Tag: Reserve Bank NZ

Next New Zealand Cash Rate Move Is Likely Down

The Reserve Bank NZ said today the Official Cash Rate (OCR) remains at 1.75 percent. Given the weaker global economic outlook and reduced momentum in domestic spending, the more likely direction of our next OCR move is down.

Employment is near its maximum sustainable level. However, core consumer price inflation remains below our 2 percent target mid-point, necessitating continued supportive monetary policy.

The global economic outlook has continued to weaken, in particular amongst some of our key trading partners including Australia, Europe, and China. This weaker outlook has prompted central banks to ease their expected monetary policy stances, placing upward pressure on the New Zealand dollar.

Domestic growth slowed in 2018, with softness in the housing market and weak business investment contributing.

We expect ongoing low interest rates, and increased government spending and investment, to support economic growth over 2019. Low interest rates, and continued employment growth, should support household spending and business investment. Government spending on infrastructure, housing, and transfer payments also supports domestic demand.

As capacity pressures build, consumer price inflation is expected to rise to around the mid-point of our target range at 2 percent.

The balance of risks to this outlook has shifted to the downside. The risk of a more pronounced global downturn has increased and low business sentiment continues to weigh on domestic spending. On the upside, inflation could rise faster if firms pass on cost increases to prices to a greater extent.

We will keep the OCR at an expansionary level for a considerable period to contribute to maximising sustainable employment, and maintaining low and stable inflation.

RBNZ Holds Cash Rate At 1.75%

The New Zealand Reserve Bank said today that the Official Cash Rate (OCR) remains at 1.75 percent. They expect to keep the OCR at this level through 2019 and 2020. The direction of the next OCR move could be up or down.

Employment is near its maximum sustainable level. However, core consumer price inflation remains below our 2 percent target mid-point, necessitating continued supportive monetary policy.

Trading-partner growth is expected to further moderate in 2019 and global commodity prices have already softened, reducing the tailwind that New Zealand economic activity has benefited from. The risk of a sharper downturn in trading-partner growth has also heightened over recent months.

Despite the weaker global impetus, they expect low interest rates and government spending to support a pick-up in New Zealand’s GDP growth over 2019. Low interest rates, and continued employment growth, should support household spending and business investment. Government spending on infrastructure and housing also supports domestic demand.

As capacity pressures build, consumer price inflation is expected to rise to around the mid-point of our target range at 2 percent.

There are upside and downside risks to this outlook. A more pronounced global downturn could weigh on domestic demand, but inflation could rise faster if firms pass on cost increases to prices to a greater extent.

They will keep the OCR at an expansionary level for a considerable period to contribute to maximising sustainable employment, and maintaining low and stable inflation.

RBNZ To Lift Bank Capital Requirements

The Reserve Bank of New Zealand has released a discussion paper in which they consult on proposals to lift the capital held by banks in New Zealand.

The expected effect on banks’ capital is an increase of between 20 and 60 percent. This represents about 70 percent of the banking sector’s expected profits over the five-year transition period. They expect only a minor impact on borrowing rates for customers.

They say “Banks currently get the vast majority of their money by borrowing it (usually over 90 percent), with the rest coming from owners (usually less than 10 percent). The Reserve Bank is proposing to change this balance by requiring banks to use more of their own money. This proposal is consistent with steps taken by other banking regulators after the Global Financial Crisis”.

Banks currently get the vast majority of their money by borrowing it (usually over 90 percent), with the rest coming from owners (usually less than 10 percent). The Reserve Bank is proposing to change this balance by requiring banks to use more of their own money. This proposal is consistent with steps taken by other banking regulators after the Global Financial Crisis.

If banks increase their capital, they will be more resilient to economic shocks and downturns, which will strengthen New Zealand’s banking system and economy.

Because the level of a bank’s capital can have an impact on the interest rate it charges on its loans, it is possible that higher capital requirements could make it more expensive for New Zealanders to borrow money from a bank. While we certainly take this into account, we think this impact should be minimal.

Another potential impact is that bank owners would earn less from their investment in the bank. While we agree that this is likely to be the case, we believe this cost would be more than offset by the benefits of a safer banking system for all.

