Bollard looks to toughen up tools

Dr Alan Bollard. Photo / Kenny Rodger

The Reserve Bank is examining possible additional tools it might use to strengthen the resilience of the financial system and reduce the risk that lenders' behaviour will amplify the economic cycle in a destabilising way.

Governor Alan Bollard outlined work in progress on these "macro-prudential" issues to a conference in Sydney yesterday. "There has not been a pressing need for the use of such tools, given recent weakness in the credit cycle. However we do need to keep preparing for how we might deal with credit and asset price booms when they recur in the future. Our expectation is that we would use these tools infrequently."

One tool under consideration is a counter-cyclical capital buffer, which would require banks to hold additional capital during periods of exceptionally strong credit growth.

The Basel Committee on Banking Supervision had suggested such an instrument might be used once every 10 to 20 years. "We think this is a useful perspective," Bollard said.

"However, our calculations suggest it would have only a small dampening effect on the upswing of the credit cycle through its effect on the cost of funds, unless one makes extreme assumptions about the size of the counter-cyclical buffer or the market cost of capital."

Another measure, already in use in some countries, would restrict loan-to-value ratios in response to overheating in housing markets.

The Reserve Bank has already adopted a liquidity policy based on a "core funding ratio" which requires banks to fund their lending from more stable but expensive sources - deposits and longer-term wholesale money - than they would use if driven by cost alone.

During periods of rapid credit growth this is expected to automatically push up the interest rates banks charge borrowers without the Reserve Bank having to raise the official cash rate so much, which should reduce upward pressure on the dollar.

A multi-pronged approach might be the most effective. "For example, faced with evidence of excessive credit growth, counter-cyclical capital requirements could be used alongside increases in the bank's core funding ratio, and this might represent a more even-handed approach than focusing on either one alone."