Reserve Bank defends one in 200 year calculation, on eve of capital announcement

Reserve Bank governor Adrian Orr will announce on Thursday how much more capital banks will be required to hold. Photo / File

The Reserve Bank has defended proposing that the banking sector should be able to weather a one in 200 year crisis, a day out from releasing its decision on changes to bank capital requirements.

Governor Adrian Orr and his colleagues appeared before a select committee in Parliament on Wednesday to discuss its recent financial stability report, which was released last week.

But the session came on the eve of the central bank releasing its final decisions on capital requirements, which could require the sector to hold an additional $20 billion as a safety buffer to allow institutions to cope in times of severe strain.

In December 2018 the Reserve Bank caught the sector by surprise when it announced proposals which would "materially" increase the amount of capital banks would be required to hold in New Zealand, estimating some banks would need to raise the amount of capital held by up to 60 per cent.

Although the Reserve Bank had said publicly that it was of the view that the banks should hold more capital, the proposed level was higher than expected, with the proposals based on positioning the banking sector to cope with a one in 200 year financial shock.

At times on Wednesday the bank's senior leadership appeared to verge on defending its proposals, including when Orr responded to questions on why so much more capital was needed when New Zealand's trading banks comfortably coped with the Reserve Bank's own stress tests.

"While they're interesting tests, they are not a one in 200 year test," Orr said of the stress tests, theoretical studies of how banks would cope in times of financial or economic strain.

"They're a one in 50 year test and they're about a part of a portfolio. They're also a partial analysis where when you're doing those stress tests in the bank, you know the future, you know how it unravels, you know how long you have to sit there and pay the money.

"They really are limited, so they are useful, necessary, but far from sufficient to say that any banking system is sound and what we're saying is more is better."

Asked whether the idea of coping with one in 200 year storms was too conservative, deputy governor Geoff Bascand said New Zealand was subject to "an enormous array of shocks".

"Obviously seismic [shocks], but also as a small, open, trading economy with very high debt levels, we're exposed to international shocks of potentially great momentum, and so a high level of resilience has some real worth to it.

"You have to weigh that against the cost of capital requirements, but we'll talk more about that tomorrow," Bascand said.

National's finance spokesman Paul Goldsmith said the responses of the bank sounded as if they were "very committed to the one in 200 year risk [tolerance] and so that seems like an indication that they're sticking to the broad parameters" of the 2018 proposals.

Goldsmith has spoken publicly in recent weeks suggesting the Government ought to have input into the way the Reserve Bank carries out its prudential responsibilities, as the central bank moved further into areas which could impact the economy.

"The worry is if they're excessively conservative with the capital requirements, a real risk is that there'll be less capital available for the productive sector, especially small businesses and farms.

"The Minister [of Finance] and the Government of the day should be asking very tough questions."