The key changes are:

Limit the extent to which capital requirements differ between the Internal Ratings-Based approach (IRB) and the Standardised approach, by re-calibrating the IRB approach and applying a floor linked to the Standardised outcomes. This reflects one of the principles of the Capital Review: where there are multiple methods for determining capital requirements, outcomes should not vary unduly between methods. In essence, there should be as level a playing field as possible, both between IRB banks and between IRB and Standardised banks;

These proposals are expected to raise risk-weighted assets (RWA) for the four IRB-accredited banks to approximately 90 percent of what would be calculated under the Standardised approach;

Set a Tier 1 capital requirement (consisting of a minimum requirement of 6 percent and prudential capital buffer of 9-10 percent) equal to 16 percent of RWA for banks deemed systemically important, and 15 percent for all other banks;

Assign 1.5 percentage points of the proposed prudential capital buffer requirements to a countercyclical component, which could be temporarily reduced to 0 percent during periods of exceptional stress;

Assign 1 percentage point of the proposed prudential capital buffer requirement to D-SIB buffer, to be applied to banks deemed to be systemically important;

Retain the current Tier 2 capital requirement of 2 percent of RWA, but raise the question of whether Tier 2 should remain in the capital framework; and

Staged transition of the different components of the revised framework over the coming years.


Why Higher Capital Is Required

Reserve Bank of New Zealand Governor Adrian Orr spoke  on “Higher capital better for banking system and NZ“.

This is probably one of the most significant speeches on the issue, as it gets to the core thinking driving bank regulation. Essentially it is this. If there were to be a financial crisis, experience has shown the costs to the broader economy are substantial, and are born by society.

As a result, Orr argues that while a significant toolkit is available to lean against these risks, the cornerstone is lifting bank capital.

Note though that the toolkit includes under crisis management OBR – deposit bail-in!

As a result, the amount of capital required will be significantly higher.

Implicitly, this approach enables the financial system to continue to expand, to drive debt higher (as we saw in his recent post), with the financial stability risks offset by higher capital. But as we have said many times, this faith in ever great debt as a growth lever is deeply flawed.  And those borrowing will be required to pay more, as higher capital costs!

Here is the speech in full.

The Reserve Bank is tasked with ensuring the banking system is both sound and efficient. To achieve our task we have a range of tools (see Table 1). The most important tool in our kit is ensuring banks hold sufficient capital (equity) to be able to absorb unanticipated events. The level of capital reflects the bank owners’ commitment – or skin in the game – to ensure they can operate in all business conditions, bringing public confidence.

Given its importance, we have been undertaking a review of the optimal level of capital for the New Zealand system. We conclude that more capital is better. We are sharing our work with the banking sector and public, and expect to hear one side of the story loud and clear, that capital costs banks. We need to hear a broader perspective than that, to best reflect New Zealand’s risk appetite.

What have we done in practice?

The Reserve Bank needs to ensure there is sufficient capital in the banking “system” to match the public’s “risk tolerance”. This is because it is the New Zealand public – both current and future citizens – who would bear the social brunt of a banking mess.

We know one thing for sure, the public’s risk tolerance will be less than bank owners’ risk tolerance. How do we know this? Surely the more capital a bank has the safer it is and the more it can lend. Why don’t banks hold as much capital as they can?

First, there is cost associated with holding capital, being what the capital could earn if it was invested elsewhere. Second, bank owners can earn a greater return on their investment by using less of their own money and borrowing more – leverage. And, the most a bank owner can lose is their capital. The wider public loses a lot more (see Figure 2).

Hence, we need to impose capital standards on banks that matches the public’s risk tolerance. We have been reassessing the capital level in the banking sector that minimises the cost to society of a bank failure, while ensuring the banking system remains profitable.

The stylised diagram in Figure 3 highlights where we have got to. Our assessment is that we can improve the soundness of the New Zealand banking system with additional capital with no trade-off to efficiency.

In making this assessment, our recent work makes the explicit assumption that New Zealand is not prepared to tolerate a system-wide banking crisis more than once every 200 years. We have calibrated our ‘sweet spot’ thinking about economic ‘output’ and financial stability benefits.
How did we arrive at this position?

Current levels of capital are based on international standards, and are not optimal for any one country. The standards are also a minimum. There is a clear expectation that individual countries tailor the standards to their financial system’s needs.

Banks also hold more capital than their regulatory minimums, to achieve a credit rating to do business. The ratings agencies are fallible however, given they operate with as much ‘art’ as ‘science’.

Bank failures also happen more often and be more devastating than bank owners – and credit ratings agencies – tend to remember. The costs are spread across the public and through time.

Many large banks are foreign owned – especially in New Zealand. Their ‘parents’ are subject to capital requirements in their home and host country. This creates continuous tension as to who gets the lion’s share of capital and failure management support. It would be naïve to expect a foreign taxpayer to bail out a domestic banking crisis.

