REINZ has released their January 2020 residential report today, and they reported the busiest January in 4 years. The annual average rise across New Zealand was 7%, with Auckland at 4.4% and other areas up 9.1%. Auckland is actually now among the faster-rising regions. Prices in Canterbury are rising, although to date this has been slower than many other regions.
In January the median number of days to sell a property nationally decreased by 6 days from 48 to 42 when compared to January 2019 – the lowest days to sell for the month of January in 3 years.
Low interest rates and lighter regulation are driving the market. Over 2019, the RBNZ cut the OCR from 1.75 percent to 1 percent and they indicate that the OCR will remain at 1 percent for some time. In response, household debt continues to rise. Lower debt servicing costs enables higher household spending on consumption, although returns from savings will be lower as well.
Over the past year New Zealand construction activity has ramped up substantially while net migration has steadily declined. The cancellation of earlier plans to introduce a capital gains tax has also helped to drive the market.
For New Zealand excluding Auckland, the number of properties sold increased by 0.9% when compared to the same time last year (from 3,279 to 3,308) – also the highest for the month of January in 4 years.
In Auckland, the number of properties sold in January increased by 9.7% year-on-year (from 1,180 to 1,295) – the highest number of residential properties sold in the month of January since January 2016.
Sales in Auckland were the highest for the month of January in four years, with particularly strong uplifts in sales volumes in North Shore City (+29.0%), Waitakere City (+28.6%) and Rodney District (+21.1%).
Regions outside Auckland with the highest percentage increase in annual sales volumes during January were: • Nelson: +42.6% (from 54 to 77 – 23 more houses) • Manawatu/Wanganui: +15.3% (from 281 to 324 – 43 more houses) – the highest for the month of January in 3 years • Bay of Plenty: +11.5% (from 340 to 379 – 39 more houses) – the highest for the month of January in 4 years • Marlborough: +11.3% (from 62 to 69 – 7 more houses). Regions with the largest decrease in annual sales volumes during January were: • Tasman: -29.3% (from 58 to 41 – 17 fewer houses) – the lowest since January 2017 • Southland: -27.2% (from 151 to 110 – 41 fewer houses) – the lowest for the month of January in 6 years • Otago: -17.1% (from 269 to 223 – 46 fewer houses) – the lowest for the month of January in 9 years.
In the recent Reserve Bank NZ Monetary Policy Statement, they indicated that over the medium term, annual house price inflation is expected to slow as net immigration moderates, residential construction activity remains high, and the effects of past lower mortgage rates fade.
However, they expect residential investment growth is expected to pick up over the next six months, in line with recent high levels of residential building consent issuance. That said, residential investment is forecast to decline very gradually as a share of GDP later in the projection period, reflecting ongoing capacity constraints in the construction sector.
In December 2019, the Government announced a substantial investment package of $12bn, equivalent to around 4 percent of annual nominal GDP. The Treasury forecasts that $8.1bn will be spent between June 2020 and June 2024, mainly on infrastructure projects
Which is probably just as well, given that business investment is forecast to fall ahead.
Financial system vulnerabilities remain elevated and more effort is required to ensure that the system remains resilient over the longer-term, Reserve Bank Governor Adrian Orr says in releasing the November Financial Stability Report.
International risks to the
financial system have increased. Global growth has slowed amid continued
uncertainty about the outlook for world trade. This has resulted in reductions
in long-term interest rates to historic lows, including in New Zealand. While
necessary to maintain near-term inflation and employment objectives, prolonged
low interest rates can promote excess debt and investment risk-taking, and
overheat asset prices, Mr Orr says.
Mr Orr noted that the Reserve Bank’s Loan-to-Value Ratio (LVR) restrictions have been successful in reducing the more excessive household mortgage lending, thereby improving the resilience of banks to a significant deterioration in economic conditions.
But, there remains the risk that prolonged low interest rates could lead to a resurgence in higher-risk lending. As such, we have decided to leave the LVR restrictions at current levels at this point in time.
Mr Orr says the Reserve Bank
is committed to bolstering the long-term resilience of the financial system.
“Strong bank capital buffers are key to enabling banks to absorb losses and
continue operating when faced with unexpected developments. The Reserve Bank
has proposed increasing these buffers further with final decisions on the
Capital Review proposals to be announced on 5 December.”
Deputy Governor Geoff
Bascand says good governance and robust risk management processes within
financial institutions are important to maintain long term resilience. Our
recent reviews of banks and life insurers, and the number of recent breaches in
key regulatory requirements, reinforces the need for financial institutions to
improve their behaviour.
“We are engaging with
industry to ensure that they strengthen their own assurance processes and
controls. We have also reviewed our own supervisory strategy and will be taking
a more intensive approach, which will involve greater scrutiny of institutions’
compliance,” Mr Bascand says.
“Some life insurers have low
solvency buffers over minimum requirements. Recent falls in long-term interest
rates are putting further pressure on solvency ratios for some of these
insurers. Affected insurers are preparing plans to increase solvency ratios and
are subject to enhanced supervisory engagement. This highlights the need for
insurers to maintain strong buffers, and insurer solvency requirements will be
reviewed alongside an upcoming review of the Insurance (Prudential Supervision)
Act.”
Westpac New Zealand Limited (Westpac) has retained its
accreditation as an internal models bank following completion of an extensive
remediation process required by the Reserve Bank.
In 2017 the Reserve Bank
required Westpac to undertake an independent review of its compliance with
internal models obligations. The review found that Westpac was using a number
of unapproved models and that it had materially failed to meet requirements around
model governance, processes, and documentation.
The Reserve Bank imposed a
precautionary capital overlay in light of the regulatory breaches, and gave
Westpac 18 months to remedy the failures or risk losing its accreditation as an
internal models bank.
