Reserve Bank says bank profits may be out of proportion to risks they face

Wednesday, 13 February 2019

The Financial Markets Authority found people think banks act in their own interests, not the long-term interest of customers

The Reserve Bank has fired back at claims its plans to make banks safer could raise borrowing costs sharply, hinting that bank profits are disproportionate to risk.

On Wednesday, Reserve Bank governor Adrian Orr made his first public comments on a proposal which would require the four major Australian-owned banks to hold significantly more capital than they do now.

Announced shortly before Christmas, the plans came as a surprise to the industry, with analysts at one investment bank, UBS, warning mortgage rates would increase by more than 1 percentage point in response, as banks sought to recoup higher funding costs.

'We seriously struggle with the analysis that has gone in there,' Orr said of the UBS research.

***** Banks asked to take on bigger share of market risk

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Reserve Bank governor Adrian Orr said the central bank believed that the returns being made by the major New Zealand banks may be disproportionate to the risks the banks were taking, when there was a risk that in a collapse the costs could be paid for by the public. Orr was defending a proposal which would require the Australian-owned banks to hold significantly more capital than they currently do.

* Counting the cost of the Australian banking scandal****

'It's partial and it's assuming that all of the interest can be passed on, will be passed on to one sector, ie, those who hold mortgages and many other assumptions that we just do not adhere to. We don't at all buy into that scenario.'

Orr said if banks could simply pass on the cost of higher capital requirements to customers through higher margins, this would mean the market was not competitive.

'I would love to be in an industry where you could just pass on every cost increase. I would love to be in an industry where you could set your return on equity expectations in advance of doing business, but that's not a competitive industry.'

Orr said higher capital requirements would lead to a more robust banking sector and lower fiscal risk, which 'all other things equal, that means lower volatility, lower borrowing costs'.

Part of the plan was to ensure that the banks were equipped to cope with severe financial shocks, with the Reserve Bank's consultation document saying the banks should be capable with handling a one in 200 year crisis.

Orr said currently banks may be making returns while the sector left the risk that the public may have to bail it out during a crisis.

'The return on equity should be related to the risks they're taking. At the moment the return on equity for banking is incredibly strong, and, we would hazard, over and above the risks they are holding themselves as private banks, because there is an aspect in every OECD country and most countries in the world in the ability to 'free ride',' Orr said.

'Where returns can be privatised and loses can be socialised, and what we're saying is how can we shift that balance back a little bit.'

Deputy governor Geoff Bascand played down the risk that banks may seek to respond to the higher capital requirements by shrinking their balance sheets, meaning they would raise capital by lending less to consumers.

'New Zealand banks are amongst the most profitable in the world, so you're talking about why would they want to shrink that business in a significant way, when they're making a large amount of money out of it.'

Orr is likely to face being grilled on the plans by MPs when he appears before a select committee on Thursday.

On Monday, National leader Simon Bridges said the capital plans were part of a suite of measures which could have 'a recessionary effect' on the New Zealand economy.