Hence, New Zealand needs to assess its own risk tolerance, and decide who pays to clean up any mess and the scale of that mess.

A word of caution. Output or GDP are glib proxies for economic wellbeing – the end goal of our economic policy purpose. When confronted with widespread unemployment, falling wages, collapsing house prices, and many other manifestations of a banking crisis, wellbeing is threatened. Much recent literature suggests a loss of confidence is one cause of societal ills such as poor mental and physical health, and a loss of social cohesion. If we believe we can tolerate bank system failures more frequently than once-every-200 years, then this must be an explicit decision made with full understanding of the consequences.

An Urgent “Bail-In” Update

Economist John Adams and I discuss the latest of the question on deposit account “Bail-In” and try to answer John’s question “Is Parliament  “Too Stupid to be Stupid”?

Either way, the question of deposit bail-in remains unclear in our view.

We also discuss the Reserve Bank of New Zealand Dashboard which is designed to assist Kiwi’s as they try to pick which bank to place their deposits with. In New Zealand it is QUITE CLEAR, bank deposits are available for “Bail-In”!

Household Debt Is The Biggest Risk – RBNZ

The New Zealand Reserve Bank has issued their latest financial stability report.  They say that New Zealand’s financial system remains sound. Household debt is firmly in the frame as the biggest potential risk!

The banking system holds sufficient capital and liquidity buffers, guided by our prudential regulatory requirements. These buffers reduce New Zealand banks’ exposure to adverse shocks.An ongoing driver of financial soundness is the conduct and culture of banks and insurance companies. These features are being jointly reviewed by the Financial Markets Authority and ourselves, and we will report our findings over coming months. The financial system vulnerabilities are much the same as we discussed in our previous Financial Stability Report.

Household mortgage debt remains high. However, financial risk has lessened with both lending and house price growth slowing in the last 12 months – in part due to our imposition of loan-to-value (LVR) ratio restrictions. This more subdued lending growth needs to be further sustained before we gain sufficient confidence to again ease the LVR restrictions.

However, the banks says the high level and concentration of household sector debt in New Zealand is the largest single vulnerability of the financial system. Some households are vulnerable to developments that reduce their debt servicing capacity, such as higher interest rates or a change in financial circumstances. Households with severe debt servicing problems could default on their loans, creating losses for lenders. If debt servicing problems were widespread, weaker consumption and investment could reduce incomes and contribute to an economic downturn. This could threaten financial stability by causing households and businesses to default, and by reducing the value of assets against which banks have lent, such as houses.

The high level and concentration of household sector debt in New Zealand is the largest single vulnerability of the financial system. Some households are vulnerable to developments that reduce their debt servicing capacity, such as higher interest rates or a change in financial circumstances. Households with severe debt servicing problems could default on their loans, creating losses for lenders. If debt servicing problems were widespread, weaker consumption and investment could reduce incomes and contribute to an economic downturn. This could threaten financial stability by causing households and businesses to default, and by reducing the value of assets against which banks have lent, such as houses.

The rise in household debt since 2012 has coincided with a sharp rise in house prices, particularly in Auckland (figure 2.2). The simultaneous rise in household debt and house prices could partly reflect a self-reinforcing cycle, where bank lending has boosted house prices and, in turn, higher house prices have supported more bank lending, by increasing the value of homeowners’ collateral. But this cycle can also operate in reverse, driving down bank lending and house prices. This negative interaction can amplify the financial stability impact of a household income shock, by lowering collateral values and reducing households’ ability to service their existing debts by increasing their borrowing.

In the past two years, concerns about vulnerabilities in the household sector have caused a tightening in bank lending standards to the sector. This is partly the result of the Reserve Bank tightening its restrictions on new mortgage lending, particularly to investors, at high loan-tovalue ratios (LVRs) in October 2016.1 It also reflects actions by banks to tighten lending standards, such as the use of higher household living cost assumptions when assessing borrowers’ ability to service loans. As a result, a lower proportion of banks’ new mortgage loans have high risk characteristics than in 2016.

However, the share of new lending with high risk characteristics is still concerning. The proportion of new mortgage lending to borrowers with debt-to-income ratios above five is high compared to international peers, such as the UK. Households with this level of indebtedness are
particularly vulnerable to even modest changes in income or interest rates.