Deputy Governor Geoff
Bascand says that following the remediation process, Westpac is now operating
with peer-leading processes, capabilities and risk models in a number of areas.
“Westpac has taken the
findings of the independent review as an opportunity to make meaningful
improvements to its risk management, and we commend it for its co-operative and
constructive engagement in working with Reserve Bank over the remediation
period.
“The changes that Westpac
has made to its internal processes, governance and resourcing, as well as a
suite of new credit risk models for which it has sought approval, have given us
confidence in its capital modelling and compliance and satisfied us that it now
meets the internal models bank standard.
“Looking forward, we will continue
to hold all internal model banks to the same high standards.”
Internal models banks are
accredited by the Reserve Bank to use approved models to calculate their
regulatory capital requirements. Accreditation is earned through maintaining
high risk management standards, and comes with stringent responsibilities for
the bank’s directors and management.
Banks are required to
maintain a minimum amount of capital, which is determined relative to the risk
of each bank’s business. The way that risk is measured is important for
ensuring that each bank has an appropriate level of capital to absorb large and
unexpected losses.
The Reserve Bank will amend
Westpac’s conditions of registration from 31 December to remove the two
percentage point overlay applying to its minimum capital requirements.
As a condition of retaining
its accreditation Westpac will need to satisfy several ongoing requirements,
which it has committed to resolving, Mr Bascand says.
The Reserve Bank of New Zealand (RBNZ) and Financial Markets
Authority (FMA) today released their findings on life insurers’ responses to
the joint Conduct and Culture Review.
Overall, the regulators were
disappointed by the responses. Significant work is still needed to address the
issues of weak governance and ineffective management of conduct risk,
identified in the regulators’ report earlier this year.
Rob Everett, FMA Chief
Executive, said: “While we’re disappointed, we’re not surprised as the
responses confirm what we found in our original review. It’s clear that
progress has been slow and not as far-reaching as required.
Some providers have started
work to identify the customer and conduct issues they face, others have not
provided any detail on this.”
Sixteen life insurers were
asked to provide work plans outlining the steps they will take to improve their
existing processes and address the regulators’ findings and recommendations.
There was wide variance in
the comprehensiveness and maturity of the plans provided.
Adrian Orr, Reserve Bank
Governor, said, “We’re disappointed the industry’s response has been
underwhelming. The sector has failed to demonstrate the necessary urgency and
prioritisation, around investment in systems, to provide effective governance
and monitoring of conduct risk.”
There was also a wide
variance in the quality and depth of the systematic review of policyholders and
products. Some did not complete this exercise and others did not provide data
on the number of policyholders affected or the estimated cost of remediation
activities. Insurers that completed the exercise identified at least 75,000
customer issues requiring remediation, with a value of at least $1.4 million.
Some of the new issues identified included:
Overcharging of premiums and benefits not being updated due to system errors, human errors and under-reporting of deaths
Poor customer conversations overlooking eligibility criteria and poor post-sale communications, which lead to declined claims and underpayment of benefits
Poor value products were identified, where premiums charged were not fair value for the cover provided.
Sales incentives and
commissions
The FMA and RBNZ committed
to report back on staff incentives and commissions for intermediaries. Previous
reports by the FMA reflected the concerns with conflicted conduct associated
with high up-front commissions and other forms of incentives, (like overseas
trips) paid to advisers.
Although some insurers have
committed to removing sales incentives for employees and their managers, not
all committed to removing or altering indirect sales incentives.
Those providers that have
removed sales incentives for employees don’t typically use external advisers to
distribute products. Providers using external advisers told the regulators that
changing long-held business arrangements and distribution models is difficult
and will take time to implement.
Mr Everett said, “We’re
ready to work with life insurers to ensure they prioritise their focus on
serving the needs of their customers, while at the same time balancing the need
to remunerate advisers for the important work they do to help these customers.
But we do not think high up-front commissions create confidence that insurers
and advisers are acting in the best interests of customers.”
Mr Orr said, “Good
governance within insurance firms requires the effective management of conflicts
of interest. We need to see much better systems and controls in place to manage
the inherent conflicts where advisers or sales staff are offered incentives to
sell or replace insurance policies.”
Next steps
Those companies that have
not undertaken comprehensive systematic reviews of policyholders and products
have been asked to complete further reviews of their systems to identify
issues, and to develop mature plans to respond and remediate any of their
findings. These plans must be completed by December 2019.
The FMA and RBNZ will
continue to monitor how the insurers are responding to recommendations and
implementing their work plans. Life insurers are currently not legally required
to become more customer-focused and the FMA and RBNZ found that the sector has
a weak appetite for change.
Deficiencies in some of the
plans received, and some insurers’ lack of commitment to implementing the
regulators’ recommendations, further demonstrates the need for additional
obligations to be included in the regulation of conduct of life insurers.
There is an interesting paper the Reserve Bank NZ has put out, seeking comments by 31 August. The Future of Cash Use. It was issued in June 2019.
The paper describes the transition to digital alternatives, and explains some of the reasons. But what caught my eye was this section. “All members of society will lose the freedom and autonomy that cash provides, be more exposed to cyber threats, and lose the ability to use cash as a back-up form of payment”. And “other activity in the shadow economy is unlikely to be affected by the disappearance of cash as people find other ways to circumvent the law”.
So two points, New Zealand followers you might want to read the paper, and make a submission – not been much publicity so far.
Those following the DFA campaign relating to the War on Cash in Australia, here is more evidence that the proposal to ban cash transactions above $10,000 will not achieve their stated aims – but of course there is a wider monetary policy objective, as we have discussed.
