the US Federal Reserve (Fed) published the results of the 2019 Dodd-Frank Act stress test (DFAST) for 18 of the largest US banking groups, all of which exceeded the required minimum capital and leverage ratios under the Fed’s severely adverse stress scenario; via Moodys’.

These results are credit positive for the banks because they show that the firms are able to withstand severe stress while continuing to lend to the economy. In addition, most firms achieved a wider capital buffer above the required minimum than in last year’s test, indicating a higher degree of resilience to stress. The 2019 results support our view of the sector’s good capitalization and benefit banks’ creditors.

The median stressed capital buffer above the required Common Equity Tier 1 (CET1) ratio increased to 5.1% from 3.5% last year, a substantial change. However, the 18 firms participating in 2019 were far fewer than the 35 that participated in 2018, helping lift the results this year. This is because passage of the Economic Growth, Regulatory Relief, and Consumer Protection Act in May 2018 resulted in an extension of the stress test cycle to two years for 17 large and non-complex US bank holding companies, generally those with $100-$250 billion of consolidated assets, which pose less systemic risk.

This is the fifth consecutive year that all tested firms exceeded the Fed test’s minimum CET1 capital requirement. As in prior years, the banks’ Tier 1 leverage and supplementary leverage ratios had the slimmest buffers of 2.8% and 2.4%, respectively, above the required minimums as measured by the aggregate.

Under DFAST, the Fed applies three scenarios – baseline, adverse and severely adverse – which provide a forward-looking assessment of capital sufficiency using standard assumptions across all firms. The Fed uses a standardized set of capital action assumptions, including common dividend payments at the same rate as the previous year and no share repurchases. In this report, we focus on the severely adverse scenario, which is characterized by a severe global recession accompanied by a period of heightened stress in commercial real estate markets and corporate debt markets.

This year’s severely adverse scenario incorporates a more pronounced economic recession and a greater increase in US unemployment than the 2018 scenario. The 2019 test assumes an 8% peak-to-trough decline in US real gross domestic product compared with 7.5% last year and a peak unemployment rate of 10% that, although the same as last year, equates to a greater shock because the starting point is now lower (the rise to peak is now 6.2% compared with 5.9% last year).

The severely adverse scenario also includes some assumptions that are milder than last year: housing prices drop 25% and commercial real estate prices drop 35%, compared with 30% and 40% last year; equity prices drop 50% compared with 65% last year; and the peak investment grade credit spread is 550 basis points (bp), down from 575 bp last year. We consider this exercise a robust health check of these banks’ capital resilience.

Finally, the three-month and 10-year Treasury yields both fall in this year’s severely adverse scenario, resulting in a mild steepening of the yield curve because the 10-year yield falls by less. As a result banks’ net interest income faces greater stress than in last year’s scenario, which assumed unchanged treasury yields and a much steeper yield curve.