The tightening in lending standards has contributed to the annual growth rate of household credit slowing to 6 percent, slightly above the rate of income growth (figure 2.4). This has coincided with a slowdown in national house price growth, to 4 percent in the year to April. The
decline in house price inflation partly reflects the announcement and implementation of government policies (such as KiwiBuild, the extension of the bright-line test and plans for ‘loss ring-fencing’). But low mortgage rates and high net migration continue to support house prices.

The growth rates of household debt and house prices have been fairly stable over the past six months. Combined with tighter bank lending standards, this suggests the financial system’s vulnerability to household debt has not changed materially since the previous Report.

Ultimately, continued stabilisation, or a further reduction, in the growth rates of household debt and house prices, will be required before the risk to the financial system is normalised. Bank lending standards will have an influence over both. Currently, banks expect to keep their lending standards relatively tight for the rest of 2018.

In a similar vein, the dairy farming sector remains highly indebted. Most dairy farms are currently cash-flow positive, but remain vulnerable to any possible downturn in dairy prices and agriculture shocks. Reducing this bank lending concentration risk requires more prudent lending practices.

The high dairy-farm indebtedness, and the fact that LVRs were necessary, reflects that banks’ allocative efficiency – eg deciding how much to lend to whom – can be impaired due to the pursuit of short-term, rather than longer-term, profits.

The report also commented on the Australia Economy:

The Australian economy is growing steadily. But vulnerabilities have risen in recent years, particularly in the household sector, which carries a relatively high level of debt. House prices also appear stretched in some cities. Regulators have responded in a number of ways, including by requiring banks to conduct more rigorous loan serviceability assessments. These changes, coupled with a broader improvement in lending standards and an easing in housing market conditions, have improved the outlook for risks in the Australian household sector. But the Australian financial system remains vulnerable to developments that could weaken households’ ability to service their debts.

NZ Reserve Bank Leaves Cash Rate unchanged at 1.75 percent

In the statement by NZ Reserve Bank Governor Adrian Orr, the Official Cash Rate (OCR) will remain at 1.75 percent for some time to come.

Future direction of the rate next move is equally balanced, up or down. Only time and events will tell.

Economic growth and employment in New Zealand remain robust, near their sustainable levels.  However, consumer price inflation remains below the 2 percent mid-point of our target due, in part, to recent low food and import price inflation, and subdued wage pressures.

The recent growth in demand has been delivered by an unprecedented increase in employment. The number of willing workers continues to rise, especially with more female and older workers choosing to participate. Likewise net immigration has added to the supply of labour, and the demand for goods, services, and accommodation.

Ahead, global economic growth is forecast to continue supporting demand for New Zealand’s products and services. Global inflation pressures are expected to rise but remain contained.

At home, ongoing spending and investment, by both households and government, is expected to support economic growth and employment demand. Business investment should also increase due to emerging capacity constraints.

The emerging capacity constraints are projected to see New Zealand’s consumer price inflation gradually rise to our 2 percent annual target.

To best ensure this outcome, we expect to keep the OCR at this expansionary level for a considerable period of time. This is the best contribution we can make, at this moment, to maximising sustainable employment and maintaining low and stable inflation.

Our economic projections, assumptions, and key risks and uncertainties, are elaborated on fully in our Monetary Policy Statement.

LVR Limits And Home Prices

The Reserve Bank New Zealand has released a paper “Loan-to-Value Ratio Restrictions and House Prices”. 

Their analysis shows that LVR limits do have an impact on home prices. But the relationship is not linear, and needs to be binding to have significant impact.

This paper contributes to the international policy debate on the effect of macroprudential policy on housing-market dynamics. We use detailed New Zealand housing market data to evaluate the effect of loan-to-value ratio (LVR) restrictions on house prices. The main challenge in identifying these effects is that housing markets are affected by a range factors over and above LVR policy. For example, New Zealand experienced a raft of policy changes and macroeconomic shocks during the periods in which LVR policy changes were implemented. Many of these shocks and policies are likely to have affected the housing market. For example, when the first LVR policy was implemented, retail interest rates were rising alongside an increasing expectation for monetary policy tightening, while the New Zealand Treasury was adjusting housing-related policies at the time of the second LVR policy. This paper uses the exemption for new builds from the LVR restrictions as a natural experiment to identify the effect of LVR policy.

We find that, over the one year window around the new home exemption, the first LVR policy (referred to as ‘LVR 1’) had a 3 percent moderating effect on house prices, and this moderating effect is broadly similar across both Auckland and the rest of New Zealand.