6 Considerations arising from having less cash in society
Given the trends in cash demand and the cost pressures on the
commercial supply of cash in New Zealand, it is possible that cash will
become less widely available or used in the medium to long term. The
effects of less cash in society would be felt more keenly by certain
groups of people who rely on cash and for whom no practicable substitute
exists. The severity of these impacts would be worsened if the
transition to a society with less cash acceptance occured before
mitigating measures could be put in place. Further, the size of the
affected groups might not be large enough to motivate cash providers to
ensure future cash availability, but the size might also not be
negligible.
This section summarises the information in table 1 and Appendix A and
the issues that should be considered if cash use and availability
decline.
Issue 1: People who are financially or digitally excluded could be severely negatively affected.
Cash provides access to the financial system for those who face
barriers to financial inclusion. Further, in a society with less cash,
barriers to digital inclusion could become barriers to financial
inclusion.
Barriers to financial inclusion include limited access to the
banking system due to either a lack of trust in online security, skill
or motivation to use online financial platforms, or banking
restrictions. People who are not banked or have limitations to accessing
the banking system tend to be people without identification and proof
of address, people with convictions, people with poor credit histories,
people with disabilities, illegal immigrants and children.Elderly people
typically rely more than others on cash as a form of payment.
This could be due to low trust in online payments, low ability or
low motivation to learn new payment techniques. People with physical
disabilities, such as sight or intellectual impairments, might also find
cash a useful form of money. Children are also subject to financial
exclusion as banks do not issue debit cards to children under the age of
13. Further, New Zealand banks have full discretion in the customers
they service. This means that some people who do not meet certain bank
policies cannot obtain or keep accounts with those banks. Appendix A
describes additional groups that rely on cash rather than digital money.
Barriers to digital inclusion include insufficient internet
coverage, affordability constraints for technology hardware or data
plans, lack of skills, lack of confidence and low motivation to use
digital platforms. For example, even if people have access to the
internet they might not be motivated to upload personal details to an
online bank account due to privacy concerns.
Issue 2: Tourists, people in some Pacific islands and people who use
cash for cultural customs might be negatively affected if they cannot
use substitutes.
Tourists
Currently most tourists use cash as a reliable and easy-to-use form
of payment. Reserve Bank research has revealed that cash is typically
issued to Auckland and overseas and sent back to the Reserve Bank from
the South Island. This movement is likely due to the movement of
tourists. Many retailers in New Zealand do not accept credit cards (or
contactless payments) due to their higher interchange fees, preferring
instead to accept debit and EFTPOS cards (which require a New Zealand
bank account) that incur much lower costs for the retailers.We
are not aware of the extent to which inbound tourists’ own financial
services’ fees or portability, or their prior understanding of
transacting in New Zealand, influence this behaviour.
As per Appendix A, tourist access to payments in New Zealand could be
met by overseas-issued debit cards if cash were not available. Further,
competition might cause some retailers to accept tourist credit cards
despite higher interchange fees if cash was not available. Bounie et al
(2015) show that higher competitive pressures (the threat of losing
sales) increase the probability that a retailer will accept credit card
payments despite the higher costs.
Even if electronic payment alternatives were reliable, tourists might
be disadvantaged due to language and cultural barriers that create
actual and perceived barriers to payments in New Zealand. Further,
tourists might be particularly vulnerable to risks of robbery or loss
of payment cards if they could not rely on cash as a back-up payment.
Pacific Islands
Niue, the Cook Islands and Tokelau rely on New Zealand banknotes and
coins for their physical currency. The size of these island economies
has been thought to be a contributing factor to their use of New Zealand
currency. In addition, these islands are formally defined as states in
free association within the Realm of New Zealand. New Zealand banknotes
are also used in the Pitcairn Islands.
The Reserve Bank does not have a formal arrangement to supply these
economies with banknotes and coins. The supply of banknotes and coins to
these islands is facilitated by commercial providers, tourists, and
transfers from families. There are no ATMs on Niue and Tokelau. The Cook
Islands has two ATM providers and also issues its own banknotes and
coins. These islands also have access to digital money as in New
Zealand.
Cultural customs
New Zealand’s banknotes have been referred to as the country’s
business card. The designs on the notes represent many of our cultural
icons and contribute to our national cultural identity. Cash is also
used in many cultural customs in New Zealand. Some cultures that use
cash as gifts in traditional ceremonies might find that part of their
cultural identity is lost if they can no longer access cash easily. For
instance:
A Chinese custom is to give cash to junior family members and
friends during celebrations including New Year (Hoong Bouw — giving
money in red envelopes), at funerals, and during tea ceremonies in
traditional Chinese culture.
Some cultures have a wedding money dance where cash is gifted to
the bride and groom as they dance (the Philippines’ Saya ng Pera, and
the Taualuga in Samoa, Tonga and Western Polynesia).
Western cultures give coins to children who lose their baby teeth (Tooth Fairy).
Issue 3: All members of society will lose the freedom and autonomy
that cash provides, be more exposed to cyber threats, and lose the
ability to use cash as a back-up form of payment.
If cash use and availibility were to decline, an issue for all
members of society could be the loss of freedom that cash provides in
terms of autonomous spending and wealth stores, privacy, ability to live
off the grid, and ability to avoid the banking system. This could
result in a significant loss of social freedom in aggregate and
increased cyber security risks (leading to an increase in national
security risks). Lastly, society would lose the benefit of cash as a
‘back-up’ form of payment, although the usefulness of cash in this role
is limited.
Reduced freedom
Cash is anonymous, so provides consumers with autonomy or discretion
in how they choose to spend their money or store their wealth. The
feature of full anonymity creates personal and societal freedom and has
not been replicated in digital currencies. There are three elements in
this freedom; the first relates to the desire for privacy in making
transactions, the second relates to the desire to avoid banks or
government regulation, and the third relates to exposure to cyber-crime.