Interestingly, our estimates show that LVR 2 (which tightened restrictions on Auckland properties and loosened restrictions elsewhere) did not significantly stop Auckland house prices from rising. By contrast, house prices in the rest of New Zealand (RONZ) increased by 3 percent due to the relative loosening of the LVR restriction. In LVR 3, the RBNZ further tightened the LVR restrictions on property investors nationwide. The moderating effect of LVR 3 was clearly seen in Auckland with a 2.7 percent reduction in house prices. This LVR 3 effect is both statistically and economically significant, as during the same period the average house price increased by 5.8 percent.

Overall, we estimate that the LVR policies reduced house price pressures by almost 50 percent. However, the effect of LVR policy is highly non-linear. When it becomes binding, LVR policy can be very effective in curbing housing prices.

NZ Reserve Bank to consider employment alongside price stability mandate

The New Zealand Government’s New Policy Targets Agreement requires monetary policy to be conducted so that it contributes to supporting maximum levels of sustainable employment within the economy.

The new focus on employment outcomes is an outcome of Phase 1 of the Review of the Reserve Bank Act 1989, which the Coalition Government announced in November 2017.

“The Reserve Bank Act is nearly 30 years old. While the single focus on price stability has generally served New Zealand well, there have been significant changes to the New Zealand economy and to monetary policy practices since it was enacted,” Grant Robertson said.

“The importance of monetary policy as a tool to support the real, productive, economy has been evolving and will be recognised in New Zealand law by adding employment outcomes alongside price stability as a dual mandate for the Reserve Bank, as seen in countries like the United States, Australia and Norway.

“Work on legislation to codify a dual mandate is underway. In the meantime, the new PTA will ensure the conduct of monetary policy in maintaining price stability will also contribute to employment outcomes.”

A Bill will be introduced to Parliament in the coming months to implement Cabinet’s decisions on recommendations from Phase 1 of the Review. As well as legislating for the dual mandate, this will include the creation of a committee for monetary policy decisions.

“Currently, the Governor of the Reserve Bank has sole authority for monetary policy decisions under the Act. While clear institutional accountability was important for establishing the credibility of the inflation-targeting system when the Act was introduced, there has been greater recognition in recent decades of the benefits of committee decision-making structures,” Grant Robertson said.

“In practice, the Reserve Bank’s decision-making practices for monetary policy have adapted to reflect this, with an internal Governing Committee collectively making decisions on monetary policy. However, the Act has not been updated accordingly.”

The Government has agreed a range of five to seven voting members for a Monetary Policy Committee (MPC) for decision-making. The majority of members will be Reserve Bank internal staff, and a minority will be external members. The Reserve Bank Governor will be the chair.

“It is my intention that the first committee of seven members would have four internal, and three external members. Treasury will also have a non-voting observer on the MPC to provide information on fiscal policy,” Grant Robertson said.

The MPC is expected to begin operation in 2019 following passage of amending legislation. There will be a full Select Committee process for the legislation.

Reserve Bank Governor-Designate, Adrian Orr, said that the PTA recognises the importance of monetary policy to the wellbeing of all New Zealanders.

“The PTA appropriately retains the Reserve Bank’s focus on a price stability objective. The Bank’s annual consumer price inflation target remains at 1 to 3 percent, with the ongoing focus on the mid-point of 2 percent.

“Price stability offers enduring benefits for New Zealanders’ living standards, especially for those on low and fixed incomes. It guards against the erosion of the value of our money and savings, and the misallocation of investment.”

Mr Orr said that the PTA also recognises the role of monetary policy in contributing to supporting maximum sustainable employment, as will be captured formally in an amendment Bill in coming months.

“This PTA provides a bridge in that direction under the constraints of the current Act. The Reserve Bank’s flexible inflation targeting regime has long included employment and output variability in its deliberations on interest rate decisions. What this PTA does is make it an explicit expectation that the Bank accounts for that consideration transparently. Maximum sustainable employment is determined by a wide range of economic factors beyond monetary policy.”

Mr Orr said that he welcomes the intention to use a monetary policy committee decision-making group, including both Bank staff and a minority of external members.

“Legislating for this committee will give a strong basis for the Bank’s use of a committee decision-making process. Widening the committee to include external members also brings the benefit of diversity and challenge in our thinking, while enhancing the transparency of decision-making and flow of information.”

Phase 2 of the Review is being scoped. It will focus on the Reserve Bank’s financial stability role and broader governance reform. Announcements on the final scope will be made by mid-2018 and subsequent policy work will commence in the second half of 2018.