First, cash payments and balances cannot easily be traced. Central
agents and third parties (such as banks and governments) cannot easily
intervene or stop cash payments outside the banking system. This is a
unique feature of cash and is not fully replicated by any other form of
money. This anonymity gives people full control of and discretion with
their finances. Independent bank accounts could provide personal
freedoms but they are not always available or sufficient. For example,
individuals who are in abusive and controlling circumstances might
benefit from cash as it is easier to obtain and hide when other personal
freedoms are restricted.35
Additionally, people might feel that they benefit from the choice of
using an anonymous form of payment if it were ever needed.
However, the difficulty in tracing cash makes it relatively more
vulnerable to theft, accidental losses and fraudulent payments
(inadvertently accepting counterfeit notes). For this reason, some argue
that people would be better off with a partially anonymous form of
payment, where only the minimum information is given regarding the
identity of the payer and payee in each transaction, but each
transaction is recorded. These payments include, for example, vouchers,
and prepaid gift (debit or scheme) cards.36
Second, the offline and anonymous features of cash enable people to
separate their transactions and stores of wealth from the banking system
and some government interventions. There are legitimate motivations for
this separation.
There is currently no guarantee of the safety of bank deposits in New Zealand.37
Banks take household and business deposits and lend them to borrowers
— there is a risk that borrowers might not be able to service their
debts. Households and businesses could lose their deposits if banks were
engaging in overly-risky lending or if a severe series of events
occurred and many loans were not repaid.
People might also want to remove their savings from the banking
system if the Reserve Bank charged negative interest rates to stimulate
the economy. Cash provides an avenue for people to avoid this form of
government intervention or any other government intervention that might
occur in the future, such as capital controls.
Relatedly, people might want to store wealth outside the banking
system if they have low fundamental trust in banks or the government.
Examples are individuals who have immigrated to New Zealand from
countries where trust in the financial system is low, or where
government appropriations of assets were not uncommon. If there were
less cash in society, individuals would lose their privacy and autonomy
from government in the sense that all their transactions and savings
would be fully traceable if permitted by law.
Third, storing and transacting in cash reduces exposure to
cybercrime, such as financial losses and identity fraud. On a societal
level, New Zealand might be more exposed to cybercrime such as
state-funded cyber threats if it were totally reliant on the banking
system and digital money for all transactions and savings. On a personal
level, some people might prefer to keep their identities and finances
offline due to cyber concerns.
The loss of freedom in society in the above three areas could result
in demand for a form of digital currency issued by the central bank that
replicates some of the autonomy of cash. There are other assets in
which people could store their wealth that are offline and removed from
the financial system, for example, commodity assets and property.
However, these are more difficult to transform into spendable money and
can come with a different set of risks including fluctuating values.
Therefore, people might demand a central bank digital currency that
provides lower traceability than current electronic payments and
accounts and presents an alternative to the banking system. This could
be in the form of accounts with the central bank or tokens issued by the
central bank, which carry a very low risk of default and sit outside
the commercial banking system. A central bank digital currency could
also be designed to provide a low cost form of payment to put downward
pressure on uncompetitive prices in the payment system. Alternatively,
consumers might ask for deposit protection and greater regulation of the
banking system.38
People might also value the freedom and autonomy of cash for
illegitimate reasons. As noted in section 2, cash is used in the shadow
economy to facilitate illegal transactions or as a means to hide income
and reduce tax and other obligations. The International Monetary Fund
estimated New Zealand’s shadow economy at 11.7 percent of GDP in 1991
-2015. 39
It is difficult to assert what might occur in the shadow economy if we
had less cash. At the margin, some shadow economy activities could be
reduced as people consider the additional difficulty of engaging in them
without anonymous payments. For example, some people might be
dissuaded from buying illegal goods and services if they could not avoid
leaving electronic records of their purchases. However, it is also
possible that criminal activity would innovate to other mechanisms or
forms of payment discussed below.
There is debate on whether the anonymity of cash enables crime or
whether illegal transactions would continue without cash. Rogoff (2016)
and McAndrews (2017) agree that, without cash, criminals could use
commodity money (i.e. gold), foreign currency, and inflated invoices.
But they disagree on the extent to which these substitutes would be
used. Rogoff (2016) argues that there is no complete substitute for
cash, so criminal activity would be hindered if there were less cash in
society. McAndrews (2017) argues that inflated invoices would become the
most likely medium of exchange for criminals. He suggests that a
society without cash would likely move towards deeper institutional
corruption of businesses as criminals launder money obtained from
illegal transactions. He also warns that innocent businesses could find
themselves forced into money laundering as criminals look for businesses
to issue inflated invoices.
Issue 4 considers how some tax evasion might be reduced by less cash.
Loss of emergency back up
Cash can be a back-up payment mechanism when electronic payment
systems are not in operation or otherwise unavailable. The Reserve Bank
survey on cash use indicated that 37 percent of people held cash just in
case it was needed (i.e. not for immediate transactions). Cash is
particularly useful in case of ‘personal emergencies’, or localised or
short disruptions in electronic payments systems, and after large-scale
events conditional on the availability of retail stores able to accept
it. Figure 2 shows a spike in CIC as a percent of GDP in 1999 that could
be attributed to the ‘Y2K’ uncertainty.
Cash has several limitations in its usefulness as a back-up payment
in case of large-scale events or natural disasters. Because the supply
of cash and most retail operations are reliant on electricity and
communications, IOUs between small groups or people who are known to
each other might be more effective in periods of long electricity
outages such as those that occur in natural disasters. There might also
not be sufficient cash infrastructure capacity to meet a national
transition to cash in an emergency.
In addition, the National Risk Unit does not recommend including cash
in a civil defence kit or give guidance on the best means of payment in
a national disaster response period. This could be because people
already have their essentials in their civil defence kits, retail stores
might not be operating, and emergency responders will provide
additional supplies. In the weeks following the Christchurch February
2011 earthquake, public demand for cash did not increase substantially.
Commercial banks anticipated an increase in demand for cash and
increased their stores of cash and set up temporary ATMs based on
generators. However, the bulk of these cash stores returned to the
Reserve Bank relatively quickly. Figure 2 shows CIC did not peak as a
share of the population during 2011.
Issue 4: On balance, there would be limited effects on budgeting, financial stability and government revenue.
Transitioning to a society with less cash does not significantly or
negatively affect household budgeting, financial stability and
government revenue.
Budgeting
Cash is widely cited as a budgeting tool. Psychological studies show
that paying in cash incites a higher psychological pain of parting with
funds. This is because the tangible nature of cash results in high
transparency of payments and so generates a greater awareness of
spending.40
This greater ‘pain of paying’ encourages less spending and is useful
for managing discretionary spending, but it could reduce willingness to
pay bills or debt. Shah et al. (2016) suggest that consumers should
automate their essential payments and savings using online banking then
spend disposable (leftover) income using cash. Cash might also be useful
for limiting spending when people need to keep money separate for other
purposes.
People who prefer to use cash for budgeting might benefit from new
electronic budgeting tools such as budgeting applications on mobile
phones. For example, several banks in Dubai provide real time balance
updates or notifications every time money is spent, replicating the
relatively high ‘pain of paying’ that cash provides.
Cash is not the only nor the most important budgeting tool available
for people with low or no disposable incomes, high debts, overspending
habits, or poor mental health. For these groups, commonly cited
budgeting tools include awareness and education, direct credits,
multiple bank accounts, and removing overdrafts and credit. Cash is used
for people who are in full financial management in a Total Money
Management programme as they are allocated their weekly spending in
cash.41
However, the anonymity of cash makes it difficult for budgeting
advisors to identify areas of overspending. Cash also enables people to
default on automatic payments (for bills or debts) as they can withdraw
their full bank account balances into cash. Further, withdrawing money
into cash puts people at a higher risk of robberies than if they did not
withdraw their money. For example, people who withdraw their income
payments from ATMs at night to avoid automatic payments (processed in
the morning) face a risk of robbery, particularly if these habits are
well known in the community.
Financial stability
A society with less cash does not pose a risk to financial stability.
Cash represents a claim on the government and carries low default risk.
In theory, the ability of depositors to convert their savings into cash
represents a form of market discipline on banks that encourages them to
operate prudently. However, there is little empirical evidence to
support this. Engert et al. (2018) evaluate the bank runs during the
2007 – 2008 Global Financial Crisis and determine that cash withdrawals
are a small and unimportant source of market discipline on banks. Shin
(2009) finds that the Northern Rock bank run was triggered predominantly
by wholesale runs, and the in-branch runs to cash were insignificant.
Market discipline is only one form of discipline safeguarding our
financial system. Another form is regulatory discipline. The Reserve
Bank is mandated to use prudential regulation and supervision to
contribute to a stable financial system. The third form is
self-discipline, whereby financial market institutions self-regulate to
ensure their ongoing prudent operation.
The second aspect of stability is payment stability. Migrating from
two payment systems to one payment system would consolidate operational
risk in the single payment system. Greater emphasis would be required
on ensuring the operational reliability of the single payment system if
people could not easily revert to cash if there were a system outage.
Most electronic payments (except cryptocurrencies) rely on the same
back-end payment systems which, exhibit several single points of
failure.42
Increased tax revenue and reduced seignorage
Government revenue could be affected in two ways if cash use and
availability declined. First, removing the availability of notes and
coins might increase tax revenue as businesses would no longer use cash
to reduce their tax bills. The Inland Revenue Department has reported
that the most common ‘hidden economy’ activity is the underreporting of
taxable income, which includes income from cash jobs and transactions.43
Exactly how much tax revenue is lost due to this type of activity is
unknown. A tax working group paper suggests that unincorporated
self-employed individuals under-report approximately 20 percent of their
gross income. This estimate is based on a study commissioned by Inland
Revenue44
and could represent $850 million per annum in lost tax revenue from
unincorporated (non-trust or non-corporation) taxpayers. There is
considerable uncertainty as to the extent to which this number includes
self-employed people who are evading tax by underreporting cash revenue
versus other types of underreporting. It is also not certain that those
reducing their tax burdens by underreporting cash revenue would increase
their tax payments if cash were used less.45
Second, seignorage revenue might decline if the value of CIC declined
significantly. Seignorage revenue is the profit the Reserve Bank makes
from producing and selling cash and investing the profits, as well as
any profit the Reserve Bank makes from financial market trading. 46
The Reserve Bank estimates that it made around $148 million in
seignorage revenue last financial year by issuing cash and investing the
profits.
Other activity in the shadow economy is unlikely to be affected by
the disappearance of cash as people find other ways to circumvent the
law, as described in Appendix A. People who can no longer launder cash
will likely switch to other methods.
The New Zealand Reserve Bank has today published a summary of submissions on its consultation proposing a new mortgage bond standard aimed at supporting confidence and liquidity in New Zealand’s financial markets.
Submissions on the new
proposed mortgage bond standard are broadly supportive of the introduction of a
high grade residential mortgage backed securities framework for New Zealand –
known as Residential Mortgage Obligations (RMO).
The new standard aims to reduce
contingency risks for the Reserve Bank as a lender of last resort, ensuring
financial intermediaries supply sufficient high quality and liquid assets. The
standard also aims to provide issuers and investors with an additional funding
and investment instrument, supporting the development of deeper markets.
Assistant Governor and
General Manager of Economics, Financial Markets and Banking Christian Hawkesby
said he was pleased with the range and depth of feedback received during the
consultation process.
“The consultation process
has been successful in delivering improvements to the initial concept for a new
mortgage bond standard to support financial intermediation, liquidity
management and funding in New Zealand’s markets.”
The feedback from issuers, investors
and other market participants has been constructive and it will help inform the
Reserve Bank’s final policy decision which is expected to be published by the
end of 2019.
The Reserve Bank has decided
to update repo-eligibility conditions for RMBS in
the transition to the final RMO policy. This includes a new approval process
and requirement for a more detailed RMBS reporting template.
The New Zealand Reserve Banks says the Official Cash Rate (OCR) is reduced to 1.0 percent. The Monetary Policy Committee agreed that a lower OCR is necessary to continue to meet its employment and inflation objectives.
Employment is around its
maximum sustainable level, while inflation remains within our target range but
below the 2 percent mid-point. Recent data recording improved employment and
wage growth is welcome.
GDP growth has slowed over
the past year and growth headwinds are rising. In the absence of additional
monetary stimulus, employment and inflation would likely ease relative to our
targets.
Global economic activity
continues to weaken, easing demand for New Zealand’s goods and services.
Heightened uncertainty and declining international trade have contributed to
lower trading-partner growth. Central banks are easing monetary policy to
support their economies. Global long-term interest rates have declined to
historically low levels, consistent with low expected inflation and growth
rates into the future.
In New Zealand, low interest
rates and increased government spending will support a pick-up in demand over
the coming year. Business investment is expected to rise given low interest
rates and some ongoing capacity constraints. Increased construction activity
also contributes to the pick-up in demand.
Our actions today
demonstrate our ongoing commitment to ensure inflation increases to the
mid-point of the target range, and employment remains around its maximum
sustainable level.
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.
The Reserve Bank of New Zealand has released an important statement on the new approach they are going to adopt in policy setting. The focus will be on improving wellbeing. In addition they are expanding their dna to avoid group think. This follows their recent moves to lift bank capital.
There is so much here the RBA should embrace.
The Reserve Bank has significantly changed the way it makes monetary policy decisions, keeping itself in step with public expectations.
In a panel discussion last week at the Institute for Monetary and Economic Studies (Bank of Japan) in Tokyo, Reserve Bank Assistant Governor and General Manager of Economics, Financial Markets and Banking Christian Hawkesby talked about the importance of good decision making and governance, and of being credible and trusted, in achieving the long-term goal of improving wellbeing.
“We maintain our legitimacy as an institution by serving the public interest and fulfilling our social obligations. Keeping our ‘social licence’ to operate depends on maintaining the public’s trust that we are improving wellbeing,” Mr Hawkesby said.
“Thirty years ago New Zealand was prepared to accept a single expert – the Governor – making decisions about how to fight inflation. People now expect to see how and why decisions are made, expect that decision makers reflect wider society, and that current issues and concerns are factored into the decision making. By meeting these expectations, we can improve public trust in the legitimacy of the Reserve Bank’s work,” he said.
Mr Hawkesby outlined the new committee process that the Reserve Bank uses for deciding the official cash rate, noting that diversity among decision makers improves the pool of knowledge, insures against extreme views, and reduces groupthink.
“This diversity is needed to confront issues such as climate, technological, and other structural and social changes,” he said.
He also said that collaboration with government can be undertaken in a way that maintains the Reserve Bank’s political independence while working on the broader objective of improving wellbeing.
Here is the supporting speech.
Introduction
Tena koutou katoa
Thank you for the opportunity to talk about the Reserve Bank of New
Zealand and the changes we are making to maintain our credibility in
times of change.
I would like to focus on two building blocks of credibility:
renewing a social licence to operate by aligning our objectives with the needs of the public; and
achieving those objectives through good decision making enabled by a framework of good governance.
A common theme is the importance of transparency.
The imperative for change: Central banks in the 21st century
The first building block of credibility is the renewal of a social
licence to operate—by this I mean the legitimacy an institution earns by
serving the public interest. It is granted by the public when an
institution is seen to fulfil its social obligations.1
New Zealand was the first country to officially adopt inflation
targeting in 1989, with a number of central banks around the world
following the example.2
Under a single-decision-maker model, we brought inflation down from
around twenty percent to two percent in five years. In doing so, we
helped build our credibility during the high-inflation environment of
the times.3
Fast-forward to 2019, and monetary policy in New Zealand has
undergone major change. Firstly, we have adopted a dual mandate, focused
on achieving price stability and supporting maximum sustainable
employment. Secondly, we have adopted a committee structure for decision
making, and are delivering greater transparency in our decision making.
Why the change?
The reform of our framework was not merely a simple choice based on
technical performance. As you can see in figure 1, when it comes to
inflation and growth, over the past 30 years inflation-targeting central
banks (e.g. New Zealand and the United Kingdom) have a pretty similar
track record to central banks with a dual mandate (e.g. Australia and
the United States). 4
The imperative for change comes from more than examining our history;
it comes from our expectations of the future, and the present we find
ourselves in. Our policy framework changed because times are changing.
For the Reserve Bank to maintain its credibility and relevance, we must
change too.
Figure 1: Inflation, and GDP growth across monetary policy frameworks5
Wellbeing of our people
Inflation has been low and stable in New Zealand for nearly 30 years.
There is a greater appreciation that low inflation is a means to an
end, and not the end itself. In the fight to lower inflation that was
perhaps easy to forget. The end goal is, of course, improving the
wellbeing of our people.6
For many in the general public, employment is one tangible measure of wellbeing. Employment can provide an opportunity to earn your own wage, contribute to society, and live a fulfilling life.
It is in this light that the Reserve Bank Act (1989) has been amended to include a dual mandate with an employment
objective alongside our price stability goal. Incorporating the
objective of supporting maximum sustainable employment, and equally
weighting it alongside inflation, emphasises our long-term goal of
improving New Zealanders’ wellbeing. This aligns us with the needs of
the public. And it helps us renew our social licence to operate – the
first building block for maintaining our credibility.
But it is not enough for the public to believe in and understand our
objectives. We must also prove to them that they can be achieved. This
brings us to the second building block necessary for maintaining
credibility: establishing modern governance principles for dealing with
modern problems, and translating good governance into good decisions.
Good governance
In preparing for our dual mandate, and a formal Monetary Policy
Committee (MPC), we have updated the principles and processes that form
our governance framework for monetary policy.
In pursuit of greater transparency, we have also published these
principles and processes in a comprehensive Monetary Policy Handbook
(the Handbook). 7 This is an essential document, for everyone from school students to MPC members.
Importantly, it is also a living document that will evolve as our understanding evolves.
Principles
The first part of the Handbook I would like to cover is the section on MPC deliberation principles. 8
Figure 2: MPC deliberation principles
There are three principles which guide the deliberations within the MPC.
I’ve talked already about providing clarity around our objectives –
the equal weighting of our employment and inflation goals. This is the
first of our three principles.
The second, is diversity – diversity in the skills, experiences, thoughts, and personal characteristics of the MPC members.
The third, is inclusion – inclusion of information and people, ensuring decisions are made on the basis of all the available insights, and reflecting the views of all of the committee members.
Why are diversity and inclusion so important?
The governance literature shows that diversity and inclusion improves
the pool of committee knowledge, insures against extreme views, and
reduces groupthink.9 These principles drive the committee towards an unbiased policy decision – the best that is possible given existing information.
Think about this from a practical perspective. Modern monetary policy
is confronted by diverse issues such as climate, technological, and
other structural and social changes. A sole decision maker or uniform
committee cannot possibly hope to possess the broad range of insights
necessary to consider these issues.
A diverse committee operating in an inclusive environment can. It is
these additional insights that improve collective understanding, and
lead to better monetary policy decisions.
So you see these principles are not simply rhetorical devices. They
are carefully chosen pillars to support our credibility though good
decision making in achieving our dual mandate.
Good decision making
Processes
Our principles of good governance have directly influenced the policy-setting process of the MPC. 10
This is a process that has been designed with consensus-based decision
making front and centre, consistent with the agreement with the Minister
of Finance. 11
Figure 3: The structure of the forecast week for quarterly Monetary Policy Statements
We begin with information pooling, which flows through to MPC
deliberations, and culminates in the final decision making meeting.
As you can see, the policy-setting framework is highly collaborative
and deliberate. Deliberate in the sense that the process inspires lively
debate, giving MPC members every possible chance to challenge
assumptions, critique policy judgements and assess a range of policy
strategies to achieve our dual mandate objectives.
A crucial part of this is that the MPC members hold back their views
on the decision until the final stages, rather than starting with them.
This supports evidence-based decision making and guards against
confirmation bias.
The process begins with open information pooling on recent
developments and the outlook for the economy. Here, the MPC have the
opportunity to investigate and challenge the assumptions made in the
staff’s initial forecasts. This is where the MPC member’s judgement
enters the picture, and where creative tensions improve collective
understanding.
While the MPC members may enter the room with different insights and
questions about the economy, at the end of the information pooling stage
the committee shares a common reference point for the economic outlook.
There are numerous opportunities to discuss and reflect on key
issues, judgements, risks, strategy, and communication throughout the
week. There are also a number of anonymous internal surveys we perform
to gauge collective opinion among staff and MPC members.12
By the end of the week-and-a-half, the final monetary policy decision reflects the greater momentum of the MPC’s discussion.
We publish the final Official Cash Rate (OCR) decision, a Monetary Policy Statement (MPS), and a Summary Record of Meeting at the same time.
The Summary Record of Meeting captures the key judgements
and risks underpinning the central forecasts and decision, as well as
indicating where members of the MPC had different views. We identify any
differing views, and communicate where the most significant
uncertainties lie in our baseline forecasts.13
If consensus cannot be reached, a vote by simple majority would be
carried out, and the reasoning behind different stances disclosed in the
Summary Record of Meeting.
Our desire is that the transparency provided in the Handbook can help
the public understand how the Bank’s collective ‘mind’ works. If the
public can see the analytical rigour in our decision making, they should
have greater confidence in the MPC’s conclusions, and thus more faith
in the Reserve Bank.
Our credibility will be supported in the long run if the decisions
made by the MPC are unbiased and effective ones. Our results will speak
louder than our words.
Monetary policy strategy and our May decision
So far I’ve talked about the principles and processes we follow in
setting policy. Now I’m going to cover how we ‘walk the talk’ in
formulating our monetary policy decisions.14
Sound and effective monetary policy strategy requires more than just
deciding whether the OCR should go up or down on any given day; instead
central banks need to be transparent about their views of the economy
over the medium-term and how monetary policy might respond to a changing
economic landscape.
In this regard, around twenty years ago, the Reserve Bank became a
pioneer in another way. When publishing our interest rate decisions, we
also began to publish a forward (and endogenous) projection of interest
rates in the future. We use this to capture the overall stance of
monetary policy.
This tool remains integral to how the MPC sets monetary policy and understands the potential trade-offs with a dual mandate.
The first monetary policy decision of the new MPC occurred last
month, in May. Our starting point was a New Zealand economy where the
labour market was operating near maximum sustainable employment, and
annual core inflation pressures were within our 1 to 3 percent target
range but below the 2 percent mid-point.
We discussed the slowdown in global growth, and how this might affect
New Zealand. We also addressed the recent loss of domestic economy
momentum since mid-2018, through both tempered household spending and
restrained business investment.
In order to continue achieving our policy objectives, we agreed that
additional monetary stimulus was needed to help bring inflation back to
the 2 percent mid-point and support maximum sustainable employment. We
then turned to the question of the magnitude of stimulus we wanted to
adopt (the stance) and the timing and means by which we would try to
deliver this (the tactics).
Figures 4–6 show how different OCR paths could have been used to
achieve our objectives. While each path was consistent with meeting our
objectives, they each offered different trade-offs.15
Figure 4: Official Cash Rate (OCR) paths to achieve alternative monetary policy stances
Figures 5-6: Inflation, and employment gap under alternative OCR paths
If we kept rates unchanged (the higher OCR path), our projections
suggested that it would have taken a number of years for inflation to
return to target, and employment would have fallen below the maximum
sustainable level.
If we lowered the OCR by around 75 basis points over the next 12 months
(the lower OCR path), our projections suggested it would result is a
situation where both inflation and employment would be overshooting
their targets.
By contrast, the baseline (our final published projection), with the
OCR around 40 basis points lower over the next 12 months, brought
inflation back to target in a reasonable time period, with employment
remaining near the maximum sustainable level. We decided this path
captured our preferred strategy, and was robust to the key risks we had
discussed.
After agreeing on the appropriate stance of monetary policy, MPC
turned to the tactical decision of where to set the OCR at the May
meeting, and decided to cut the OCR by 25 basis points to provide a more
balanced outlook for interest rates.
This brings us to discuss the future.
Maintaining credibility in the future
Our central view is that New Zealand’s interest rates will remain
broadly around current levels for the foreseeable future. However, we
need to be ready to adapt to changing conditions, to meet our objectives
even when confronted with unforeseen developments.
An issue that policymakers and academics are grappling with around
the world is the role of both monetary and fiscal stimulus in a world of
low interest rates.
There is emerging consensus that coordination is necessary for an optimal response of broader macroeconomic policy.16 For central banks, operational independence does not have to mean operational isolation.
Rather, collaboration with government can be done in a way that builds
and reinforces the social licence to operate, by showing a willingness
to work with other partners to do whatever is necessary to achieve the
broader objective—improving public wellbeing.
Even with coordination between monetary and fiscal policy, if further
macroeconomic stimulus is needed quickly, the first line of defence
will still inevitably fall upon central banks.17
In New Zealand, we are in the strong position of having further room to provide conventional monetary stimulus if required (using the OCR).
Having effective unconventional policy options expands the
toolbox of a central bank, which is naturally more relevant in a low
interest rate environment. In this spirit, we published a Bulletin article last year on the practicalities of unconventional monetary tools in a New Zealand context, and we continue to learn from the lessons of our central banking cousins.18
It’s better to have a tool and not need it, than need one and not have it.
Conclusion
In the Handbook, we explore the history of central banking objectives, and see how dramatically they have evolved over time. 19
We haven’t always had a mandate to support maximum sustainable
employment, or to achieve price stability, or even control over interest
rates or the money supply.
Nothing lasts forever, and it is possible that the role of central
banks may change again in the future. Our Handbook will inevitably
change. We need to be ready to adapt when changes beckon.
And it is not enough to grudgingly adapt. In order to
maintain credibility, central banks must embrace change and prove to the
public that they are capable of delivering on their objectives. To
remain credible is to remain relevant. Central banks should keep their
eyes open, and be ready to change tack. Our destination—a world with
improved wellbeing for our citizens—may not change, but the best route
for getting there may.
We must adapt. We must continue to improve the wellbeing of our citizens. We must remain credible.
The New Zealand financial system remains resilient to a broad range of economic risks. However, financial system risks remain elevated, and ongoing effort is necessary to bolster system soundness and efficiency.
Domestically,
debt levels are high in the household and dairy sectors, leaving borrowers and
lenders exposed to unanticipated events. Similar challenges exist globally,
given current high public and private debt levels, and stretched asset prices
in many of New Zealand’s trading partners.
Some regions have recently had high house price growth. This is not an immediate financial stability concern as those regions have smaller and less stretched housing markets than Auckland. But if strong price growth continued, the financial system would become more exposed to those regions. The Global Financial Crisis (GFC) showed that house prices can fall dramatically in small regions.
At a national level, the growth of household debt and house prices has slowed, but household debt has still grown faster than income in the past year. Housing market pressures could re-emerge if there is a strong response to the recent decline in mortgage rates, or reduced uncertainty about the future tax treatment of property investments.
Given this environment, the financial system’s vulnerability to risks in the household sector remains elevated, and must continue to be closely monitored and managed.
The capacity for some foreign governments and central banks to respond to unanticipated negative events is also limited by their current high government debt and low nominal interest rates. It is imperative to improve New Zealand’s financial system resilience while conditions are conducive.
Increasing financial institutions’ capital positions is central to ensuring that they can withstand severe shocks. We have proposed higher capital requirements for banks, and are currently reviewing public submissions on this proposal.
There is also a need for some insurers and non-bank deposit takers to improve their capital buffers. We will be reviewing insurer solvency standards in the months ahead.
Financial
resilience also includes service providers taking a long-term customer outcome
focus, to both maintain confidence and promote sound resource allocation. We
will ensure banks and insurers respond to the issues identified in our recent
review of their conduct and culture.
A longer-term
focus is also necessary for financial firms to adapt to the changing
competitive, regulatory, and natural environment.
Insurers are changing how they manage their exposure to natural disaster events, which is altering affordability. Risks associated with climate change are also impacting on the accessibility of insurance, with potential flow-on effects on bank lending. These risks must be appropriately identified and priced, so as to best ensure a stable transition over coming years.
The Reserve Bank’s loan-to-value ratio (LVR) restrictions have been successful in reducing some of the risk associated with high household indebtedness. The current LVR settings remain appropriate for now, with any further easing subject to continuing subdued growth in credit and house prices and banks maintaining prudent lending standards.
